A DR is a type of negotiable (transferable) financial security traded on a local stock exchange but represents a security, usually in the form of equity, issued by a foreign, publicly-listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depository receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.
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Since then, DRs have spread to other parts of the globe in the form of global depository receipts (GDRs). The other most common type of DRs are European DRs and International DRs. ADRs are typically traded on a US national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in US dollars, but can also be denominated in Euros.
History of Depository Reciepts
American Depositary Receipts have been introduced to the financial markets as early as April 29, 1927, when the investment bank J. P. Morgan launched the first-ever ADR program for the UK’s Selfridges Provincial Stores Limited (now known as Selfridges plc.), a famous British retailer.
Its creation was a response to a law passed in Britain, which prohibited British companies from registering shares overseas without a British-based transfer agent, and thus UK shares were not allowed physically to leave the UK.2
The ADR was listed on the New York Curb Exchange (predecessor to the American Stock Exchange.)
The regulation of ADR changed its form in 1955, when the U.S. Securities and Exchange Commission (SEC) established the From S-12, necessary to register all depositary receipt programs. The Form S-12 was replaced by Form F-6 later, but the principles remained the same till today.
Crucial novelties brought the new regulatory framework introduced by the SEC in 1985, which led to emergence of range of DR instruments, as we know it nowadays. Then the three different ADR programs were created, the Level I, II and III ADRs. This change was one of the impulses for revival of activity on the otherwise stagnant ADR market.
In April 1990, a new instrument, referred to as Rule 144A was adopted, which gave rise to private placement depositary receipts, which were available only to qualified institutional buyers (QIBs). This type of DR programs gained its popularity quickly and it is very frequently employed today.
The ADRs were originally constructed solely for the needs of American investors, who wanted to invest easily in non-US companies. After they had become popular in the United States, they extended gradually to other parts of the world (in the form of GDR, EDR or IDR). The greatest development of DRs has been recorded since 1989.
In December 1990, Citibank introduced the first Global Depositary Receipt. Samsung Corporation, a Korean trading company, wanted to raise equity capital in the United States through a private placement, but also had a strong European investor base that it wanted to include in the offering. The GDRs allowed Samsung to raise capital in the US and Europe through one security issued simultaneously into both markets.
In 1993, Swedish LM Ericsson raised capital through a rights offering in which ADDs were offered to both holders of ordinary shares and DR holders. The Ericsson ADDs represented subordinated debentures that are convertible into ordinary shares or DRs. German Daimler Benz AG became the first European Company to establish a Singapore depositary receipts program (SDRs) in May 1994.
Types of Depositary Receipts
American Depositary Receipts (ADR)
Companies have a choice of four types of Depositary Receipt facilities: unsponsored and three levels of sponsored Depositary Receipts. Unsponsored Depositary Receipts are issued by one or more depositaries in response to market demand, but without a formal agreement with the company. Today, unsponsored Depositary Receipts are considered obsolete and, under most circumstances, are no longer established due to lack of control over the facility and its hidden costs. Sponsored Depositary Receipts are issued by one depositary appointed by the company under a Deposit Agreement or service contract. Sponsored Depositary Receipts offer control over the facility, the flexibility to list on a national exchange in the U.S. and the ability to raise capital.
Sponsored Level I Depositary Receipts
A sponsored Level I Depositary Receipt program is the simplest method for companies to access the U.S. and non-U.S. capital markets. Level I Depositary Receipts are traded in the U.S. over-the-counter (“OTC”) market and on some exchanges outside the United States. The company does not have to comply with U.S. Generally Accepted Accounting Principles (“GAAP”) or full Securities and Exchange Commission (“SEC”) disclosure. Essentially, a Sponsored Level I Depositary Receipt program allows companies to enjoy the benefits of a publicly traded security without changing its current reporting process.
The Sponsored Level I Depositary Receipt market is the fastest growing segment of the Depositary Receipt business. Of the more than 1,600 Depositary Receipt programs currently trading, the vast majority of the sponsored programs are Level I facilities. In addition, because of the benefits investors receive by investing in Depositary Receipts, it is not unusual for a company with a Level I program to obtain 5% to 15% of its shareholder base in Depositary Receipt form. Many well-known multinational companies have established such programs including: Roche Holding, ANZ Bank, South African Brewery, Guinness, Cemex, Jardine Matheson Holding, Dresdner Bank, Mannesmann, RWE, CS Holding, Shiseido, Nestle, Rolls Royce, and Volkswagen to name a few. In addition, numerous companies such as RTZ, Elf Aquitaine, Glaxo Wellcome, Western Mining, Hanson, Medeva, Bank of Ireland, Astra, Telebrás and Ashanti Gold Fields Company Ltd. started with a Level I program and have upgraded to a Level II (Listing) or Level III (Offering) program.
Sponsored Level II And III Depositary Receipts
Companies that wish to either list their securities on an exchange in the U.S. or raise capital use sponsored Level II or III Depositary Receipts respectively. These types of Depositary Receipts can also be listed on some exchanges outside the United States. Each level requires different SEC registration and reporting, plus adherence to U.S. GAAP. The companies must also meet the listing requirements of the national exchange (New York Stock Exchange, American Stock Exchange) or NASDAQ, whichever it chooses.
Each higher level of Depositary Receipt program generally increases the visibility and attractiveness of the Depositary Receipt.
Private Placement (144A) Depositary Receipt
In addition to the three levels of sponsored Depositary Receipt programs that trade publicly, a company can also access the U.S. and other markets outside the U.S. through a private placement of sponsored Depositary Receipts. Through the private placement of Depositary Receipts, a company can raise capital by placing Depositary Receipts with large institutional investors in the United States, avoiding SEC registration and to non-U.S. investors in reliance on Regulation S. A Level I program can be established alongside a 144A program.
Global Depositary Receipts (GDR)
GDRs are securities available in one or more markets outside the company’s home country. (ADR is actually a type of GDR issued in the US, but because ADRs were developed much earlier than GDRs, they kept their denotation.) The basic advantage of the GDRs, compared to the ADRs, is that they allow the issuer to raise capital on two or more markets simultaneously, which increases his shareholder base. They gained popularity also due to the flexibility of their structure.
GDR represents one or more (or fewer) shares in a company. The shares are held by the custody of the depositary bank in the home country. A GDR investor holds the same rights as the shareholders of ordinary shares, but typically without voting rights. Sometimes voting rights can be the executed by the depositary bank on behalf of the GDR holders.
Mechanism – DR Trade
A Depositary Receipt is a negotiable security which represents the underlying securities (generally equity shares) of a non-U.S. company. Depositary Receipts facilitate U.S. investor purchases of non-U.S. securities and allow non-U.S. companies to have their stock trade in the United States by reducing or eliminating settlement delays, high transaction costs, and other potential inconveniences associated with international securities trading. Depositary Receipts are treated in the same manner as other U.S. securities for clearance, settlement, transfer, and ownership purposes. Depositary Receipts can also represent debt securities or preferred stock.
The Depositary Receipt is issued by a U.S. depositary bank, such as The Bank of New York, when the underlying shares are deposited in a local custodian bank, usually by a broker who has purchased the shares in the open market.
Once issued, these certificates may be freely traded in the U.S. over-the-counter market or, upon compliance with U.S. SEC regulations, on a national stock exchange.
When the Depositary Receipt holder sells, the Depositary Receipt can either be sold to another U.S. investor or it can be canceled and the underlying shares can be sold to a non-U.S. investor.
In the latter case, the Depositary Receipt certificate would be surrendered and the shares held with the local custodian bank would be released back into the home market and sold to a broker there.
Additionally, the Depositary Receipt holder would be able to request delivery of the actual shares at any time. The Depositary Receipt certificate states the responsibilities of the depositary bank with respect to actions such as payment of dividends, voting at shareholder meetings, and handling of rights offerings.
Depositary Receipts (DRs) in American or Global form (ADRs and GDRs, respectively) are used to facilitate cross-border trading and to raise capital in global equity offerings or for mergers and acquisitions to U.S. and non-U.S. investors.
Demand For Depositary Receipts
The demand by investors for Depositary Receipts has been growing between 30 to 40 percent annually, driven in large part by the increasing desire of retail and institutional investors to diversify their portfolios globally. Many of these investors typically do not, or cannot for various reasons, invest directly outside of the U.S. and, as a result, utilize Depositary Receipts as a means to diversify their portfolios. Many investors who do have the capabilities to invest outside the U.S. may prefer to utilize Depositary Receipts because of the convenience, enhanced liquidity and cost effectiveness Depositary Receipts offer as compared to purchasing and safekeeping ordinary shares in the home country. In many cases, a Depositary Receipt investment can save an investor up to 10-40 basis points annually as compared to all of the costs associated with trading and holding ordinary shares outside the United States.
Depositary Receipts are issued or created when investors decide to invest in a non-U.S. company and contact their brokers to make a purchase.
Brokers purchase the underlying ordinary shares and request that the shares be delivered to the depositary bank’s custodian in that country.
The broker who initiated the transaction will convert the U.S. dollars received from the investor into the corresponding foreign currency and pay the local broker for the shares purchased.
The shares are delivered to the custodian bank on the same day, the custodian notifies the depositary bank.
Upon such notification, Depositary Receipts are issued and delivered to the initiating broker, who then delivers the Depositary Receipts evidencing the shares to the investor.
Transfer – (Intra-Market Trading)
Once Depositary Receipts are issued, they are tradable in the United States and like other U.S. securities, they can be freely sold to other investors. Depositary Receipts may be sold to subsequent U.S. investors by simply transferring them from the existing Depositary Receipt holder (seller) to another Depositary Receipt holder (buyer); this is known as an intra-market transaction. An intra-market transaction is settled in the same manner as any other U.S. security purchase. Accordingly, the most important role of a depositary bank is that of Stock Transfer Agent and Registrar. It is therefore critical that the depositary bank maintain sophisticated stock transfer systems and operating capabilities.
What are Indian Depository Receipts (IDRs)?
IDRs are transferable securities to be listed on Indian stock exchanges in the form of depository receipts created by a Domestic Depository in India against the underlying equity shares of the issuing company which is incorporated outside India.
As per the definition given in the Companies (Issue of Indian Depository Receipts) Rules, 2004, IDR is an instrument in the form of a Depository Receipt created by the Indian depository in India against the underlying equity shares of the issuing company. In an IDR, foreign companies would issue shares, to an Indian Depository (say National Security Depository Limited – NSDL), which would in turn issue depository receipts to investors in India. The actual shares underlying the IDRs would be held by an Overseas Custodian, which shall authorise the Indian Depository to issue the IDRs. The IDRs would have following features:
Overseas Custodian: Foreign bank having branches in India and requires approval from Finance Ministry for acting as custodian and Indian depository has to be registered with SEBI.
Approvals for issue of IDRs : IDR issue will require approval from SEBI and application can be made for this purpose 90 days before the issue opening date.
Listing : These IDRs would be listed on stock exchanges in India and would be freely transferable.
Eligibility conditions for overseas companies to issue IDRs:
Capital: The overseas company intending to issue IDRs should have paid up capital and free reserve of atleast $ 100 million.
Sales turnover: It should have an average turnover of $ 500 million during the last three years.
Profits/dividend : Such company should also have earned profits in the last 5 years and should have declared dividend of at least 10% each year during this period.
Debt equity ratio : The pre-issue debt equity ratio of such company should not be more than 2:1.
Extent of issue : The issue during a particular year should not exceed 15% of the paid up capital plus free reserves.
Redemption : IDRs would not be redeemable into underlying equity shares before one year from date of issue.
Denomination : IDRs would be denominated in Indian rupees, irrespective of the denomination of underlying shares.
Benefits : In addition to other avenues, IDR is an additional investment opportunity for Indian investors for overseas investment.
Taxation issues for Indian Depository Receipts (IDRs)
Standard Chartered Banks’s Indian Depository Receipts (IDR) issue may raise concerns relating to tax treatment, the draft red herring prospectus (DRHP) filed by the bank with SEBI said. The UK-based bank’s draft red herring prospectus was uploaded on the SEBI’s website in end-March. “The Income Tax Act and other regulations do not specifically refer to the taxation of IDRs. IDRs may therefore be taxed differently from ordinary listed shares issued by other companies in India”, the prospectus said. “In particular, income by way of capital gains may be subject to a higher rate of tax”.
The introduction of the Direct Tax Code from the next fiscal may also alter tax treatment of Indian Depository Receipts. “The tax treatment in future may also vary depending on the provisions of the proposed Direct Taxes Code which is currently due to take effect from April 1, 2011, and which is only in draft form at this time”, Standard Chartered PLC has mentioned among the possible risk factors.
Economic development and volatility in the securities markets in other countries may cause the price of the IDRs to decline, the prospectus said. Any fluctuations that occur on the London Stock Exchange or the Hong Kong Stock Exchange that affect the price of the shares may affect the price and trading of the IDRs listed on the stock exchanges.
Further, the draft red herring prospectus states to what extent IDRs are legal investments, whether they can be used as collateral for various types of borrowing, and whether there are other restrictions that apply to purchase or pledge of the Indian Depository Receipts.
How are IDRs different from GDRs and ADRs?
GDRs and ADRs are amongst the most common DRs. When the depository bank creating the depository receipt is in the US, the instruments are known as ADRs. Similarly, other depository receipts, based on the location of the depository bank creating them, have come into existence, such as the GDR, the European Depository Receipts, International Depository Receipts, etc. ADRs are traded on stock exchanges in the US, such as Nasdaq and NYSE, while GDRs are traded on the European exchanges, such as the London Stock Exchange.
How will the IDRs be priced, and will cross-border trading be allowed?
IDRs will be freely priced. However, in the IDR prospectus, the issue price will have to be justified as is done in the case of domestic equity issues. Each IDR will represent a certain number of shares of the foreign company. The shares will be listed in the home country. Normally, the DR can be exchanged for the underlying shares held by the custodian and sold in the home country and vice-versa. However, in the case of IDRs, automatic fungibility i.e. the quality of being capable of exchange or interchange is not permitted.
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What are the benefits of issuing IDRs to companies?
Currently, there are over 2,000 Depositary Receipt programs for companies from over 70 countries. The establishment of a Depositary Receipt program offers numerous advantages to non-U.S.companies. The primary reasons to establish a Depositary Receipt program can be divided into two broad considerations: capital and commercial.
Expanded market share through broadened and more diversified investor exposure with potentially greater liquidity.
Enhanced visibility and image for the company’s products, services and financial instruments in a marketplace outside its home country.
Flexible mechanism for raising capital and a vehicle or currency for mergers and acquisitions.
Enables employees of U.S. subsidiaries of non-U.S. companies to invest more easily in the parent company.
Quotation in U.S. dollars and payment of dividends or interest in U.S. dollars.
Diversification without many of the obstacles that mutual funds, pension funds and other institutions may have in purchasing and holding securities outside of their local market.
Elimination of global custodian safekeeping charges, potentially saving Depositary Receipt investors up to 10 to 40 basis points annually.
Familiar trade, clearance and settlement procedures.
Competitive U.S. dollar/foreign exchange rate conversions for dividends and other cash distributions.
Ability to acquire the underlying securities directly upon cancellation.
Benefit for Investors
They allow global investing opportunities without the risk of investing in unfamiliar markets, ensure more information and transparency and improve the breadth and depth of the market. Increasingly, investors aim to diversify their portfolios internationally. However, obstacles such as undependable settlements, costly currency conversions, unreliable custody services, poor information flow, unfamiliar market practices, confusing tax conventions and internal investment policy may discourage institutions and private investors from venturing outside their local market.
Why will foreign companies issue IDRs?
Any foreign company listed in its home country and satisfying the eligibility criteria can issue IDRs. Typically, companies with signifi-cant business in India, or an India focus, may find the IDR route advantageous. Similarly, the foreign entities of Indian companies may find it easier to raise money through IDRs for their business requirements abroad.
Besides IDR there are several other ways to raise money from foreign markets
Foreign Currency Convertible Bonds (FCCBs): FCCBs are bonds issued by Indian companies and subscribed to by a non-resident in foreign currency. They carry a fixed interest or coupon rate and are convertible into a certain number of ordinary shares at a preferred price. This equity component in a FCCB is an attractive feature for investors. Till conversion, the company has to pay interest in dollars and if the conversion option in not exercised, the redemption is also made in dollars. These bonds are listed and traded abroad. The interest rate is low  but the exchange risk is more in FCCBs as interest is payable in foreign currency. Hence, only companies with low debt equity ratios and large forex earnings potential opt for FCCBs.
The scheme for issue of FCCBs was notified by the government in 1993 to allow companies easier access to foreign capital markets. Under the scheme, bonds up to $50 million are cleared automatically, those up to $100 million by the RBI and those above that by the finance ministry. The minimum maturity period for FCCBs is five years but there is no restriction on the time period for converting the FCCBs into shares.
External Commercial Borrowings (ECBs): Indian corporate are permitted to raise finance through ECBs (or simply foreign loans) within the framework of the policies and procedures prescribed by the Government for financing infrastructure projects. ECBs include commercial bank loans; buyers’/suppliers’ credit; borrowing from foreign collaborators, foreign equity holders; securitized instruments such as Floating Rate Notes (FRNs) and Fixed Rate Bonds (FRBs); credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial institutions such as the IFC, ADB and so on. While the ECB policy provides flexibility in borrowings consistent with maintenance of prudential limits for total external borrowings, its guiding principles are to keep borrowing maturities long, costs low and encourage infrastructure/core and export sectors financing, which are crucial for overall growth of the economy
Since 1993, many of the firms have chosen to use the offshore primary market instead of the domestic primary market for raising resources. The factors that can be attributed to this behaviour are as follows.
(i) The time involved in the entire public issue on the offshore primary market is shorter and the issue costs are also low as the book building procedure is adopted.
(ii) FIIs prefer Euro issues as they do not have to register with the SEBI nor do they have to pay any capital gains tax on GDRs traded in the foreign exchanges. Moreover, arbitrage opportunities exist as GDRs are priced at a discount compared with their domestic price.
(iii) Indian companies can collect a large volume of funds in foreign exchange from international markets than through domestic market.
(iv) Projections of the GDP growth are very strong and consistent which have created a strong appetite for Indian paper in the overseas market.
(v) An overseas issuance allows the company to get exposure to international investors, thereby increasing the visibility of Indian companies in the overseas market.
Money Raising Instruments in India
Qualified institutions placement (QIP): A designation of a securities issue given by the SEBI that allows an Indian-listed company to raise capital from its domestic markets without the need to submit any pre-issue filings to market regulators, which is lengthy and cumbersome affair. SEBI has issued guidelines for this relatively new Indian financing avenue on May 8, 2006. Prior to the innovation of the qualified institutional placement, there was concern from Indian market regulators and authorities that Indian companies were accessing international funding via issuing securities, such as American depository receipts (ADRs), in outside markets. This was seen as an undesirable export of the domestic equity market, so the QIP guidelines were introduced to encourage Indian companies to raise funds domestically instead of tapping overseas markets.
QIP has emerged as a new fund raising investment for listed companies in India. The issue process is not only simple but can be completed speedily. QIP issue can be offered to a wider set of investors including Indian mutual funds, banks, insurance companies and FIIs. A company sells its shares to qualified institutional buyers (QIBs) on a discretionary basis with the two-week average price being the floor. In a QIP, unlike an IPO or PE investment, the window is shorter (four weeks) and money can be raised quickly. This rule came into being after SEBI changed the pricing formulae. Earlier, the pricing was based on the higher of the six-month or two-week average share price This turned out to be a dampener in a volatile market
However, merchant bankers gave the feedback that the two-week average price often worked out to be higher than the current market price. As such, many investors were reluctant to take a mark-to-market loss on their books right from the start.
Rights issues: In other words, it is the issue of new shares in which existing shareholders are given preemptive rights to subscribe to the new issue on a pro-rata basis. Such an issue is arranged by an investment bank or broker, which usually makes a commitment to take up its own books any rights that are not sold as part of the issue. The right is given in the form of an offer to existing shareholders to subscribe to a proportionate number of fresh, extra shares at a pre-determined price.
In India rights market has been a favoured capital mobilizing route for the corporate sector. However, this market has shrunk significantly in India over the years. This is due to an absence of a trading platform for the post issue trading rights.
Private placement: The direct sale of securities by a company to some select people or to institutional investors (financial institutions, corporates, banks, and high net worth individuals) is called private placement. In other words, private placement refers to the direct sale of newly issued securities by the issuer to a small number of investors through merchant bankers. Company law defined privately placed issue to be the one seeking subscription from 50 members. No prospectus is issued in private placement. Private placement covers equity shares, preference shares, and debentures  . It offers access to capital more quickly than the public issue and is quite inexpensive on account of the absence of various issue expenses.
In recent years resource mobilization through private placement route has subdued. The reason is stricter regulations introduced by RBI and SEBI starting from early 2000s on private placements. When RBI found that banks and institutions had larger exposure in the private placement market, it has issued guidelines to banks and financial institutions for investment in such cases. 
Comparison ADR/GDR Vs. QIP
The First Wave of Indian Fundraising: QIPs
Unitech set the QIP ball rolling on what is really the first major wave of India’s recent fund-raising jamboree. Indian companies raised US$24 billion in the April-June quarter of 2009, according to data from Delhi-based research firm Prime Database. Of this, 56% was raised in the last week of June, an indicator of the increasing tempo of action.
According to Prime Database chairman Prithvi Haldea “QIPs cornered over 96% of the total money mobilized” during that quarter. Ten QIPs were issued, totaling US$22.5 billion. The leading issuers included
Unitech (US$900 million)
Indiabulls Real Estate (US$530 million)
HDIL (US$330 million)
Sobha Developers (US$100 million)
Shree Renuka Sugars (US$100 million)
PTC (US$100 million).
Hong Kong-based Finance Asia magazine said in its headline that India has gone QIP crazy
But as other instruments started gaining favor the QIP wave appeared to be weakening. The QIBs don’t see a huge bargain any longer. When companies were relatively desperate for funds, they were offering prices that left a lot on the table for buyers. Unitech is a case in point. The first issue gave returns of 100% plus. A record Rs 34,100 crore were raised by the 51 QIPs made during the year 2009
According to a study by rating agency Crisil, most QIPs in 2009 were actually making losses for investors. The study used the prices on July 10, although the markets have improved since then. Still, says Crisil, as of that date, if you leave out the first Unitech issue, the total return on all QIPs was a negative 12%.
As per head of equities at CRISIL “We expect raising capital through the QIP route may slow down significantly,” He further explains that the significant run up in stock prices before the Union Budget made QIP deals unattractive. The reason being that shrewd investors made their decisions based on company fundamentals and there was no reason to believe that the inherent fundamentals of most companies which queued up for QIPs have changed materially.
Not all QIPs have been successful. GMR Infrastructure received its shareholders’ permission to raise up to US$1 billion through this route. According to merchant bankers, it came to the market with an offering of US$500 million, then reduced both the size of the offering and the price in the face of a tepid response, and finally withdrew altogether.
However, according to Haldea, several more QIPs — including Hindalco, Cairn Energy, GVK Power, HDFC, JSW Steel, Essar Oil, Parsvanath and Omaxe — are waiting in the wings, looking to raise more than US$12 billion. QIPs could become attractive again if the market falls or if companies start offering large discounts, investment experts say.
Increased Activity for ADR/GDR
The slowdown in the QIP wave does not mean that foreign investors — who, as in the Unitech issue, were the principal buyers — have lost interest in India. In fact, the reverse could be true. Indian fundraising has now embarked on its second wave — through American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). (ADRs are foreign stock stand-ins traded in U.S. exchanges but not counted as foreign stock holdings. A U.S. bank buys the shares on a foreign market and trades a claim on those shares. Many U.S. investors are attracted to ADRs because these securities may meet accounting and reporting standards that are more stringent than
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