What is a depositary receipt (DR)?
A depositary receipt is a tradable certificate issued by a bank that represents ownership of shares in a company incorporated and listed in a different country. The depositary bank holds the actual foreign shares (via a custodian) and issues receipts that trade on a local exchange in the investor’s home market. DRs let investors buy and sell foreign equity exposure through local markets, settlement systems, and currencies.
Key terms (defined)
– Depositary bank: the financial institution that issues the DR and handles custody, conversions, and corporate actions.
– Custodian: the local, foreign bank or agent that physically holds the underlying shares.
– ADR (American Depositary Receipt): a DR issued by a U.S. bank and quoted in U.S. dollars on U.S. exchanges.
– GDR (Global Depositary Receipt): a similar instrument often used for cross-listing on European exchanges; may be denominated in USD or euros.
– ADR ratio (or conversion ratio): how many underlying foreign shares are represented by one DR (can be fractional or whole).
How DRs work (step-by-step)
1. A foreign company arranges with a depositary bank to create DRs. The company may cooperate directly (sponsored ADR) or not (unsponsored ADR).
2. The depositary bank acquires the underlying shares and places them with a custodian in the company’s home market.
3. The bank issues DRs in the investor’s market and lists them on an exchange or trades them over‑the‑counter.
4. Investors buy/sell the DRs in local currency and through local settlement systems.
5. Any dividends or corporate actions on the underlying shares are processed by the depositary bank, converted into the DR currency (net of taxes and fees), and distributed to DR holders.
Why investors use DRs
– Convenience: trade foreign companies without opening foreign brokerage accounts or handling foreign settlement systems.
– Currency simplification: DRs are quoted and traded in the investor’s local currency (e.g., ADRs in USD).
– Information access: depositary banks often require foreign issuers to provide financial disclosures suited to the listing market.
– Diversification: easy access to international companies without direct cross‑border trading.
Common benefits and drawbacks
Benefits
– Easier market access and settlement in local currency.
– Potential receipt of dividends and voting rights comparable to direct ownership (subject to the terms in the deposit agreement).
– Can open markets to companies that would otherwise be inaccessible to local investors.
Drawbacks
– Liquidity: some DRs have thin trading volumes, which can widen bid–ask spreads and make execution slower.
– Fees and administration: depositary banks charge fees that may reduce returns.
– Currency and country risk: DR value and dividend amounts still reflect the underlying company’s exposure to its home economy and currency fluctuations.
– Potential withholding taxes: dividends may be subject to foreign tax withholding before conversion and payment.
Sponsored vs. unsponsored ADR (brief)
– Sponsored ADR: the foreign issuer signs an agreement with the depositary bank, usually provides financial statements, and helps meet regulatory/listing requirements. These ADRs are more likely to be listed on major exchanges.
– Unsponsored ADR: created by a depositary bank without direct cooperation from the issuer. They often trade OTC and may have less disclosure or investor services.
How a depositary receipt transaction is typically accomplished (summary)
– Issuer + depositary bank agree on terms; underlying shares are delivered to the custodian.
– Depositary bank issues DRs and lists them in the local market.
– Investors buy/sell DRs; the depositary bank handles conversion of dividends, corporate actions, and communication with the issuer.
Taxation (high level)
– Dividends and sale proceeds received by DR holders are paid in the trading currency (e.g., USD for ADRs), after the depositary bank converts and withholds any applicable foreign taxes and fees.
– The investor typically reports the full income on their tax return; foreign taxes
taxes paid may be creditable or deductible on the investor’s home-country tax return, subject to local rules and any tax treaty between the investor’s country and the issuer’s country.
Tax reclaim and foreign tax credit (high level)
– Foreign tax credit: Many jurisdictions allow residents to claim a credit (a dollar-for-dollar offset) or a deduction for foreign income taxes withheld on dividends. In the U.S., the foreign tax credit is claimed on Form 1116 (or directly on Form 1040 in some cases). Claiming a credit avoids double taxation to the extent rules permit.
– Reclaim procedures: Some countries permit a partial refund of withholding for qualifying foreign investors, but refunds usually require paperwork submitted to the foreign tax authority and can take months. The depositary bank or broker may assist or provide documentation.
– Withholding on sale proceeds: Most depositary receipts are structured so dividend withholding is the main source of foreign tax. Some countries also tax capital gains for nonresidents; where that occurs, the purchaser may face withholding or post-sale taxation.
– Fees and conversion: Depositary banks may charge fees for processing dividends or corporate actions; those fees reduce the investor’s net cash. Currency conversion rates used by the depositary also affect net amounts received.
Reporting and recordkeeping checklist (practical)
– Save the DR prospectus or deposit agreement — it lists fees, conversion ratios, and withholding mechanics.
– Keep broker trade confirmations showing quantity, price, and commission for cost-basis calculation.
– Save dividend statements showing gross dividend, foreign tax withheld, depositary fees, and net credited amount.
– Record exchange rates used for converting foreign-currency amounts to your tax-currency (broker reports often include this).
– If you intend to claim a foreign tax credit or a reclaim, keep forms and communications from the depositary bank and any receipts of foreign tax paid.
Worked numeric examples
1) Dividend example (typical flow)
– Position: 100 ADRs; gross declared dividend = $1.50 per ADR.
– Gross dividend = 100 × $1.50 = $150.00.
– Foreign withholding tax = 15% of gross = $22.50.
– Depositary processing fee = $0.03 per ADR = $3.00.
– Net dividend credited to investor = $150.00 − $22.50 − $3.00 = $124.50.
– Tax reporting: report $150 as dividend income on the tax return (rules differ by country), and claim $22.50 as foreign tax paid for potential foreign tax credit (subject to local rules and limitations).
2) Capital-gains example (simple)
– Bought 100 ADRs at $25.00 = cost basis $2,500.
– Sold 100 ADRs at $30.00 = proceeds $3,000.
– Nominal capital gain = $3,000 − $2,500 = $500.
– If a foreign capital-gains withholding of 10% applied to proceeds (rare but possible in some jurisdictions) = $300 withheld at settlement; you would report the full $3,000 proceeds and $500 gain on your tax return, and then treat the $300 withheld as foreign tax paid for credit/reclaim purposes (procedures vary).
Practical pre-trade checklist (step-by-step)
1. Confirm whether the DR is sponsored or unsponsored (sponsored usually offers better issuer cooperation and disclosure).
2. Read the DR prospectus/deposit agreement for fee schedules, conversion ratio (how many underlying shares per DR), and dividend mechanics.
3. Check the withholding-tax rate for dividends and capital gains under the issuer country’s tax laws and any tax treaty with your country.
4. Verify how your broker reports foreign taxes (e.g., on Form 1099 for U.S. investors) and whether it provides documentation for credits or reclaims.
5. Consider liquidity and ADR share count — less liquid DRs can have wider spreads and larger trading costs.
6. Maintain records required to claim foreign tax credits or refunds.
Where to verify withholding rates and tax treatment
– The DR deposit agreement or prospectus (provided by the depositary bank) — primary source for fees and mechanics.
– The issuing country’s tax authority or official treaty documents for withholding rates on dividends and capital gains.
– Your local tax authority guidance (for claiming foreign tax credits).
– Broker/customer-service or depositary bank contacts for practical documentation and proof of withheld taxes.
Key assumptions and caveats
– Tax rules vary by investor residence, issuer country, and whether a tax treaty applies. The examples above assume a hypothetical withholding and simple fee structure for illustration.
– Brokers and depositary banks differ in how quickly they pass through foreign payments, how they report amounts, and
and the documentation they supply to investors for tax reclaims or reporting.
Practical checklist for using depositary receipts (DRs)
– Confirm the DR type and sponsor status:
– ADR = American Depositary Receipt (listed in the U.S.). GDR = Global Depositary Receipt (often listed outside the U.S.).
– Sponsored DR: issuer works with a single depositary bank; usually better corporate disclosure. Unsponsored DR: one or more depositaries create receipts without issuer cooperation; can have uneven reporting.
– Check the DR ratio: number of underlying foreign shares represented by one DR (e.g., 1 ADR = 2 ordinary shares).
– Verify fees and charges: look for per-DR custody/administration fees, currency-conversion spreads, and any broker pass-throughs.
– Determine withholding tax rules: identify issuer-country withholding on dividends (and any applicable treaty reduction) and whether the depositary passes gross or net amounts.
– Confirm tax documentation and timing: which forms the depositary/broker will issue (e.g., year-end and withholding statements), and the timeline for claiming refunds or credits with your tax authority.
– Check voting and corporate-action mechanics: does the DR carry voting rights or only an economic interest? What is the process/timeline for exercising votes or receiving rights offerings?
– Assess liquidity and market microstructure: compare average daily volume of the DR vs. the underlying shares; wider spreads and lower size can increase trading costs.
– Ask your broker/depositary these specific questions: How are dividends paid and converted? Do you pass through foreign withholding tax? What paperwork for tax credits or reclaims do you provide?
Worked numeric example — dividend flow, fees, and withholding reclaim
Assumptions:
– Underlying company declares 1.00 local-currency dividend per ordinary share.
– ADR ratio = 2 underlying shares per ADR.
– FX rate when dividend is paid: 1 local currency = 1.30 USD.
– Issuer-country withholding = 15% unless reduced by treaty.
– Deposit transfer/administration fee charged by depositary = $0.05 per ADR (flat).
– Investor’s tax treaty reduces withholding to 5% if proper paperwork is filed for reclaim.
Step 1 — Calculate gross dividend per ADR in local currency:
– Gross local = 2 shares × 1.00 = 2.00 local currency.
Step 2 — Convert to USD:
– Gross USD = 2.00 × 1.30 = $2.60.
Step 3 — Apply withholding retained at source (if depositary/broker passes net to investor):
– Withholding retained = 15% × $2.60 = $0.39.
– Cash received before depositary fee = $2.60 − $0.39 = $2.21.
Step 4 — Subtract depositary fee:
– Net cash to investor = $2.21 − $0.05 = $2.16.
Step 5 — Potential reclaim under tax treaty:
– Treaty rate = 5% ⇒ actual withholding should be $0.13 rather than $0.39.
– Potential reclaim amount = $0.39 − $0.13 = $0.26 recovered (after submitting required forms).
– Net after successful reclaim = $2.16 + $0.26 = $2.42.
Notes and caveats for the example
– Timing: reclaim processes can take months. Cash flows in the interim reflect initial withholding.
– Fees and FX spreads: many brokers add currency-conversion spreads that reduce the effective received amount; include these in your cost estimate.
– Documentation: reclaim usually requires documentation from the depositary or custodian and sometimes proof of beneficial ownership on the record date.
– No guarantee: some countries don’t permit refunds or won’t honor treaty rates for certain categories of investor. Always confirm with the depositary and tax authorities.
Key operational and regulatory differences that matter
– Voting rights: DR holders may have limited or no direct voting rights. If votes are possible, the depositary typically forwards voting instructions in a specified window.
– Corporate actions: rights issues, stock splits, and mergers are processed by the depositary based on the underlying company’s corporate action timetable; foreign holidays and settlement conventions can delay processing.
– Regulatory oversight: DRs listed in a host market must meet that market’s listing rules, but the underlying issuer remains subject to its home-country regulation; information flow can be asymmetric.
– Settlement and custody risk: DRs are backed by deposited shares held by cust
…odians in the issuer’s home market; this creates custody and settlement risk if the custodian or local clearing system experiences operational problems, insolvency, or political disruption. Investors should note the depositary’s creditworthiness, the legal framework governing custody, and how claims on the underlying shares would be handled in stress scenarios.
How DRs are created and cancelled (step‑by‑step)
1. Issuer and depositary agreement: A foreign issuer and a depositary bank sign an agreement specifying the terms for issuing depositary receipts (DRs).
2. Deposit of underlying shares: The issuer or holders deliver ordinary shares to a custodian in the issuer’s home market (the custodian is appointed by the depositary).
3. Receipt issuance: The depositary issues DRs in the host market at a defined ratio (e.g., 1 DR = 2 ordinary shares). The DRs represent beneficial ownership; the custodian holds legal title to the deposited shares.
4. Listing and trading: DRs can be listed on an
an exchange in the depositary’s jurisdiction (the “host market”) or trade over‑the‑counter (OTC). The depositary registers the DRs with the host regulator as required, and the DRs begin trading at the host market level while the custodian continues to hold the underlying ordinary shares in the issuer’s home market.
5. Corporate actions and dividends: The depositary and custodian track corporate events (dividends, stock splits, rights issues, mergers). When the issuer pays dividends in its home currency, the custodian receives them, the depositary converts the proceeds into the host currency (after any required local withholding), deducts fees and taxes, and distributes net cash dividends to DR holders on a per‑DR basis according to the depositary’s distribution policy.
6. Voting and shareholder rights: The depositary’s agreement specifies how voting rights are handled. In many programs the depositary forwards proxy materials and either passes votes to DR holders (who instruct the depositary) or votes the underlying shares in accordance with the depositary’s procedures. The extent and timing of voting rights can vary by program.
7. Cancellation (redeeming DRs for underlying shares): If a holder wants the underlying ordinary shares, they request cancellation through their broker. The depositary collects the DRs, instructs the custodian to transfer the equivalent ordinary shares to the holder (or to a broker in the home market), cancels the DRs, and updates registers. Cancellation may be subject to minimum lot sizes, fees, and regulatory or tax constraints.
8. Sponsored vs. unsponsored programs: In a sponsored program the issuer signs an agreement with the depositary and cooperates with reporting, corporate actions, and proxies. In an unsponsored program a depositary issues DRs without an issuer sponsorship; information, corporate action processing, and voting can be less complete.
Key operational details investors should know (short checklist)
– Issuance ratio: how many underlying shares each DR represents (e.g., 1 DR = 2 ordinary shares).
– Currency conversion: underlying shares are in the issuer’s home currency; the depositary converts amounts to the host currency.
– Fees: depositary fees, cancellation fees, custodial fees and broker commissions.
– Taxes: local withholding on dividends and whether a tax treaty reduces withholding. Reclaim procedures can be complex.
– Liquidity and listing venue: exchange‑listed DRs are usually more liquid than OTC‑traded ones.
– Voting procedure: whether DR holders can instruct votes and timing.
– Sponsored status and disclosure level: sponsored = better issuer cooperation.
Pricing and parity (formula and worked example)
Theoretical parity: DR price ≈ (Underlying share price × Shares per DR × FX rate) − adjustment for expected fees and taxes.
Assumptions for worked numeric example:
– Underlying share price (home market) = 50.00 home currency (HC) per share.
– Ratio = 1 DR represents 2 underlying shares.
– FX rate = 0.80 host currency (HostC) per 1 HC (so 1 HC = 0.80 HostC).
– No immediate taxes or fees for the price example.
Theoretical DR price = 50 HC × 2 × 0.80 HostC/HC = 80 HostC.
Practical adjustments:
– If investors expect a future dividend that will be withheld at 15% in the home market, or depositary fees of 0.50 HostC per DR, that may lower market pricing relative to parity. Market supply/demand and liquidity differences also create deviations.
Dividend pass‑through example (numeric)
Assumptions:
– Dividend declared by issuer = 1.50 HC per underlying share.
– Ratio = 1 DR = 2
– Dividend per underlying share = 1.50 HC.
– Ratio = 1 DR = 2 underlying shares.
Step-by-step numeric calculation
1) Gross dividend per DR (in issuer/home currency, HC)
– Gross_DR_HC = Dividend_per_share × Ratio
– = 1.50 HC × 2 = 3.00 HC
2) Convert gross dividend to investor/host currency (HostC) using FX = 0.80 HostC per 1 HC
– Gross_DR_HostC = Gross_DR_HC × FX
– = 3.00 HC × 0.80 HostC/HC = 2.40 HostC
3) Apply withholding tax (15% on the dividend in the home market)
– Net_after_tax_HostC = Gross_DR_HostC × (1 − 0.15)
– = 2.40 × 0.85 = 2.04 HostC
4) Subtract depositary fee (0.50 HostC per DR)
– Cash_received_per_DR = Net_after_tax_HostC − Depositary_fee
– = 2.04 − 0.50 = 1.54 HostC
Summary of results (numbers)
– Gross dividend per DR (HostC): 2.40 HostC
– Net dividend received per DR after 15% withholding and 0.50 fee: 1.54 HostC
Price‑impact interpretation (how parity shifts)
– Theoretical DR price before dividend (from your earlier parity example) = 80 HostC.
– If markets adjusted by the gross dividend only, one would expect an ex‑dividend drop ≈ Gross_DR_HostC = 2.40 HostC, producing a post‑ex price ≈ 77.60 HostC.
– Because DR holders actually receive net cash (after withholding and fees), the DR market may instead price closer to a drop equal to the net cash per DR (1.54 HostC), implying a post‑ex price ≈ 78.46 HostC.
– In practice the actual adjustment can lie between these values. Which way the market moves depends on investors’ expectations about withholding, depositary fees, ability and likelihood of tax reclaim, liquidity, and arbitrage activity. FX moves between the record and pay dates can also change realized outcomes.
Checklist: how to compute expected cash and parity effect for any DR
1. Note dividend declared per underlying share (home currency).
2. Multiply by the DR ratio (shares per DR).
3. Convert to investor currency using the relevant FX rate at the appropriate date.
4. Subtract statutory withholding (apply treaty rates if applicable).
5. Subtract depositary and processing fees (per-DR).
6. Compare gross vs net amounts to judge whether markets will adjust by gross dividend or by expected net cash.
7. Adjust for timing, FX risk, tax‑reclaim likelihood, and liquidity effects.
Assumptions and caveats
– Assumed FX rate is constant between declaration and payment; in reality FX can move and change realized HostC amounts.
– Withholding applied at source with no reclaim; some investors can reclaim part/all of withholding under tax treaties or local procedures—this changes net receipt and expected price adjustments.