What Is a Depositary Receipt (DR)?

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What Is a Depositary Receipt (DR)?

Let me explain what a depositary receipt, or DR, really is. It's a negotiable certificate that banks issue, representing shares in a foreign company right on your local stock exchange. This setup means you can hold those foreign shares without ever dealing with international markets directly, which saves you time and money. Take American Depositary Receipts, or ADRs—they've been around since the 1920s and open up global investment options, showing just how popular these receipts have become.

Key Takeaways

You need to know that depositary receipts give you a straightforward way to hold shares in foreign companies without trading on international markets. American depositary receipts let U.S. investors tap into foreign stocks, where you can earn capital gains and dividends all in U.S. dollars. Then there are global depositary receipts, which help companies list shares on foreign exchanges like the London Stock Exchange, making investment possible worldwide. The benefits include diversifying your portfolio and easier access to foreign markets, but watch out for risks like low liquidity and currency conversions. Overall, these receipts can be cheaper and more convenient than buying foreign stocks directly, even if they come with some economic and administrative hurdles.

Breaking Down Depositary Receipts: How They Work

Here's how depositary receipts function in practice. They let you hold shares in stocks from companies listed on foreign exchanges without you having to trade directly on those markets. Instead, you deal with a major financial institution in your own country. This approach cuts down on fees and makes the whole process much more convenient than buying stocks straight from foreign markets.

Exploring American Depositary Receipts: U.S. Access to Global Stocks

If you're in the U.S., you can access foreign stocks through American depositary receipts, or ADRs. These are issued by U.S. banks for foreign stocks traded on exchanges like the American Stock Exchange, NYSE, or Nasdaq. When you buy an ADR, it's listed in U.S. dollars, and the actual underlying security is held by a U.S. financial institution overseas, not some global entity. With ADRs, you can buy shares in foreign companies, earn capital gains, and possibly receive dividends, all paid out in U.S. dollars. You trade in dollars, skipping foreign currency hassles since ADRs clear through U.S. systems. Plus, U.S. banks require detailed financial info from those foreign companies, so you get an easier way to evaluate their health compared to purely international trades.

An Example of an ADR

Consider ICICI Bank Ltd., which is listed in India and usually not available to foreign investors. But it has an American depositary receipt issued by Deutsche Bank that trades on the NYSE, so most U.S. investors can get in on it. This expands its availability to a much wider investor base.

Important Note

You should gain more insight about depositary receipts from our in-depth tutorial on ADR Basics.

Global Depositary Receipts: Expanding Investment Horizons Beyond the U.S.

Depositary receipts aren't just a U.S. thing—they've spread globally as global depositary receipts (GDRs), European DRs, and international DRs. While ADRs trade on U.S. exchanges, GDRs are often listed on European ones like the London Stock Exchange. Both are usually in U.S. dollars, but they can also be in euros. A GDR operates like an ADR but flipped—a U.S. company wanting to list on the London Stock Exchange can do so via a GDR. The company agrees with a London depository bank, which then issues shares in Britain, complying with regulations in both countries.

Benefits of Depositary Receipts: A Gateway to Diversified Investing

Depositary receipts appeal to you as an investor because they help diversify your portfolio by letting you buy into foreign companies. Diversification means building a portfolio with a variety of stocks across industries, and using these receipts alongside other investments keeps your holdings from being too concentrated in one area or sector. You get the benefits and rights of the underlying shares, like voting and dividends, and they open markets you might not access otherwise. They're more convenient and cheaper than direct foreign stock purchases, with ADRs cutting administration and duty costs on transactions.

Fast Fact

Depositary receipts help international companies raise capital globally and encourage international investment.

Potential Drawbacks of Depositary Receipts: Navigating the Risks

On the downside, many depositary receipts aren't listed on stock exchanges and might only trade among institutional investors. Liquidity can be low, with few buyers and sellers leading to delays when you want to enter or exit positions, and sometimes there are significant administrative fees. For ADRs, they don't remove currency risk from the underlying shares in another country—dividends in euros get converted to dollars after expenses and taxes, per the deposit agreement, and exchange rate fluctuations can affect dividend values. You also face risks if the foreign company's country hits a recession, bank failures, or political issues, which would impact the receipt's value along with heightened foreign risks. Plus, some receipts aren't backed by a company and can be withdrawn anytime, with delays in getting proceeds from share sales.

Frequently Asked Questions

Let me address some common questions directly.

How is a depositary receipt transaction accomplished?

A foreign-listed company typically hires a financial advisor to navigate regulations for creating a depositary receipt abroad. The company also uses a domestic bank as custodian and a broker in the target country. That domestic bank lists the firm's shares on an exchange like the NYSE in the target country.

How are depositary receipts taxed?

Dividends and gains on American depositary receipts are paid in U.S. dollars, after expenses and foreign taxes. Banks usually withhold for foreign taxes, but you still report the full income on your U.S. tax return, which might lead to double taxation unless you take steps to avoid it.

What is a 'sponsored' ADR?

A sponsored American depositary receipt involves a depositary bank working with the foreign company and its custodian bank. Otherwise, unsponsored ADRs are issued by brokers or dealers owning the foreign company's common stock and aren't commonly on exchanges.

The Bottom Line

Depositary receipts offer you a convenient and often cost-effective way to invest in foreign companies without trading directly on international exchanges, thanks to lower fees. However, you must consider risks like economic instability in the issuer's home country and liquidity issues. While ADRs simplify things by using U.S. dollars, they don't fully eliminate foreign exchange risks. As an investor, evaluate these factors to ensure they fit your strategy and risk tolerance.

What Is a Depositary Receipt (DR)?

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