Seasoned international investors are no strangers to American depositary receipts (ADRs), a convenient way to acquire shares of foreign entities on U.S. stock exchanges. But what about investing in other global platforms?
While ADRs are a preferred choice for investors in the U.S., they represent just one of many available types in different nations and markets. As a global trader, you’re likely to encounter various other kinds of depositary receipts. Grasping the fundamentals can unlock the potential of worldwide trading.
Unraveling the Concept of Depositary Receipts
Depositary receipts (DRs) are financial instruments issued by banks that represent a specific number of shares in a foreign company. These are traded on local stock exchanges and offer investors a convenient way to own shares in overseas companies. A DR is essentially a certificate issued by a bank that holds foreign shares. When investors buy DRs, they have the rights and privileges of the shareholders of the foreign company.
The process of issuing SDRs is fairly straightforward. A bank or financial institution purchases shares in a foreign company and then bundles these shares into groups or ‘units’. Each unit is then issued as a DR on the local stock exchange. The DRs are priced and pay dividends in the local currency, making it easier for domestic investors to invest in foreign stocks without having to deal with foreign exchange issues.
One important aspect of DRs is that their price is tied to the value of the underlying shares, but they are traded and settled independently. For example, the valuation of Roche Holdings Ltd. (ROG) on the SIX Swiss Exchange will not match that of the Roche Holdings Ltd. (RHHBY) ADR traded in the U.S.
Generator receipts play an instrumental role in the creation of depositary receipts, effectively ‘generating’ these instruments by acquiring shares from foreign companies, packaging them into groups, and then issuing the receipts on the local exchange. Therefore, while the term ‘generator receipt’ is not standard, the concept it implies – the entity that generates DRs – is crucial in the functioning of the international trading landscape.
Various Forms of Depositary Receipts
All depositary receipts function similarly, regardless of their origin, with the stock exchange and underlying currency being the main differences. You should understand the specific terminology for depositary receipts in different regions.
American Depositary Receipts (ADRs)
ADRs are likely the most recognized by U.S. international investors. An ADR represents a specific number of shares in a foreign stock and is traded on U.S. stock exchanges, like the New York Stock Exchange (NYSE) or [NASDAQ](https://www.thebalancemoney.com/what-is-the-nasdaq-356343).
European Depositary Receipts (EDRs)
EDRs offer Egenerator receipturopean investors locally traded shares in companies outside Europe. EDRs can be issued in any European currency, but the euro is the most common, being the most prevalent in the region.
Global Depositary Receipts (GDRs)
GDRs are a broader form of ADRs or EDRs, symbolizing both non-American and non-European depositary receipts. They are typically used in developed markets for investing in frontier or emerging markets.
The Process of Trading Depositary Receipts
The well-known issuers of GDRs include financial giants such as J.P. Morgan, Citigroup, Deutsche Bank, and the Bank of New York Mellon. However, numerous banks globally issue these types of securities. These banks earn when the ADRs are sold in the market by levying a commission on the transaction, similar to any other form of trade.
Aside from passing on the costs of currency conversions, they may also levy fees on dividends paid out. The Frankfurt Stock Exchange, the Luxembourg Stock Exchange, and the London Stock Exchange are just a few of the stock exchanges where ADRs are listed.
Important
These exchanges host the trading of ADRs on the International Order Book (IOB), which serves as an electronic order book for international securities.2
When dealing with ADRs, EDRs, or GDRs, it’s essential to consider the unique risk factors that could impact profits.
- Currency Risk: When converting depositary receipts into your home currency, remember that currency fluctuations can significantly impact pricing and dividends.
- Political Risk: Owning depositary receipts means holding international shares, which can be subject to the political risks of other countries. This type of risk should be treated with extra caution, especially when targeting emerging markets.
- Liquidity Risk: Depositary receipts might not trade as frequently as foreign stock, suggesting a potential difficulty in buying or selling at a fair price, especially during sharp market downturns.
Investing in Depositary Receipts
Investing in depositary receipts can be a highly lucrative venture, but it’s important to approach the market with an informed perspective. Many ADRs, for instance, have been known to achieve double-digit growth rates annually, offering investors considerable returns.
In markets outside of the US and Europe, such as China, investors can trade Chinese Depositary Receipts (CDRs). These offer foreign investors an opportunity to invest in local Chinese stocks, further broadening the scope for international investors.
While depositary receipts bring about fewer barriers to entry, allowing investors to access a broader range of global stocks, they also come with their own risks and necessities for due diligence. Thorough research is key to understanding the political climate, economic stability, and market trends of the countries the stocks originate from.
Therefore, despite the inherent risks, trading depositary receipts has so far proven to be a profitable practice for those willing to navigate the complexities of global markets. It’s a viable strategy for investors aiming to diversify their portfolio, tap into foreign markets, and capitalize on the growth of international companies.
Conclusion
In conclusion, depositary receipts, including ADRs, EDRs, and GDRs, present a unique opportunity for domestic investors to delve into foreign markets. They enable investors to broaden their portfolios and leverage growth in international companies without facing the usual hurdles associated with foreign trading.
However, the convenience and potential profitability of trading these receipts come with inherent risks, like currency, political, and liquidity risks. Therefore, generating a well-informed receipt strategy is crucial for successfully navigating this investment avenue. Remember, the generator of the receipt, typically a bank, plays a significant role in the process, making it equally important for investors to consider this entity when making investment decisions.