Last editedSept 20212 min read
If you’ve researched foreign investment at all, you’ll probably have come across the term depositary receipt. In fact, these were created by US investors looking to gain security in their foreign investments, so you may often hear them referred to as American depositary receipts (ADRs). Whether you’re looking to take your business global or are considering some form of foreign investment, a good understanding of depositary receipts can help you to navigate these decisions.
Learn more about ADR depositary receipts with this simple guide and prepare yourself for foreign investment and stock trading.
Depositary receipt definition
Put simply, ADR depositary receipts are designed to simplify foreign investing. First of all, it’s important to understand equity securities, which are distinct from debt securities. The term security here has a slightly different meaning to what you may be used to, as it refers to a kind of financial instrument that has monetary value. In other words, it is a representation of someone’s ownership of part of a company’s net assets.
American depositary receipts are a form of equity security that allow investors to have shares in foreign public companies. ADRs are freely traded on domestic stock exchanges such as the New York Stock Exchange. On the other hand, you may also hear about global depositary receipts (GDRs), which are usually listed on the London Stock Exchange.
For this reason, these depositary receipts allow for trading across borders and can assist non-US companies to raise capital. When it comes to mergers and acquisitions, this capital can be used as acquisition currency to create a more attractive deal. What’s more, they allow companies to make their shares available internationally and facilitate operations for investors in the US and elsewhere.
How do depositary receipts work?
When a company decides to list its stock internationally, they must create a depositary receipt. In order to do this, there are a number of requirements that the company must first satisfy, which are established by the exchange in question. In addition to this process, ADR depositary receipts may also be issued as part of an initial public offering, or they may even be traded over-the-counter.
The process of creating a depositary receipt is easier to understand with a real-life example. For example, say a German automobile country decides that they want to list its public traded shares using an ADR. In order to do this, a US broker must purchase shares of the company and send them to a German custodian bank of the depositary bank. The custodian bank will then confirm receipt of the funds to the depositary bank, who then issues the shares to the broker.
Each ADR will represent a certain number of shares based on a predefined ratio, and can then be traded freely in the US on the New York Stock Exchange. The broker who invested has the same privileges that a shareholder of ordinary shares has, which will be detailed on the ADR certificate.
Depositary receipt vs common stock
Now that you understand the depositary receipt definition, how does this differ from that of common stock? Essentially, there isn’t much of a difference.
Once the process of creating the ADR depositary receipt has been completed, these DRs behave in a similar way to common stocks. They are traded on a local exchange in exactly the same way as common stock is.
It is possible for a company to convert these depositary receipts into common stock, but generally they remain as two distinct categories. Put simply, the key difference is that they represent different types of investment: that in companies that are based in the same country, and that in international companies.
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