A depositary receipt is a negotiable security that is bought and sold on a stock exchange. The receipt typically represents one or more foreign stocks issued by international companies in their home country. The depositary receipt allows investors to purchase an interest in foreign companies without going through an international stock exchange. The two most common types of these receipts are the American and Global Depositary Receipts. The first trades on U.S. stock exchanges while the second typically trades on the London Stock Exchange and other international locations.
A depositary receipt typically requires a company to meet a stock exchange’s specific rules before listing its stock for sale. For example, a company must transfer shares to a brokerage house in its home country. Upon receipt, the brokerage uses a custodian connected to the international stock exchange for selling the depositary receipts. This connection ensures that the shares of stock actually exist and no manipulation occurs between the foreign company and the international brokerage house.
The American Depositary Receipt allows investors to price foreign stocks in U.S. dollars. This helps them determine their return on investment through price increases and dividends from international companies. For companies to use these properly, a U.S. financial institution with overseas connections must be used with these receipts. A benefit from these receipts is that it ultimately reduces the costs associated with owning these stocks. This allows investors to avoid fees on each individual transaction when purchasing foreign stock.
The Global Depositary Receipt works in a similar fashion, although an international bank holds the information for a foreign company’s stock. This receipt also allows for investors to value their stock or dividends in either U.S. dollars or foreign currency, depending on the location of the company and/or international bank holding the receipt. When investors desire these receipts be priced in euros, the document is a European Depositary receipt.
Investors can sell these receipts back to the foreign company, a process called cross trading. This results in the U.S. broker selling the receipts back into the foreign country’s market. From there, the foreign brokerage house can sell the shares of stock back to the company and transfer the money to the U.S. bank or other investors as needed. This process also allows individuals originally from foreign countries the ability to buy and sell shares of stock in their home country through an international stock exchange.