Global depository receipts

What Are Global Depository Receipts?

Global Depository Receipts (GDRs) are negotiable certificates issued by a depositary bank that represent ownership of a specified number of shares in a foreign company. These financial instruments allow companies to raise capital in international markets by enabling their shares to be traded on local stock exchanges outside their home country. GDRs fall under the broader category of international finance and are a key mechanism for cross-border investment, providing investors with a way to gain exposure to foreign companies without directly purchasing shares in their home market. The underlying shares themselves are held by a custodian bank in the company's domestic market. GDRs facilitate portfolio diversification for investors and simplify the process for foreign companies seeking to access global capital markets.

History and Origin

The concept of depository receipts emerged to bridge the gap between foreign companies and international investors. The first American Depository Receipt (ADR) was introduced in 1927 by J.P. Morgan for the British retailer Selfridges on the New York Curb Exchange, the precursor to the American Stock Exchange.¹², This innovation allowed American investors to invest in non-U.S. companies by holding certificates that represented underlying foreign shares, circumventing complexities of international share transfers and foreign currency transactions.¹¹

Building on the success of ADRs, Global Depository Receipts evolved as a means for companies to access a wider, multi-national investor base beyond just the United States. While specific details of the very first GDR vary in historical accounts, Citibank played a pivotal role in their development, particularly with the issuance of GDRs for Samsung Corporation in December 1990. This allowed Samsung to raise equity capital in both the U.S. and European markets simultaneously through a single security.¹⁰ The evolution of global depository receipts reflects the increasing globalization of financial markets and the continuous drive for companies to tap into diverse funding sources and for investors to broaden their investment horizons.⁹

Key Takeaways

• Global Depository Receipts (GDRs) are bank-issued certificates representing shares of a foreign company, traded on local exchanges outside the issuer's home country.
• They enable foreign companies to raise capital from a broader, international investor base and provide global investors with access to overseas equities.
• GDRs are typically denominated in major international currencies, such as the U.S. dollar, simplifying transactions for investors.
• GDRs can offer benefits like increased liquidity for the underlying shares and lower transaction costs compared to direct foreign market investment.
• However, they carry risks such as currency risk, political risk of the home country, and potential for limited voting rights for the holder.

Formula and Calculation

The valuation of a Global Depository Receipt is fundamentally tied to the price of its underlying shares and the prevailing exchange rate between the currency of the underlying shares and the currency in which the GDR is denominated. There isn't a single "formula" for a GDR itself, as it's a representation of equity. However, its theoretical price can be expressed as:

Where:

• ( P_{GDR} ) = Price of one Global Depository Receipt
• ( P_{Share} ) = Price of one underlying equity share in its home market currency
• ( R ) = Ratio of underlying shares per GDR (e.g., 1 GDR = 5 shares, or 1 GDR = 0.5 shares)
• ( FX ) = Exchange rate between the GDR's denominated currency and the home market currency of the underlying share (e.g., USD per local currency unit).

This relationship highlights the direct impact of the underlying stock's performance and fluctuations in exchange rates on the GDR's value.

Interpreting the Global Depository Receipt

Interpreting a Global Depository Receipt involves understanding its relationship to the underlying shares and the markets in which it trades. The price of a GDR will generally move in tandem with the price of the ordinary shares of the issuing company on its home stock exchange, adjusted for the share-to-GDR ratio and currency conversion.

For investors, a GDR simplifies access to foreign companies by allowing transactions in their local currency and through domestic settlement systems. For instance, if an investor buys a GDR denominated in U.S. dollars, they transact in dollars and receive any dividends in dollars, even if the underlying company's primary listing and operations are in a different country and currency. This avoids the complexities and additional costs associated with opening foreign brokerage accounts or dealing with foreign clearing and settlement procedures. However, it's crucial to understand that while the currency conversion is managed by the depositary bank, investors are still exposed to currency risk because the value of the underlying shares, when converted back to the GDR's denomination, can be affected by fluctuations in the foreign exchange market.

Hypothetical Example

Imagine a technology company, "AlphaTech," based in Japan, wants to raise capital from international investors, including those in Europe. AlphaTech's ordinary shares trade on the Tokyo Stock Exchange at ¥1,000 per share.

To facilitate international investment, AlphaTech arranges with a depositary bank to issue Global Depository Receipts, with each GDR representing 5 ordinary shares of AlphaTech. The GDRs are denominated in Euros (€) and listed on the London Stock Exchange.

Let's assume the current exchange rate is €1 = ¥160.

The theoretical price of one AlphaTech GDR would be:

• Underlying shares per GDR: 5 shares
• Price per share in JPY: ¥1,000
• Equivalent value in JPY for one GDR: ( 5 \text{ shares} \times ¥1,000/\text{share} = ¥5,000 )
• Converting to EUR: ( ¥5,000 / 160 = €31.25 )

So, one AlphaTech GDR would theoretically trade around €31.25.

If the price of AlphaTech's ordinary shares rises to ¥1,100 in Tokyo, and the exchange rate remains the same, the GDR price would rise to: ( (5 \times ¥1,100) / 160 = €34.375 ).

Conversely, if the Yen weakens against the Euro (e.g., €1 = ¥170), the GDR price would decrease, even if the share price in JPY remains ¥1,000: ( (5 \times ¥1,000) / 170 = €29.41 ). This illustrates the impact of currency fluctuations on GDR values.

Practical Applications

Global Depository Receipts serve multiple critical functions in the global financial landscape for both issuing companies and investors. For companies, GDRs are a powerful tool for raising capital from a broader pool of international investors beyond their domestic market. This can be particularly appealing for companies in emerging markets seeking foreign direct investment or wishing to increase their global profile. By issuing GDRs, a company can tap into more developed and liquid markets, potentially achieving better valuation and access to greater funding amounts.

For investors, GDRs offer a convenient and often cost-effective way to achieve portfolio diversification by investing in foreign companies without navigating foreign stock exchanges, currencies, or regulatory hurdles. They simplify the process of holding international assets and can broaden investment opportunities beyond domestic borders. GDRs trade like ordinary shares on major international exchanges, making them accessible through standard brokerage accounts. For instance, a European investor can easily buy GDRs of an Asian company listed on the London Stock Exchange, rather than setting up an account to trade directly on an Asian exchange. These instruments allow for trading during local market hours and settlement according to local conventions, streamlining the investment process.

Limitations and Crit⁸icisms

While Global Depository Receipts offer significant advantages, they also come with inherent limitations and criticisms that investors should consider. One primary concern is exposure to various forms of risk. GDRs are inherently subject to the country risk of the underlying company's home nation, including economic instability, political unrest, and regulatory changes. Furthermore, despite being denominated in a major currency like the U.S. dollar or Euro, GDRs are susceptible to currency exchange risk. Fluctuations in the exchange rate between the underlying share's home currency and the GDR's denominated currency can impact returns, even if the underlying company's performance is strong.

Critics also point to t⁷he potential for inefficiencies and portfolio management risks associated with GDRs. These instruments may tr⁶ansmit various risks, including sovereign credit risk and geopolitical risks. Additionally, GDR holder⁵s often have limited or no direct voting rights, as the underlying shares are held by the depositary bank. This can diminish shareholder influence compared to direct equity ownership. Administrative fees, cus⁴todian fees, and potential taxation in both the country of issuance and the country of trading can also add to the overall cost for investors. Regulatory compliance fo³r issuing GDRs can be complex, involving requirements in both jurisdictions, which can increase compliance costs for the issuing company.

Global Depository Re²ceipts vs. American Depository Receipts

Global Depository Receipts (GDRs) and American Depository Receipts (ADRs) are both types of depositary receipts that allow investors to own shares of foreign companies without directly purchasing them on foreign exchanges. The key distinction lies in their target markets and geographic reach.

American Depository Receipts (ADRs) are specifically designed for the U.S. market. They are issued by U.S. depositary banks and trade on U.S. stock exchanges (such as the NYSE or Nasdaq) or in the over-the-counter (OTC) market. ADRs are denominated in U.S. dollars and are primarily aimed at providing U.S. investors with an easier way to invest in non-U.S. companies and offering non-U.S. companies access to the U.S. capital markets.

Global Depository Rec¹eipts (GDRs), on the other hand, have a broader, global focus. They are issued by depositary banks and typically trade on exchanges outside the U.S., such as the London Stock Exchange, Luxembourg Stock Exchange, or other European and Asian markets. While they are most commonly denominated in U.S. dollars, they can theoretically be in any major currency. GDRs aim to attract a diverse, multinational investor base, offering companies access to capital from various countries worldwide. In essence, ADRs are a specific type of depositary receipt tailored for the U.S. market, while GDRs are a more expansive form designed for wider international distribution and trading across multiple global markets.

FAQs

What is the primary purpose of a Global Depository Receipt?

The primary purpose of a Global Depository Receipt is to enable a foreign company to raise capital from investors in international markets and to provide investors with a convenient way to invest in those foreign companies without directly trading on their home stock exchanges.

Are GDRs actual shares of a company?

No, GDRs are not actual shares. They are negotiable certificates issued by a depositary bank that represent a certain number of underlying shares of a foreign company held by a custodian bank in the issuer's home country.

What are the main benefits for companies issuing GDRs?

Companies issue GDRs to access a wider, more diverse pool of international investors, increase the liquidity of their shares, potentially lower their cost of capital, and enhance their global visibility and status. This provides an alternative to traditional public offerings in multiple jurisdictions.

What are the main risks for investors holding GDRs?

Investors in GDRs face risks such as currency risk (due to exchange rate fluctuations between the GDR's currency and the underlying share's home currency), country-specific risks (economic or political instability in the foreign company's domicile), and potential liquidity risk if the trading volume of the GDRs is low. Holders may also have limited voting rights compared to direct shareholders.

Where are Global Depository Receipts typically traded?

Global Depository Receipts are typically traded on major international stock exchanges, with common venues including the London Stock Exchange and the Luxembourg Stock Exchange.