Depositories- Meaning & Its Types

By | July 23, 2019
Depository

Meaning of ‘Depository’

A depository can be defined as a firm or an individual with the capacity to keep the securities safely. In simple terms, depository can be understood as a storing place where one can deposit something in order to secure it from the outer world. They are the companies which are formed and got registered under the Companies Act, 2013 and got a Certificate of Registration under subsection (1A) of Section 12 of SEBI Act, 1992.

If any individual has entered into an agreement with any depository, he is required to provide the Certificate of Security of the depository, which he wants to avail the services. All the securities, which are dealt with by a depository, must be in fungible as well as dematerialised form. A depository will be considered to be the enlisted owner on behalf of a beneficial owner for the reasons for effecting the transfer of ownership.

An institution that is used for storing the securities in a dematerialised form is known as depository. In India, there are two types of depositories viz., NSDL (National Securities Depository Limited) and CSDL (Central Depository Services (India) Limited). Depository Participants (DP) are the agents of these depositories. With the help of DPs, the depositories interface with the investors. Banks (foreign, public and private), sub- registered trading members and financial institutions are the various forms of Depositories.

Transferring ownership of shares from the account of one investor to the account of another investor whenever trade takes place forms one of the main functions of the Depository. Moreover, another main function of the depository is that it removes most of the risks in the form of damage, loss, delay bin deliveries or theft, which are attached with the physical form of securities.

Recognition of Securities

There are many foreigners who invest in India and with the help of international factor movement, they control the ownership of the business in our country. Bonds and public stocks are the forms of foreign portfolio investment, which is a kind of passive investment in the securities of some other country. However, they are not in anyone’s control. But foreign direct investment becomes an important factor for controlling management and technology.

In 1991, the Government of India allowed investment in our country through foreign agencies under the Foreign Exchange Management Act (FEMA). This Act empowered foreigners to control ownership in a business in India by the means of foreign direct investment. This was done as per the agreements with World Trade Organisations.

Depository Receipts

A ‘depository receipt’ can be defined as a form of transferrable and negotiable financial security which can be used for trading on a local stock exchange yet it depicts security, mostly in the nature of equity, which is issued by any public listed company or a foreign company. It is a kind of physical certificate, which allows all the investors to possess shares in the equity of the country.

Whenever a foreign company shows its willingness to get its securities listed on the stock exchange of another company, a Depository Receipt (DR) is created. There are various criteria which a country provides for listing securities in its stock exchange, the company is required to fulfil these requirements. The share of a foreign company, which is represented by the DR, is supplied and stored with the help of the custodian bank of depository, which is entitled to create DR. This process is followed before a DR is created. Whenever the shares are delivered by the custodian bank, a DR gets created and issued by the depository to the investors of that country, where DR gets listed. Then, these DRs get listed as well as traded in the local stock exchange of another country.

Various kinds of Depository Receipts are present in the global market. Some of which are as follows:

  1. Indian Depository Receipt (IDRs)
  2. The American Depository Receipt (ADRs)
  3. The Global Depository Receipt (GDRs)
  4. The European Depository Receipt (ADRs), etc.

Indian Depository Receipt (IDRs)

A financial device which is dominated in Indian Rupees is known as Indian Depository Receipt (IDRs). It is a type of depository receipt which is generated by a Domestic Depository (Custodian of Securities which is registered with the SEBI) against the principal equity of the issuer which helps the foreign companies to raise money from the Securities Market of India.

These securities are transferrable in nature and get listed on Stock Exchange of  India in the nature of depository receipts which are generated by Domestic Depository of India against the principal equity shares of the issuer that is a company not incorporated in India.

IDR is priced freely. However, it is essential to justify the issue price of IDR in its prospectus as it is done whenever domestic equity is issued. Each IDR is used to depict a fixed quantity of shares for the foreign company. The shares always get listed in their home country. Typically, DRs are capable of getting exchanged for underlying shares which are possessed by the custodian and can be sold in the home country and vice-versa. Automatic fungibility is not allowed in the case of IDRs.

American Depository Receipt (ADRs)

A negotiable instrument which is used to represent security on behalf of a non- American Company for trading in the financial market of America is known as an American Depository Receipt (ADRs).

With the help of ADRs, shares of a lot of non- American Companies trade on American Stock Exchange. ADRs pay dividends and are denominated in American Dollar and are likely to be treated as a regular share of stock. ADRs are used for trading with the help of American broker-dealers during the American trading hours. Investing in foreign security has become easier because of the depository banks which is entitled to manage all the issued relating to custody, currency and local taxes.

American Depository Receipt can be considered as the domestic equivalent of GDR (Global Depository Receipt). American Depository Shares are the securities of the foreign company which are depicted by ADRs.

In 1927, J. P. Morgan introduced first ADR for the British retailer Selfridges on the New York Curb Exchange, which is the precursor of the Stock Exchange of America. One of the many kinds of depository receipts (DR) is ADR. It is negotiable instruments, which is used to represent the shares of various companies, which are foreigners for the market which is used for trading the DR. It empowers domestic investors to purchase various kinds of securities issued by foreign companies even without accompanying any risk and inconvenience of any kind of cross-currency or cross- border transactions.

A domestic custodian bank is used to issue each ADR when an underlying share is stored in any foreign depository bank, normally with the help of brokers who have already bought the securities from the open market, which is local to the foreign companies. An ADR is capable to depict multiple shares, a single share or a fraction of share of any foreign security. The owner of an ADR is entitled to receive underlying foreign security which is represented by the DR, but it more convenient for investors to own the DRs. The value of foreign security in its home market is generally tracked by the price of a DR, which is adjusted for the ratio of DRs to the shares of foreign company.

For instance, if a company is domiciled in Australia, creation of ADRs attracts a creation fee of 1.5% (creation fee is different from the stamp duty reverse tax charge by the Government of Australia). There are various duties of depository banks towards DR holders and towards that issuing foreign company which is represented by the DR.

When an ADR programme is established by any company, it must be decided what exactly the company wants from the said programme, as well as the quantity of time, efforts and other resources that they want to commit. For this very reason, there are two kinds of facilities or programmes, which can be chosen by a company.

An individual can either get a new ADR by getting the corresponding domestic shares of the company deposited in the depository bank, which is administering ADR programme, or an individual can get existing ADRs in secondary market. One can achieve the latter by two means i.e. buying the ADRs on any American stock exchange and by buying underlying domestic shares of any company on the primary stock exchange and later, exchanging them with ADRs; this exchanging/ swapping is known as secondary trading.

Most of the ADR programmes are subjected to the termination. Such possible termination of ADR agreements will not only lead to cancellation of all the DRs but also subsequent delisting from all the exchanges where they are traded. This termination can be subjected to the discretion of a foreign issuer or the depository bank and it is done normally at the plea of the issuer.

Global Depository Receipt (GDR)

It is also termed as IDR (International Depository Receipt). A depository bank issues a Certificate known as Global Depository Receipt (GDR), which is used for purchasing shares of foreign companies and depositing it in the account. They are based on ADRs and hence, GDRs are considered as global equivalent of ADR (American Depository Receipt). GDRs are used to represent the ownership of the underlying number of shares possessed by a foreign company and are normally used for investing in companies from emerging and developing markets by investors of developed markets.

The values of GDR find its basis on the prices of related shares, but they are settled and traded independently of underlying shares. Normally, ten underlying shares combine to form one GDR, but any ratio can be used. It is a negotiable device that is denominated in some freely convertible currency. GDRs allows a company, which is the issuer, to get access to the investors in the capital market outside of its home country.

Various characteristics are attached to GDRs. Some of them are as follows:

  1. They are a kind of unsecured securities.
  2. It is possible to convert them into any numbers of shares.
  3. Redemption and interest price is public in a foreign agency.
  4. They are traded and listed in the stock exchange.

For instance, if any Chinese Company has issued ADRs in the American market and it wants to further extend them to other developed and advanced countries such as in Europe, then it can sell these ADRs to the European public and the same would be regarded as GDR.

JP Morgan Chase, Deutsche Bank, Citigroup, the Bank of New York Mellon are some of the international banks which issue GDRs. They are often listed in Luxemberg Stock Exchange, London Stock Exchange and Frankfurt Stock Exchange, which provide platform to trade in the International Order Book (IOB).

European Depositary Receipt (EDR)

A European Depository Receipt is used to represent that an individual possesses shares of a non- European Company, which is willing to trade in the financial market of Europe. It is a European equivalent of the actual American Depository Receipt (ADRs). A bank in Europe, which represents stocks trade on an exchange outside of the bank’s home country, typically issues EDR.

The stock of some of the non- European Companies are used for trading on European stock exchanges such as London Stock exchange with the help of EDRs. They allow investors of Europe to purchase shares, which are issued by foreign companies even without accompanying any risk and inconvenience of cross-currency or cross- border transactions. Though ‘Euro’ is the most commonly used currency for this form of security, EDRs are those shares that can be issued in any currency. If EDRs get issued in euro, the EDRs will carry the prices in ‘euro’, will pay the dividends in ‘euro’. Similarly to the shares of companies which are based in Europe, EDRs can be used for trading.

Difference between IDRs, ADRs and GDRs

ADRs and GDRs are the most common types of depository receipts. When the depository bank which is used to create the depository receipt is based in U. S., those negotiable instruments are known by the term ‘ ADRs’. Similarly, other depository receipts, which have come into existence, are based on the depository bank’s location that has created that DR likes the EDRs and GDRs. European exchanges, for example, London Stock Exchange, are used to trade in GDRs, while American Stock Exchanges, for example, Nasdaq, are used to trade in ADRs

Akriti Gupta
Author: Akriti Gupta

Akriti Gupta is a fourth-year learner of BBA LLB programme in Symbiosis Law School, NOIDA. She has done moots and has various publications in her name. Mooting and research papers have helped her a lot to enhance her researching and drafting abilities.

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