Global Depositary Receipt (GDR) Definition and Example

What Is a Global Depositary Receipt (GDR)?

A global depositary receipt (GDR) is a negotiable financial instrument issued by a depositary bank. It represents shares in a foreign company and trades on the local stock exchanges in investors' countries. GDRs make it possible for a company (the issuer) to access investors in capital markets beyond the borders of its own country.

GDRs are commonly used by issuers to raise capital from international investors through private placement or public stock offerings.

A global depositary receipt is very similar to an American depositary receipt (ADR) except that an ADR only lists shares of a foreign company in U.S. markets.

Understanding Global Depositary Receipts (GDRs)

A global depositary receipt is a type of bank certificate that represents shares of stock in an international company. The shares underlying the GDR remain on deposit with a depositary bank or custodial institution.

While shares of an international company trade as domestic shares in the country where the company is located, global investors located elsewhere can invest in those shares through GDRs.

Using GDRs, companies can raise capital from investors in countries around the world. For those investors, the GDRs will be denominated in their home country currencies. Since GDRs are negotiable certificates, they trade in multiple markets and can provide arbitrage opportunities to investors.

GDRs are generally referred to as European Depositary Receipts, or EDRs, when European investors wish to trade locally the shares of companies located outside of Europe.

GDR transactions tend to have lower costs than some other mechanisms that investors use to trade in foreign securities.

Example of a GDR

A U.S.-based company that wants its stock to be listed on the London and Hong Kong Stock Exchanges can accomplish this via a GDR. The U.S.-based company enters into a depositary receipt agreement with the respective foreign depositary banks. In turn, these banks package and issue shares to their respective stock exchanges. These activities follow the regulatory compliance regulations for both of the countries.

GDR Characteristics

GDRs are exchange-traded securities that are not directly backed by any underlying collateral (as shares of a company are backed by their assets). GDRs instead represent ownership of shares in a foreign company, where those actual shares are traded abroad.

Different GDRs may also have specific characteristics that differ from one to the next. These may include:

• Conversion ratio: The conversion ratio is the number of shares of the underlying company that are represented by each GDR. This ratio can vary from one GDR to another, and it may be adjusted over time to reflect changes in the underlying shares.
• Denomination: GDRs can be denominated in different currencies, such as U.S. dollars, euros, or pounds sterling. The currency used for a GDR may impact its price and the risks associated with the investment, such as currency risk, as the price of its shares overseas are priced in local currency.
• Sponsorship: GDRs are issued by depository banks, and the specific bank that sponsors a GDR may vary from one GDR to another. Different banks may have different reputations, financial strength, and other characteristics that could impact the risks and potential returns of a GDR.
• Fees: GDRs may also vary in terms of the fees that are charged for issuing, trading, or holding the GDRs. These fees can impact the overall cost and potential returns of an investment in a GDR.

Special Considerations

A GDR distributed by a depositary bank represents a particular number of underlying shares—anywhere from a fraction to multiple shares—in a specific international company. The particular share makeup for a GDR depends on how attractive an investment it will make to local investors. For instance, in the U.S., a depositary bank would want to create GDRs with the number of shares, or fractions thereof, and associated U.S. dollar value that U.S. investors might be most comfortable with.

The depositary bank first buys the shares of the international company (or, receives them from an investor who already owns them). It then bundles a certain number of them. This bundle is represented by a GDR. The GDR is then issued by the depositary bank on a local stock exchange. The underlying shares remain on deposit with the depositary bank (or custodian bank in the international country).

The trading process involving GDRs is regulated by the exchange on which they trade. For example, in the U.S., global depositary receipts are quoted and trade in U.S. dollars. They also pay dividends with U.S. dollars. They're subject to the trading and settlement process and regulations of the exchange where their transactions take place.

Typically, GDRs are offered to institutional investors via a private offer, due to the fact that they can take advantage of exemptions from registration under the Securities Act of 1933. This makes GDRs an efficient and cost-effective way to access cross-border capital. In fact, because of their flexibility and efficiencies, issuers from regions such as the Middle East and Africa, Asia Pacific, Latin America as well as Europe have increased their use of GDR programs to help them achieve the objectives they have for raising capital.

Trading GDRs

International companies issue GDRs to attract capital from foreign investors. GDRs trade on the investors' local exchanges while offering exposure to an international marketplace. A custodian/depositary bank has possession of the GDRs underlying shares while trades take place, ensuring a level of protection and facilitating participation for all involved.

Brokers who represent buyers manage the purchase and sale of GDRs. Generally, the brokers are from the home country and operate within the foreign market. The actual purchase of the assets is multi-staged, involving a broker in the investor's country, a broker located within the market of the international company, a depositary bank representing the buyer, and a custodian bank.

Brokers can also sell GDRs on an investor's behalf. An investor can sell them as-is on the proper exchanges, or the investor can convert them into regular stock for the company. Additionally, they can be canceled and returned to the issuing company.

Traders dealing in GDRs often compare the, for example, U.S. dollar price of the GDR with the U.S. dollar equivalent price of the shares trading on the international company's domestic exchange. They'll typically buy the less expensive security and sell the other. Eventually, this arbitrage trading activity causes the underlying shares and the GDRs to reach parity.

Advantages and Disadvantages of GDRs

Advantages

• GDRs help international companies reach a broader, more diverse audience of potential investors.
• They can potentially increase share liquidity.
• Companies can conduct an efficient and cost-effective private offering.
• Shares listed on major global exchanges can increase the status or legitimacy of an otherwise unknown foreign company.
• For investors, GDRs provide the opportunity to diversify portfolios internationally.
• GDRs are more convenient and less expensive than opening foreign brokerage accounts and purchasing stocks in foreign markets.
• Investors don't have to pay cross-border custody or safekeeping charges.
• GDRs trade, clear, and settle according to the investor's domestic process and procedures.
• U.S. holders of GDRs realize any dividends and capital gains in U.S. dollars.

Disadvantages

• GDRs may have significant administrative fees.
• Dividend payments are net of currency conversion expenses and foreign taxes.
• The depositary bank automatically withholds the amount necessary to cover expenses and foreign taxes.
• U.S. investors may need to seek a credit from the Internal Revenue Service (IRS) or a refund from the foreign government's taxing authority to avoid double taxation on capital gains realized.
• GDRs have the potential to have low liquidity, making them difficult to sell.
• In addition to liquidity risk, they can have currency risk and political risk.
• This means that the value of GDR could fluctuate according to actual events in the foreign county, such as recession, financial collapse, or political upheaval.

GDRs vs. ADRs

Global Depositary Receipts

Global depositary receipts allow a company to list its shares in more than one country outside of its home country. For example, a Chinese company could create a GDR program that issues its shares through a depositary bank intermediary into the London market and the United States market. Each issuance must comply with all relevant laws in both the home country and foreign markets individually.

American Depositary Receipts

On the other hand, an American depositary receipt, which also represents shares of an international company, lists only on U.S. stock exchanges. To offer ADRs, a U.S. bank will purchase shares on a foreign exchange. The depositary bank will hold the underlying shares and issue an ADR for domestic trading.

Sponsored ADRs

A bank issues a sponsored ADR on behalf of a foreign company. The bank and the business enter into a legal arrangement. Usually, the foreign company pays the costs of issuing an ADR and retains control over it, while the bank handles the transactions with investors.

Sponsored ADRs are categorized by the degree the foreign company complies with SEC regulations and American accounting procedures.

Unsponsored ADRs

A bank may also issue an unsponsored ADR. This certificate represents no direct involvement, participation, or even permission from the foreign company.

Theoretically, there could be several unsponsored ADRs for the same foreign company, issued by different U.S. banks. These different ADRs could also offer varying dividends. With sponsored programs, there is only one ADR, issued by the depositary bank working with the foreign company.

The Bottom Line

For U.S. investors, global depositary receipts offer a way to own equity in foreign companies while trading its representative shares on a local stock exchange. Certainly, GDRs have their risks, including home country economic and political risk, currency risk, and liquidity risk.

However, GDRs also offer noteworthy benefits that include the potential for a globally diversified portfolio, the ability to trade, clear, and settle transactions according to local regulations, no cross-border custody/safekeeping charges, and dividend payments in U.S. dollars.