A depositary receipt is a negotiable certificate (receipt) issued by a domestic depository bank for equity or debt instruments of a foreign-based corporation that are held on deposit with a foreign depository bank and entitle the certificate’s holder to all rights of ownership of the underlying instrument. Depositary receipts eliminate difficulties encountered in trading in foreign securities, such as transferring certificates or converting currencies in share sales and purchases or dividend and interest payments. They allow companies to offer securities denominated in the local currency to investors more easily than by trading directly on the local markets.
DRs include American depositary receipts, global depositary receipts and euro depositary receipts:
- American depositary receipt (ADR) – A negotiable certificate (receipt) traded in the United States and issued by a US depository bank for the shares or bonds of a foreign-based corporation that are held in custody in the issuer’s home market and entitle the certificate’s holder to all rights of ownership of the securities – either unsponsored or sponsored.
- Global depositary receipt (GDR) – A depositary receipt for the negotiable equity or debt securities of a foreign-based corporation issued and traded internationally, but outside the United States, often listed in the Frankfurt Stock Exchange, Luxembourg Stock Exchange and the London Stock Exchange.
- Euro depositary receipt (EDR) – A depositary receipt for the negotiable securities of a foreign-based corporation denominated and quoted in euros and traded predominantly in Europe.
Greater demand in one market than the other causes depository receipts to trade at a premium or discount to the underlying security, thus creating an arbitrage opportunity. The formula for the theoretical pricing of a depositary receipt trading in the US and the underlying share trading in the local market is:
Depositary Receipt Price = Ordinary Share Price x Ratio x FX +/− Transaction Costs