Investing in foreign shares: direct, depository receipts and global shares

How can you own a foreign company’s shares?

There are four routes, and the exam asks you to tell them apart by who sets them up, where they trade and what currency they use.

Owning foreign sharesfrom your home market, or from theirs

• Direct investing Use it buy on the foreign exchange, in its currency
• Depository receipt (DR) Memorize a bank holds the shares; the receipt trades like a local share
  • American depository receipt (ADR) Memorize traded in the US, in USD
  • Global depository receipt (GDR) Memorize issued outside the home market and outside the US
• Global registered share (GRS) Memorize the share itself, traded in several markets and currencies
• Basket of listed DRs (BLDR) Use it a fund holding many depository receipts

Direct investing means buying the shares on the foreign exchange. Everything happens in the company’s currency: the purchase, the dividends and the sale. You must also follow that market’s trading, clearing and settlement rules, and deal with its disclosure standards. Foreign markets may be less liquid and audited information may be harder to get. Some countries also restrict foreign ownership, to limit outside control, to leave shares for domestic investors, or to calm capital flows.

For foreign shares there is a third source of return beside price change and dividends: foreign exchange gains (or losses) . If the foreign currency rises against yours, you earn a gain; if it falls, a loss. Lesson 4 shows how to calculate it.

The other three routes bring the foreign company to your market.

What is a depository receipt?

A depository receipt (DR) is a security that trades like a local share but represents an economic interest in a foreign company’s shares. The shares are deposited with a depository bank in the country where the receipts will trade. The bank issues the receipts, acts as custodian and registrar, and handles dividends, stock splits and tax events. Dividends are paid in the receipt’s currency.

A receipt can stand for one share, several shares or a fraction of a share. The ratio is fixed when the receipt is created. The receipt’s price follows the underlying shares and the exchange rate, and any gap between the two prices is quickly closed by traders.

$$P_{DR} = \frac{Q \times P_{local}}{X}$$

Here $Q$ is shares per receipt, $P_{local}$ the local share price, and $X$ the local currency units per USD.

Sponsored or unsponsored: who votes?

A sponsored depository receipt is set up with the foreign company’s direct involvement. Holders have the same rights as direct owners, including the vote and the dividend, and the company must meet more reporting requirements (in the US, Securities and Exchange Commission (SEC) registration). An unsponsored depository receipt is issued by a bank without the company’s involvement. The bank buys the shares and keeps the voting rights. Disclosure is lower.

Exam tip Sponsored: the company signed up, so holders vote. Unsponsored: the bank acted alone, so the bank votes.

What are GDRs and ADRs?

A global depository receipt (GDR) is issued outside the company’s home country and outside the United States, often in London or Luxembourg. Most are priced in USD. Because they are sold outside the home country, they avoid some foreign-ownership and capital-flow limits there. GDRs cannot be listed on US exchanges, although they can be placed privately with US institutions.

An American depository receipt (ADR) is a USD receipt that trades in the United States. The underlying shares that the receipts represent are the American depository share (ADS). There are four types of ADR, set by the amount of SEC registration.

ADR typesthe more SEC registration, the more you can do

• Level I Memorize over the counter; no new capital
• Level II Memorize listed on a US exchange; no new capital
• Level III Memorize listed; can raise capital in a public offering
• Rule 144A Memorize unlisted; raises capital by private placement to institutions

Level I is over the counter, with minimal registration, and cannot raise capital. Level II is listed on a US exchange with full registration but still cannot raise capital. Level III is listed and can raise capital in a public offering, and has the highest requirements. Under Rule 144A, a company sells ADRs privately to qualified institutional buyers without SEC registration.

What is a global registered share, and what is a BLDR?

A global registered share (GRS) is the actual common share, registered and traded in several markets in different currencies. A share bought in Toronto in Canadian dollars can be sold in London in pounds, with no need to exchange currency. That makes a GRS more flexible than a receipt, because it is the ownership interest itself.

A basket of listed depository receipts (BLDR) is an exchange-traded fund that holds a portfolio of depository receipts and tracks an index of them. One trade gives diversified exposure to many foreign companies.

Go deeper Why companies list abroad, and what it costs

A foreign listing builds awareness, widens the investor base and improves liquidity. Companies in smaller markets can raise capital more easily in deeper markets. A Level II or III listing brings the extra reporting duties, which raises transparency but also the compliance cost.

Go deeper The currency effect on a foreign share in one line

A DR holder’s return is (1 + local return) × (1 + currency return) − 1, because the currency moves apply to the whole investment. Lesson 4 works through an example and shows why you should not add the two returns.