Depository receipts are those instruments that are issued in the international capital markets, via the issue of equity. Let’s consider a very simple example. Let us say that there is a company in India, which is willing to raise funds overseas. The question here is, how can an Indian company raise funds from the people residing in international economies? This is possible through the system of depository receipts.
Now, if an Indian company wants to engage some prospective investors from Abroad, would they directly sell the equity shares to the investors overseas? Obviously not. Therefore, the first intermediary comes into picture, known as a “Overseas Depository Bank”. The term overseas used over here is used in context of the India company that aims to attract overseas funding. Now coming to the most important question. What role will this “Overseas Depository Bank” play in the entire system? A Depository bank plays a substantial role because this is the bank which will issue shares in the overseas country. How will they? Simple! The company that is aiming to issue shares abroad, will issue the shares to this Overseas bank, and this depository bank, when it receives its shares, it will issue receipts or certificates or instruments, known as “Depository Receipts”. This conveys that the shares will be under the custody of the Overseas depository bank, and it gives receipt holders the right to trade these receipts same as the shares of the company. However, there is a catch in this entire process! GDRs are issued against the shares received by the Depository bank; however, the shares are still under the custody of the bank and are not practically transferred to the receipt holders. Now since we know about the international flow of these shares, let’s talk about the Indian scenario. In the domestic sense, another intermediary gets involved, and that is known as a “Domestic Custodian”. As the name suggests, the domestic Custodian would be located in that country in which the company issuing shares is located. In our example, the Indian economy. Now, how important is this Domestic custodian in the entire system? The Domestic Custodian is the entity, which will be the agent of the overseas depository bank. In other words, this domestic custodian will be the first entity to receive the equity shares from the Indian Company. In due course of time, the Indian company deposits its shares in this Domestic Custodian. Now, as soon as the custodian receives the shares of the Indian company, it will immediately provide acknowledgement of the share deposits to the Overseas Depository Bank. Now once the acknowledgement is received, the overseas bank will now issue GDRs. Once this entire process is completed, the depository bank will now deduct certain charges related to the issue, and then the remaining balance would now be transferred to the Indian company.
Since we know about the process of issue of GDRs, let’s list down certain benefits of investing in them.
i. Diversification of Portfolio: A rational investor would never put all his money in one particular financial instrument. Hence, investors can use this particular financial instrument in order to diversify their portfolio of securities and hence aim towards maximisation of returns and minimisation of risk.
ii. Simplification of the process: Investment in international companies can be complex and sometimes might not be available to all investors in an economy. Hence, GDRs allow more investors to invest in international companies with strong growth prospects.
iii. Liquidity Aspect: Global depository receipts are as good as equity shares when we talk about its liquidity. Global Depository Receipts purely work on the system of Demand and Supply. Hence, liquidity is also involved in this financial instrument which can facilitate investors to achieve their financial goals by proper execution of investment strategies
iv. Increase in Shareholder Base of the company: In the above 2 points we discussed the advantages from the perspective of investors. However, even companies are benefited by the issue of these GDRs. If a company issues a GDR abroad, the company will get access to a huge shareholder base, enabling the company to tap another major source of funds.
v. International Attention and Coverage: If a company is being prevalent in foreign economies, it’s pretty obvious that the company will attract more attention and coverage from investors across the globe. Hence, there is a possibility that investors might consider the company as a prospective investment target, and this entire process would therefore be in favour of the company making global presence.
Considering the entire concept of GDR and its implications, let’s now consider what can be certain risks attached to it:
i. Aspect of Taxation: This is considered to be a very important factor that holds back people from investing in these receipts. Since there is an involvement of a country located overseas, there is a possibility that the taxation process might be a bit complex which would discourage prospective investors from investing in this financial instrument.
ii. Limited Selection of Companies offering GDRs: Not all companies are allowed to issue GDRs in the global financial markets. For an instance, in the Indian Economy, the SEBI keeps on revising the turnover limit to allow only certain companies to issue GDRs.
iii. Currency and Political Risk: This risk has a substantial part in the system of GDRs. Since the investor is dealing with another country, there is a huge risk of currency rate fluctuations which might not be favourable to the investor’s financial objectives and would have a major impact on the position of his holdings in case of adverse circumstances.
The Indian Scenario with respect to ADRs (American Depository Receipts): ADRs and GDRs are almost similar to each other except for the fact that GDRs are traded outside the American Markets, while ADR’s are specifically traded in the American markets. Recently, the SEBI-Securities and Exchange Board of India, brought in liberalised norms for depository receipts, that aimed at giving Indian companies increased access to Foreign funds through ADRs/GDRs.
Several Indian companies have already made a presence in global financial markets. To name a few, companies like Dr. Reddy’s Laboratories, Infosys Ltd, Wipro Ltd, ICICI Bank Ltd, HDFC Bank Ltd, and many more.
But the important question over here is -Why would Indian companies issue GDRs rather than just launching an FPO-Follow on Public Offer or via Private Equity?
The reason is very simple. Raising funds through GDRs is one of the easiest ways of raising funds from the other countries. Secondly, the GDRs are not subject to lock-in periods, as would be the case in preferential allotment of shares. Third and the most important point, the issue of GDRs is a win-win situation for both, the investors and the company issuing the GDR. When an investor needs to exit his position, the holding depository will simply convert the GDR of the investor into shares and sell them on the floor of the stock exchange, hence there is no obligation on the issuer company in this case.
One of the major benefits of GDR, from the perspective of notifications received from SEBI, is that GDRs can be extremely useful when there is an overall economic slowdown backed by reluctancy in borrowing funds due to the fear of default in future. In such a scenario, if a company is eligible to issue GDRs, it can easily do it and therefore manage its operating expenses and ensure an efficient working capital management.
Considering all aspects related to the GDRs in global financial markets, it can be implied that there are companies that opt for that kind of a route to raise funds overseas. Considering the pros and cons of the financial instrument, several factors should be considered before investing in the depository receipts. Such factors include, risk taking capacity, portfolio objectives, time period of investing, etc. When an investor thoroughly understands these factors, only then a decision of GDR investment can be made, which can prove to be a great investment for diversification purposes and risk maximisation.
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Good succinct explanation of GDR/ADR.
I have one query: If a company issues GDR/ADR then its equity is diluted. It means that it may not always be in the interest of existing share holders. Isn’t it so? Please guide.