What Are Global Depository Receipts and How Do They Work?

Global Depository Receipts (GDRs) are financial instruments that allow companies to access international capital markets and enable investors to diversify their portfolios across borders. Representing shares in foreign companies, GDRs help these entities raise funds outside their home countries, offering growth opportunities beyond domestic boundaries.

The process of issuing GDRs involves multiple stakeholders and regulatory considerations, making it a key mechanism in global finance.

Structure and Issuance

Global Depository Receipts are created through a structured process involving several essential components. Understanding the roles and responsibilities of each element is critical to grasping how GDRs operate in the global financial system.

Depositary Bank Role

The depositary bank is central to the issuance and management of GDRs. This institution issues the receipts and ensures they accurately represent the underlying shares of the foreign company. The bank holds the original shares in custody, typically in the issuer’s home country, and facilitates their conversion into GDRs for trading on international exchanges. It also manages communication between investors and the issuing company, overseeing dividends, voting rights, and other corporate actions. This relationship is governed by a deposit agreement, which defines the terms and conditions of GDR issuance and maintenance. A reliable depositary bank plays a significant role in ensuring the success and credibility of the GDR program.

Underlying Shares

The underlying shares are the equity securities of the foreign company that GDRs represent. These shares are held in the issuer’s home market and deposited with the depositary bank. Converting these shares into GDRs involves issuing a proportional number of receipts, enabling trading on global exchanges. This structure allows investors to gain exposure to foreign companies without directly holding the underlying shares, simplifying transactions and adhering to home country regulations. The ratio between GDRs and underlying shares varies based on the issuer’s strategy and market conditions, influencing the liquidity and attractiveness of the GDRs.

Deposit Agreements

Deposit agreements are legal contracts that outline the terms under which GDRs are issued and managed. Negotiated between the foreign company, the depositary bank, and sometimes underwriters, these agreements specify the rights and responsibilities of each party, including dividend distribution, voting rights, and associated fees. They also define the procedures for converting GDRs back into underlying shares. Compliance with the deposit agreement is crucial to maintaining investor trust and ensuring the smooth operation of the GDR program. These agreements align with legal and regulatory frameworks, providing a reliable structure for international investment.

Listing and Regulatory Guidelines

For GDRs to be listed on international exchanges, issuers must adhere to listing requirements and regulatory guidelines that protect investors and ensure market transparency. Selecting a suitable exchange, such as the London Stock Exchange or Luxembourg Stock Exchange, is a key step, with each requiring comprehensive disclosures of financial statements, corporate governance practices, and risk factors. Issuers must comply with International Financial Reporting Standards (IFRS) or other accepted accounting principles recognized by the exchange.

Regulatory compliance extends to the securities laws of the target market. For example, companies marketing GDRs to U.S. investors must adhere to the Securities Act of 1933 and the Securities Exchange Act of 1934, which include filing a registration statement with the U.S. Securities and Exchange Commission (SEC) and meeting ongoing reporting obligations. The Sarbanes-Oxley Act may also impose additional responsibilities related to corporate governance and internal controls.

Anti-money laundering (AML) and know-your-customer (KYC) regulations are increasingly important in the GDR landscape. Issuers and depositary banks must implement procedures to mitigate financial crime risks, including verifying investor identities and monitoring transactions. Non-compliance can lead to severe penalties, including fines and restrictions on market access.

Accounting Treatment

The accounting treatment of GDRs requires adherence to international standards and an understanding of cross-border financial transactions. Issuing companies record GDRs as equity instruments, reflecting their nature as ownership representations. The initial issuance is accounted for as an equity increase, categorized under share capital or additional paid-in capital, depending on jurisdiction and policies. Transaction costs associated with issuance are often deducted from the equity raised, consistent with IFRS guidelines.

For investors, GDRs are recognized as financial assets. Classification under “fair value through profit or loss” or “fair value through other comprehensive income” affects how changes in GDR value are reported. For instance, under IFRS 9, gains or losses classified as “fair value through profit or loss” are immediately recognized in the income statement, impacting net income and tax liabilities.

Tax and Reporting

GDRs present distinct tax and reporting considerations for issuers and investors. Issuing companies may face corporate tax on proceeds, depending on local regulations and double taxation treaties. Withholding tax obligations on dividends distributed to GDR holders also vary based on treaties between the issuer’s and investor’s countries.

Investors must account for capital gains tax when selling GDRs, which differs depending on their country of residence. Dividends and capital gains must be reported in tax filings, adhering to domestic tax codes. U.S. investors, for example, must comply with the Internal Revenue Code (IRC) and may need to file a Foreign Bank and Financial Accounts Report (FBAR) if thresholds are met.

Voting and Dividend Entitlements

GDRs provide investors with indirect access to the rights and benefits of the underlying shares, including voting and dividend entitlements. These rights are mediated by the depositary bank and governed by the deposit agreement.

Voting rights are exercised through the depositary bank, which collects instructions from GDR holders and casts votes on their behalf. However, voting rights may be restricted or subject to conditions such as ownership thresholds or deadlines. In some cases, depositary banks may not solicit voting instructions unless required by the deposit agreement, limiting the influence of GDR holders compared to direct shareholders.

Dividend entitlements are also managed by the depositary bank. When the issuing company declares a dividend, the bank receives the payment in the home currency, converts it to the GDR currency, and distributes it to holders after deducting fees and taxes. Exchange rate fluctuations and withholding taxes, which depend on treaties between the issuer’s and investor’s countries, can impact the final amount received.

Cancellation Procedures

The cancellation of GDRs allows investors to convert their receipts back into the underlying shares. This process is initiated when investors wish to hold shares directly or liquidate their investment in the issuer’s home market. Governed by the deposit agreement, the procedure involves instructing the depositary bank to surrender the GDRs and release the underlying shares to the investor or their broker. Fees and regulatory compliance requirements, such as foreign ownership restrictions, may apply.

Market conditions, such as liquidity and price volatility, can influence the value of the underlying shares during cancellation. Taxes, including capital gains tax or stamp duties, may also be triggered. For instance, in India, securities transaction tax (STT) or capital gains tax may apply based on the holding period and investor residency. Consulting tax advisors and financial professionals is essential to navigate these complexities and align the cancellation with broader investment strategies.