Depository receipts: types, features and how they differ from stocks – R Blog

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    In this article, we will discuss a popular financial instrument – depository receipts. We will learn how they are applied, what are the DRs, and also tell about their advantages and disadvantages.

    What is a depository receipt

    Depository Receipt (DR) is a security (certificate) representing actions or bonds of a foreign company traded on a local stock exchange.

    In essence, this is a derivative security that removes any restrictions on investments – these are shares and bonds of foreign companies. These certificates have all the rights of the underlying assets, which are domestic securities.

    Depositary receipts are purchased by investors (DR holders) in accordance with the deposit agreement. The depositary is the agent of the issuer and acts as a link between investors and the issuer.

    Using depositary receipts, an investor can own shares of foreign companies without having to trade directly in foreign markets. Market players purchase depository receipts in the same way as stocks – either directly if they have access to an exchange or through brokerage companies.

    How depository receipts work

    Before describing all the nuances, let us tell you what is hidden behind such concepts as “depository” and “custodian bank”.

    The depository is a professional participant in the securities market and its main function is to register ownership of assets. In other words, the depository holds your securities.

    A custodian bank simultaneously holds and manages the securities or other financial assets of its clients. In addition, it may offer other financial services; for example, clearing, settlement or exchange transactions.

    Now let’s go back to how depository receipts work.

    They are issued when a foreign company wants to publicly trade on another country’s stock exchange. For this, the company must meet all the listing criteria for the selected country. For the issuance of depository receipts, the shares of a foreign company are transferred and stored in a depository bank.

    After the custodian bank receives the shares, the depository issues depositary receipts available to investors, which are later traded on local stock exchanges.

    For example, a Japanese car manufacturing company wants to raise money in the US market. To do this, it must initiate the issue of American depositary receipts for listing on the NYSE. This procedure will look like this:

    What are the types of depository receipts

    They are generally classified according to the market in which they are traded.

    1. Sponsored depositary receipts are issued at the initiative of the company that issued the basic shares. This company enters into an agreement with the depository, according to which it undertakes the obligation to disclose financial information.

    The depositary is an intermediary between the issuer and investors. Such securities are also considered voting securities in the same way as common stock.

    2. Unsponsored depository receipts are issued by one or more depositories without official agreement with a foreign company. These certificates are issued for securities already in circulation.
    However, since they do not represent a company’s participation, they are mainly traded in over-the-counter markets and are not considered securities with voting rights.

    Advantages of depository receipts

    • They offer investors access to foreign securities and thus opportunities to diversify their investment portfolios
    • Companies can consider them as an additional source of income. For example, with the help of global depositary receipts, they can attract money from foreign investors from all over the world
    • Local regulation. Since they are traded on local exchanges, investors do not need to worry about international politics and global regulations

    Disadvantages of depository receipts

    Summary

    Depository receipts are a popular financial instrument in the stock markets. Using them, investors have the opportunity to invest money in shares of foreign companies on local exchanges without any extra effort. At the same time, issuing companies have the opportunity to attract more investment and place their shares on world exchanges.

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    The material was prepared in

    Has been trading in financial markets since 2004. The acquired knowledge and experience make up his own approach to asset analysis, which he is happy to share with listeners of RoboForex webinars.

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