Investing across jurisdictions: dual listings and depositary receipts

How can you own a foreign company’s shares?

Investors tend to hold too much of their own market, a pattern called home asset bias . Owning foreign shares offsets it. There are three routes, and the exam asks you to tell them apart by where the shares trade, in what currency, and who keeps the vote.

Owning foreign sharesoffsets home asset bias

• Direct investing Use it buy on the foreign market, in its currency
• Dual listing Memorize the company lists the same shares in two or more markets
• Depositary receipt (DR) Memorize a bank holds the shares; the receipt trades like a local share
  • American depositary receipt (ADR) Memorize non-US shares, traded in the US in USD
  • European depositary receipt (EDR) Memorize non-European shares, traded in euro markets
  • Global depositary receipt (GDR) Memorize issued outside the home country and the US; mostly USD
  • Other domestic schemes Know the idea for example Indian and Chinese depositary receipts

Direct investing: what it takes

Direct investing means buying the shares on the foreign company’s home market. It brings a list of practical costs:

• separate local securities and cash accounts, with setup and transaction costs, to handle trades, dividends and tax payments or rebates;
• the local trading, clearing, settlement and tax rules;
• foreign trading hours in different time zones, and often a language barrier;
• different standards of disclosure and different liquidity;
• everything in the local currency, which brings exchange-rate risk, possible capital restrictions and different tax effects.

Large institutions have the expertise and scale to do this, so they hold more foreign shares directly. Smaller and individual investors tend to hold fewer.

Dual listing: the same shares in two markets

A company does not have to issue shares only at home or in one market. Some list in a single market abroad. Others choose a dual listing : the same shares are listed and traded in two or more markets at once. A fictional Danish shipping group, for example, might list its shares in both Copenhagen and London, so investors in either city can buy the same shares in their own market.

Do not confuse this with a dual class structure, which gives classes different rights (see the previous lesson). A dual listing changes where the shares trade, not what rights they carry.

What is a depositary receipt?

The other way to hold a foreign share without opening foreign accounts is indirect investing , usually through a depositary receipt (DR). The foreign company’s shares are deposited with a domestic bank, the depository bank , which issues receipts that represent them. The bank also handles the dividends, which are paid in the receipt’s currency.

A DR trades on a local exchange like any local share, priced in local currency, and carries a proportional share of the foreign company’s economics. Receipts serve both sides: companies that want to raise capital beyond their home market, and investors (individuals above all) who want foreign shares without the cost and effort of direct investing. DRs are usually named after the market where they trade:

• An American depositary receipt (ADR) lets non-US shares trade in US markets in US dollars (USD). It is the oldest and largest DR market.
• A European depositary receipt (EDR) lets non-European shares trade in European markets, typically in euros (EUR).
• Other countries have tried their own schemes, such as Indian and Chinese depositary receipts (IDR, CDR) , with mixed success.

A global depositary receipt (GDR) is issued outside the company’s home country and outside the United States. London and Luxembourg were the first exchanges to trade them, and others, such as Dubai and Singapore, followed. 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.

The DR ratio, the price and the implied exchange rate

A receipt can stand for one share, several shares or a fraction of a share. The DR ratio , quoted as shares to DRs, sets how much of a share each receipt represents. “One share to five DRs” means each DR is worth one-fifth of a share. The receipt’s price follows the underlying shares and the exchange rate.

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

Here $Q$ is shares per DR (equal to 1 ÷ DRs per share, so “one share to four DRs” is $Q$ = 0.25), $P_{local}$ is the share price in the company’s home market, and $X$ is the home currency per one unit of the DR’s currency.

Turn the formula around and it gives the implied exchange rate : the rate that the share price and the DR price together imply. Compare it with the market rate to see whether the DR is in line with its shares.

$$X_{implied} = \frac{Q \times P_{local}}{P_{DR}}$$

The rate is home currency per USD here. When the home currency is the base of the quote (for example USD per EUR), put the ADR side on top.

When do DR prices drift from the shares?

In theory, arbitrage keeps a DR in line with its shares, but not always. DRs may trade at a discount to the shares in the home market, and some face restrictions or delisting. Two illustrations show how:

• If a regulator rules that receipts cannot be converted into the underlying shares, the arbitrage that held the two prices together stops working.
• After international sanctions, an exchange can suspend trading in a country’s DRs, leaving holders unable to sell. That is geopolitical risk.

A DR market also needs enough liquidity to be worth using.

Sponsored or unsponsored: who votes?

A sponsored depositary 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 greater reporting requirements (in the US, registration with the Securities and Exchange Commission (SEC)). An unsponsored depositary receipt is issued by a bank without the company’s involvement. The depository buys the shares in the home market and issues receipts through local brokers, and the depository bank keeps the voting rights. Reporting is lighter.

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

An investor whose policy is to vote every holding would therefore choose sponsored receipts.

The issuer’s view: home, foreign or global market

A company weighs the costs and benefits of issuing in the domestic, foreign and global equity markets : at home, in a foreign market that matters more for its sales or investors, or globally through several listings that use DRs to reach investors without draining liquidity from its main venue.

Issuer's choiceweigh costs against investors reached

• Domestic equity market Know the idea home currency, home regulator
• Foreign equity market Know the idea may matter more for sales or investors
• Global equity market Know the idea several listings using DRs, without draining liquidity from the main venue