Why do I need depository receipts?

What is a depository receipt?

An investor cannot always buy stocks and bonds of foreign companies that interest him. If he wants to invest in securities that are traded only abroad, he has to conclude contracts with a foreign broker and a depository and deal with the specifics of taxation.

A depository receipt is a tool that allows you to invest money in foreign securities, while remaining on the usual exchange, through your broker. In addition, it allows you to save on commissions.

In fact, a depository receipt is a certificate of ownership of a security that is traded on a foreign platform. And there are very few securities of Chinese and Japanese corporations on the market — investors can invest in them only through depositary receipts.

Now qualified investors can purchase receipts.

How does the mechanism for issuing receipts work?

Before entering any local market, the company estimates the effort and time spent on the placement of its securities. After all, in order to start trading its shares on the stock exchange, a company must pass accreditation. Moreover, different exchanges may have very different requirements. And on the exchanges of some countries, foreign companies are completely prohibited from placing their shares directly. Therefore, it is often much easier and cheaper to attract foreign investors through a universal tool — the issuance of depositary receipts.

For example, the conditional Chinese company SimSim decided to issue depositary receipts for its shares.

First, she arranges with one of the Chinese depositories to act as her custodian — custodian of the shares for which the receipts will be issued. This depository buys the required number of SimSim shares and becomes their nominal holder.

After that, either the custodian himself or another depository bank, in agreement with SimSim, issues depositary receipts for its shares and then places them on exchanges in different countries.

Now foreign investors will be able to buy SimSim depositary receipts through their broker and actually become owners of the company's shares.

What kind of receipts are there?

Depository receipts differ by the territory in which the company plans to sell their main part. The most common of them are American (denoted ADR or ADR), global (GDR or GDR) and European (EDR or EDR).

What is the benefit of depository receipts?

Depository receipts allow the investor to diversify the composition of the portfolio at the expense of foreign stocks and bonds. After all, they often bring good returns.

When receipts are traded on the stock exchange, they can be bought and sold in the same way as stocks and bonds themselves.

Receipts give almost the same rights as the securities on which they are issued. The owner of receipts for shares receives the right to dividends, and the holder of receipts for bonds receives the right to coupon payments. Holders of share receipts can also participate in the management of the company. The depository bank sends the shareholders' meeting agendas to the holders of receipts and transmits their decisions to the meeting.

Receipts are often issued in several denominations, which correspond, for example, to one, two, ten shares or, conversely, a share of a share. Sometimes these denominations allow an investor to invest even in those securities that he cannot afford. For example, when the price of one share is several thousand dollars, you can buy a receipt for 1/10 of its share.

The value of securities and receipts for them, as a rule, coincides — taking into account the conversion of the exchange rate and the nominal value of the receipts.

In terms of reliability, securities and receipts for them almost do not differ. When issuing receipts, additional intermediaries appear — the custodian and the depository bank, but, as a rule, these are large and stable organizations.

What are the risks of receipts?

As in the case of stocks and bonds, investments in depositary receipts are not insured by the state, and income is not guaranteed. And the higher the potential profit, the higher the risk of losing everything.

To predict the value of foreign securities and receipts for them, you need to follow the news of foreign companies. It can be much more difficult to search for such information, for example, in Chinese.
There is a risk, although not great, that the custodian or the depository bank will have its license revoked. If their accounts are blocked, investors will not be able to receive income from their receipts or sell them. Then the owners of the receipts will have to involve international lawyers to sue bankrupt banks under the laws of other countries.

Investments in foreign assets are also associated with political risk. Due to the sanctions, many investors cannot dispose of their foreign securities, receive dividends and coupons on them. This restriction also applies to depositary receipts.

It is important to keep in mind that when companies issue receipts abroad, their papers are also considered foreign and may be blocked.

Now most domestic companies are winding down their depositary receipt programs and converting them into shares that investors can freely dispose of. For more information about how the exchange will take place, read the text "What to do to holders of depositary receipts in 2022".

Paying income taxes on receipts, as well as on foreign stocks and bonds, is a little more difficult than on securities. Whether it is necessary to pay personal income tax on the income from the difference between the purchase and sale price, the broker evaluates. And in cases where it is necessary, it automatically calculates, withholds and sends the tax to the Federal Tax Service (FTS).

But the income tax on dividends and coupons from foreign securities and receipts must always be paid. Moreover, you will have to file a 3-NDFL declaration and transfer money to the tax service yourself.

The securities themselves and the receipts for them are presented on the exchange. Which is better to choose?

It makes no sense to buy receipts when you can buy the shares or bonds for which they are issued. In fact, these are the same securities, but additional intermediaries appear in the transaction-banks, and taxation becomes more complicated.

Brokers in their applications sometimes do not label receipts in any way, considering them a complete analogue of shares.

Are all receipts available to novice investors?

If the receipts are included in the first or second quotation lists of the exchange, even beginners can conduct transactions with them.

Receipts for shares of the largest foreign companies, which are included in the calculation of the leading stock indices, are also freely sold.

In other cases, unqualified investors will have to undergo testing before purchasing depositary receipts. For more information about how tests are conducted and who can become a qualified investor and invest in any instruments, read the article "What to invest in for a beginner on the stock exchange and what gives the status of "quala".

In what cases is it worth buying receipts?

Investments in depository receipts are justified if you really want to invest in the securities of a particular company, and its shares are not traded on our exchange - there are only receipts.

If you decide to send money to depository receipts, it is important to adhere to the general rules of investment:

  1.  You cannot invest the last money in such investments — you must have an airbag. For example, a deposit in a reliable bank in the amount of three to six monthly incomes.
  2.  It is important to remember about the direct dependence of risk and profitability: the faster securities grow in price, the more sharply they can fall in price.
  3.  Depository receipts of one company should not occupy your entire portfolio — distribute investments between securities of different companies, preferably from different industries.

After buying securities or receipts for them, you need to monitor what is happening to the company and how this may affect the value of its shares and bonds. If it is still difficult for you to independently monitor the situation on the stock market, it is better to transfer your money to trust management or invest in a mutual fund that invests in these securities.

During the sanctions period, it is worth carefully assessing the risk of buying foreign securities, even if some broker gives such an opportunity.