Global depositary receipt

What Is a Global Depositary Receipt?

A Global Depositary Receipt (GDR) is a negotiable financial instrument issued by a depositary bank that represents ownership of shares in a foreign company. These certificates facilitate international investment by allowing companies to raise capital in global capital markets outside their home country and enabling investors to trade shares of foreign entities on local stock exchange platforms. GDRs are a key component within International Finance, providing a bridge between domestic and foreign equity markets. A global depositary receipt typically represents a specific number of underlying shares held in custody by a bank in the foreign company's home market²⁹.

History and Origin

The concept of depositary receipts originated with American Depositary Receipts (ADRs) in the early 20th century, primarily to simplify U.S. investment in foreign companies. Building upon this foundation, the global depositary receipt emerged as an instrument to facilitate cross-border equity trading beyond just the U.S. market. GDRs were developed on the basis of ADRs to securitize ownership in shares and enable companies to access capital markets worldwide²⁸. The 1990s, in particular, saw a significant increase in depositary receipt programs, especially from emerging markets, with many initially taking the form of GDRs traded on exchanges like the London and Luxembourg Stock Exchanges²⁷. This evolution was driven by the increasing internationalization of financial markets and companies seeking to diversify their investor base beyond domestic borders²⁶.

Key Takeaways

• A global depositary receipt is a certificate issued by a depositary bank that represents shares in a foreign company.
• GDRs enable foreign companies to raise capital from international investors without directly listing their shares on multiple foreign stock exchanges.²⁵
• For investors, global depositary receipts offer a convenient way to invest in foreign companies and diversify a portfolio.
• They are typically denominated in U.S. dollars or euros and traded on international stock exchanges like those in London, Luxembourg, and Frankfurt.²⁴,
• Holders of global depositary receipts generally receive dividends and may have limited voting rights, depending on the issuance terms.²³

Interpreting the Global Depositary Receipt

Understanding a global depositary receipt involves recognizing it as an accessible proxy for direct foreign equity ownership. When an investor purchases a global depositary receipt, they are effectively acquiring an interest in the underlying foreign company's shares, which are held by a custodian bank in the company's home country. The price of a GDR is directly influenced by the value of its underlying shares, though it trades and settles independently on its respective international exchange. Interpreting its value requires considering the foreign company's financial performance, the economic and political stability of its home country, and prevailing currency risk between the GDR's denomination currency and the home currency of the underlying shares.

Hypothetical Example

Consider "InnovateTech Solutions," a rapidly growing technology company based in India seeking to expand its investor base beyond its domestic market. InnovateTech decides to issue Global Depositary Receipts to attract European and Asian investors.

1. Agreement: InnovateTech partners with a large international depositary bank, such as Deutsche Bank, to facilitate the issuance.
2. Share Deposit: InnovateTech deposits a block of its ordinary shares with a local custodian bank in India, acting on behalf of Deutsche Bank.
3. GDR Issuance: Deutsche Bank then issues global depositary receipts in a freely convertible currency, such as euros, with each GDR representing five ordinary shares of InnovateTech Solutions. These GDRs are then listed and traded on the Luxembourg Stock Exchange.
4. Investor Purchase: A European investor, Maria, who wishes to invest in emerging market technology companies, can now purchase these InnovateTech GDRs directly on the Luxembourg Stock Exchange through her local brokerage account. She does not need to open an account in India or deal with Indian currency conversion or regulations.

Maria's investment in the GDRs provides her with exposure to InnovateTech's growth, and she will receive dividends paid in euros, net of any applicable foreign taxes and conversion expenses. This allows InnovateTech to raise significant capital from a broader pool of international investors, increasing its visibility and potential for further expansion.

Practical Applications

Global depositary receipts serve several practical purposes for both issuing companies and investors. For companies, GDRs are a crucial tool for global capital raising. They enable foreign companies to access a broader and more diverse audience of potential investors in international markets, improving liquidity for their shares²²,²¹. Issuers can conduct efficient and cost-effective private placement or public stock offerings using GDRs, expanding their shareholder base geographically without requiring direct listings on multiple foreign stock exchanges,²⁰.

For investors, GDRs offer a convenient and often less expensive way to gain exposure to foreign companies and markets,. This is particularly valuable for achieving international portfolio diversification, allowing investors to spread risk across different economies and industries. They simplify the investment process by allowing trading and settlement to occur under local regulations, and dividends are typically paid in a widely accepted currency like U.S. dollars or euros, avoiding the complexities of foreign currency exchange. GDRs are actively traded on major international stock exchanges, including the London Stock Exchange and Luxembourg Stock Exchange, making them readily accessible for global participation¹⁹,¹⁸.

Limitations and Criticisms

Despite their advantages, global depositary receipts come with certain limitations and criticisms. Investors in GDRs are exposed to currency risk, as fluctuations in exchange rates between the GDR's denomination currency and the underlying shares' home currency can impact the GDR's value¹⁷,¹⁶. Additionally, GDRs carry inherent country risk, meaning the investment is subject to the political stability, economic conditions, and regulatory changes within the foreign company's home country¹⁵.

From the issuer's perspective, regulatory compliance can be a significant challenge. Issuing GDRs requires adherence to regulatory requirements in both the home country and all countries where the GDRs are traded, which can lead to increased compliance costs and complexity¹⁴,¹³. Administrative fees associated with issuing and maintaining GDR programs can also be substantial.

Furthermore, GDR holders often have limited voting rights compared to direct shareholders, as the underlying shares are held by a depositary bank¹². While GDRs generally offer improved liquidity compared to direct foreign stock purchases, their liquidity might still be lower than that of domestically traded shares. Taxation can also be complex, as GDRs may be subject to taxes in both the country of issuance and the country where they are traded, potentially resulting in higher tax liabilities for investors¹¹.

Global Depositary Receipt vs. American Depositary Receipt

The primary distinction between a Global Depositary Receipt (GDR) and an American Depositary Receipt (ADR) lies in their target markets and trading venues. Both are negotiable certificates issued by banks that represent ownership in a foreign company's shares, simplifying foreign investment¹⁰. However, ADRs are exclusively created and traded on stock exchanges within the United States, such as the NYSE or Nasdaq, and are primarily aimed at U.S. investors,⁹. They are typically denominated solely in U.S. dollars.

In contrast, a global depositary receipt is traded on international stock exchanges outside the U.S., commonly in European and Asian markets, including the London Stock Exchange and Luxembourg Stock Exchange⁸,⁷. GDRs target a broader global investor base and can be denominated in various freely convertible currencies, although U.S. dollars and euros are most common⁶,. While both instruments allow companies to access international capital, GDRs provide companies with the flexibility to raise capital across multiple global markets simultaneously⁵. Both serve the purpose of bridging foreign equity markets for investors, but the choice between the two often depends on the company's capital-raising objectives and the investor's geographical location and preferred trading market⁴.

FAQs

What is the main purpose of a Global Depositary Receipt?

The main purpose of a global depositary receipt is to enable a foreign company to raise capital from international investors by making its shares tradable on multiple global stock exchanges outside its home country. It also provides investors with an accessible way to invest in foreign companies without navigating complex foreign market regulations.

How is a Global Depositary Receipt created?

A global depositary receipt is created when a foreign company partners with an international depositary bank. The bank purchases or receives a block of the foreign company's shares and holds them in custody. Against these underlying shares, the depositary bank then issues the GDRs, which are subsequently listed and traded on international stock exchange platforms.³

Do Global Depositary Receipts have voting rights?

Generally, holders of global depositary receipts may have limited or no voting rights with respect to the foreign company's decision-making processes. The actual underlying shares are held by the custodian bank, and voting power typically rests with the depositary bank, which may or may not pass through voting instructions to the GDR holders.²

Are Global Depositary Receipts liquid?

The liquidity of global depositary receipts can vary. While being traded on major international exchanges generally provides more liquidity than direct foreign stock purchases, it might still be lower than that of the company's shares traded on its domestic exchange. Factors like the specific market where they are traded and investor demand influence their liquidity.,¹