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Depositary Receipts: A Guide for Investors

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During the May 31 Weekly Update post, I mentioned my preference for direct ownership of stock in a company rather than indirect ownership through Depositary Receipts. When I got back into investing in 2016, I was not familiar with depository receipts. My guess is that if you are new to investing you are not familiar with them. So, let’s take a closer look at them.

What are Depositary Receipts?

Depository receipts (DRs) are a popular way for investors to gain exposure to foreign companies without dealing with the complexities of international markets. These financial instruments represent shares in a foreign company and trade on domestic stock exchanges, making them accessible to domestic investors.

Here’s how they work: A depository bank purchases shares of a foreign company and holds them in custody. In return, the bank issues depository receipts, which are traded on local exchanges like any other stock. This allows investors to buy shares in international companies through familiar domestic channels.

One of the key benefits of depository receipts is convenience. Investors can diversify their portfolios internationally without needing to open foreign brokerage accounts or navigate foreign regulations. Additionally, depository receipts are often denominated in the investor’s local currency, reducing the complexities of currency conversion.

However, it’s important to be aware of the potential downsides. While DRs simplify international investing, they still carry risks. These include political and economic instability in the foreign company’s home country, currency fluctuations, and potential differences in accounting and regulatory standards. Furthermore, depository banks may charge fees for their services, which can impact overall returns.

In summary, depository receipts offer a practical and accessible way for investors to gain international exposure, providing the benefits of global diversification while trading in familiar local markets. As always, it’s crucial to understand the specific risks and costs involved, and consulting with a financial advisor can help ensure that depository receipts align with your investment goals.

What types of DR are available to purchase?

There are two main types of depository receipts: American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). ADRs are issued by US banks and traded on US exchanges, such as the NYSE or NASDAQ, while GDRs are typically listed on European exchanges and can be traded in multiple markets.

American Depository Receipts

ADRs are issued by banks in the United States and represent ownership in a foreign company’s shares that are traded on a US stock exchange. The first American Depositary Receipt (ADR) was created in 1927 by the predecessor of JPMorgan Chase & Co. (NYSE: JPM), Guaranty Trust. This innovation allowed American investors to buy shares of a British retailer, Selfridges, on the New York Curb Exchange (an earlier version of the American Stock Exchange), opening up easier access to foreign companies for American investors.

Examples of American depositary receipts (ADRs):

Global Depository Receipts

The concept of Global Depositary Receipts (GDRs) emerged as a broader term encompassing depositary receipts used globally, following the success of ADRs. While a specific date for the first GDR is not available, it was after 1927 and likely coincided with the rise of depositary receipts in other financial centers around the world.

GDRs are issued by banks outside the United States and represent ownership in a foreign company’s shares that are traded on a stock exchange outside the US.

Examples of global depositary receipts (GDRs):

  • Tata Motors Logo Tata Motors Limited (NYSE: TTM): A prominent Indian multinational automotive manufacturing company.
  • Petrobras (NYSE: PBR) is a Brazilian multinational corporation in the petroleum industry

When an investor buys a DR, they are effectively purchasing a certificate that represents a certain number of shares in the foreign company. The bank or financial institution that issues the DR holds the actual shares in custody and pays any dividends or other payments to the DR holders. DRs are typically denominated in US dollars or Euros, making it easier for investors to track their investments and receive payments without worrying about currency exchange rates.

While ADRs and GDRs sound the same, there are some key differences:

  • Geography: ADRs are issued in the United States, while GDRs are issued outside of the United States. ADRs represent ownership of foreign company shares that are held in US banks, while GDRs represent ownership of foreign company shares that are held in banks outside the United States.
  • Regulation: ADRs are regulated by the US Securities and Exchange Commission (SEC), while GDRs are typically regulated by the financial regulators in the country where they are issued.
  • Denomination: ADRs are denominated in US dollars, while GDRs are denominated in a variety of currencies, such as Euros or British pounds.
  • Trading: ADRs are listed on US stock exchanges, while GDRs are typically listed on foreign stock exchanges.
  • Liquidity: ADRs generally offer more liquidity due to their listing on US exchanges and compliance with US market regulations.
  • Cost: ADRs tend to be less expensive than GDRs due to their larger market size and greater liquidity.

It is worth noting that not all foreign companies have ADRs or GDRs, and even those that do may not have them available on all stock exchanges. Additionally, ADRs and GDRs may not necessarily trade at the same price as the underlying shares in the foreign company, influenced by factors such as currency fluctuations and demand for the DRs themselves.

Not all ADRs are created equal

There are different types of ADRs, such as sponsored and unsponsored. In a nutshell, a sponsored ADR is created with the foreign company’s involvement and a single depositary bank to issue the ADRs, subject to stricter regulations and disclosure, can be listed on major US exchanges. On the other hand, an unsponsored ADR is issued without the foreign company’s involvement, is subject to less stringent regulations, and typically traded on the Over-the-Counter Market (OTCM). Sponsored ADRs are typically more liquid and have lower trading costs than unsponsored ADRs.

How to identify an ADR

While some ADRs are not obvious, such as Toyota Motor Corporation, a Japanese company, which is traded as an American ADR on the New York Stock Exchange (NYSE). This makes it easier for Canadian and American investors to purchase shares without having to deal with foreign stock exchanges.

BYD Company Other ADRs are easier to spot due to a ‘Y’ or an ‘F’ at the end of a ticker. For instance, China’s BYD Company Limited, a manufacturer of automobiles and rechargeable batteries, trades on the OTCM under the tickers OTCM: BYDDY and OTCM: BYDDF.

  • BYDDY: This represents the ADRs that trade on the OTCM. Each BYDDY ADR typically represents 10 underlying BYD shares.
  • BYDDF: This also trades on the OTC market, but each ADR represents 1 underlying share of BYD.

Both BYDDY and BYDDF allow North American investors to invest in the BYD Company without having to directly invest in the Chinese market.

What does the letter ‘Y’ or ‘F’ at the end of the ticker indicate?

When comparing ADRs (tickers ending with ‘Y’) and foreign ordinary shares trading on the OTCM (tickers ending with ‘F’), it’s important to consider several factors that affect the risk level of each. The letters ‘Y’ and ‘F’ at the end of a ticker symbol reveal crucial information about the type of security and its listing:

  1. ‘Y’ at the end of the ticker (e.g., BYDDY):
  • Indicates that the security is an American Depositary Receipt (ADR).
  • ADRs simplify international investing by allowing trades in US dollars, avoiding the complexities of direct international trading and currency conversion.
  • Generally, have higher liquidity since they are traded on major US exchanges. Higher liquidity means it is easier to buy and sell shares without significantly affecting the price.
  • Companies issuing ADRs typically provide more comprehensive financial information and disclosures in English, making it easier for North American investors to access and understand relevant information.
  • These securities are subject to stringent regulatory oversight from US exchanges (e.g., NYSE, NASDAQ) and the Securities and Exchange Commission (SEC), ensuring transparency and reduced fraud risk.
  • Are more widely recognized and accessible to Canadian and American investors, which can contribute to a perception of lower risk.
  1. ‘F’ at the end of the ticker (e.g., BYDDF):
  • Indicates that the security is a Foreign Ordinary Share, traded on the OTCM.
  • Tend to have lower liquidity because they are not traded on major exchanges. Lower liquidity can lead to larger bid-ask spreads and more price volatility.
  • Information may be less readily available, and what is available might not be as thorough or in English, making it harder for investors to make informed decisions.
  • Unlike ADRs, Foreign Ordinary Shares are not registered with the SEC. They trade on the OTCM, which generally has less regulatory oversight compared to major US exchanges.
  • Generally less accessible and less well-known, which can contribute to a perception of higher risk

In summary:

  • BYDDY is an ADR of BYD Company Ltd, allowing Canadian and American investors to trade it on US exchanges.
  • BYDDF represents the foreign ordinary shares of BYD Company Ltd, trading on the OTCM.

While both types of securities involve risks associated with investing in foreign companies, OTCM foreign ordinary shares (tickers ending with ‘F’) are generally considered riskier than ADRs (tickers ending with ‘Y’) due to lower regulatory oversight, lower liquidity, less information availability, and less market accessibility.

Canadian DRs

Let’s get more specific and explore a type of DR specifically designed for Canadian investors: The Canadian Depositary Receipt (CDR). While ADRs and GDRs have long been familiar, CDRs represent a newer option for investors. Managed by the Canadian Imperial Bank of Commerce (TSE: CM) and exclusively traded on the Cboe Canada Exchange (formerly Neo Exchange, now part of Cboe Global Markets since 2022), CDRs open up access to international companies listed on major US exchanges like the NYSE and Nasdaq for Canadian investors. You can trade CDRs through brokerage accounts that provide access to the Cboe Canada Exchange platform. Introduced in the summer of 2021, CDRs provide Canadian investors with a straightforward path to international investments, minus the complexities of currency conversions. Here’s how they work:

  • Investing in Global Companies: CDRs mirror shares of foreign companies typically listed on major US exchanges such as the NYSE or Nasdaq. By purchasing CDRs, investors gain exposure to foreign companies while trading in Canadian dollars on a Canadian exchange.
  • Convenience of trading in Canadian dollars: A major perk of CDRs is the ability to trade them in Canadian dollars. This eliminates the need for currency conversions, saving on foreign exchange fees and simplifying the investment process.
  • Built-in Currency Hedge: CDRs come with a built-in currency hedge, minimizing the impact of fluctuations between the Canadian dollar and the foreign currency (often US Dollars). This safeguard helps shield investments from currency volatility.
  • Fractional Shares: CDRs often represent fractions of a share of the foreign company, making it easier and more affordable for Canadian investors to buy into large-cap companies.
  • Trading Like Regular Stocks: CDRs are traded on Canadian exchanges just like conventional stocks and ETFs. They can be bought and sold through standard investment platforms.

Examples of CDRs include well-known companies like Apple (NEO: AAPL.NE), Nvidia, Berkshire Hathaway (NEO: BRK.NE), Walmart (NEO: WMT.NE), and Coca-Cola (NE: KO.NE). If you click on any of these links to the CDRs you will notice the CDR is much less than a share of the actual company. For example, compare the price of the Apple CDR with Apple stock (NASD: AAPL). You will see a significant difference. For an up-to-date list of available CDRs on Cboe Canada, consult their platform.

As with any investment, consider potential downsides to CDRs such as lower trading volumes leading to increased volatility, management fees impacting returns, and limited access to shareholder benefits like dividends and voting rights. Additionally, dividends paid to CDR holders may be subject to withholding tax, affecting net returns.

For Canadian investors seeking exposure to leading global companies while managing currency risks and transaction costs, CDRs offer a convenient and cost-effective avenue. Unlike buying shares on a US exchange, CDRs provide favorable currency conversion rates, trade at fractions of their US-listed counterparts, and minimizes the impact of currency fluctuations.

If you are interested in CDRs, check with your online broker or a financial planner to see if they are right for you.