Equity Financing in the International Markets, Depository Receipts; ADR, GDR, IDR

Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or have a long-term goal and require funds to invest in their growth. By selling shares, a company is effectively selling ownership in their company in return for cash.

Equity financing comes from many sources: for example, an entrepreneur’s friends and family, investors, or an initial public offering (IPO). An IPO is a process that private companies undergo to offer shares of their business to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors. Industry giants, such as Google and Meta (formerly Facebook), raised billions in capital through IPOs.

While the term equity financing refers to the financing of public companies listed on an exchange, the term also applies to private company financing.

International finance analyzes the following specific areas of study:

• International Fisher Effect is an international finance theory that assumes nominal interest rates mirror fluctuations in the spot exchange rate between nations.
• The Mundell-Fleming Model, which studies the interaction between the goods market and the money market, is based on the assumption that price levels of said goods are fixed.
• The optimum currency area theory states that certain geographical regions would maximize economic efficiency if the entire area adopted a single currency.
• Interest rate parity describes an equilibrium state in which investors are indifferent to interest rates attached to bank deposits in two separate countries.
• Purchasing power parity is the measurement of prices in different areas using a specific good or a specific set of goods to compare the absolute purchasing power between different currencies.

Sources of International Finance

The sources of international finance can be excavated deep in the international economy and international market. The various sources for International Finance are as follows:

Commercial Banks

Global Commercial Banks all over the international market provide loans in the foreign currency to the companies. These banks are very crucial in financing the non-trade international operations. They facilitate international trading to occur smoothly.

International Agencies and Development Banks

The developmental banks and other international agencies have come forth over the years for the purpose of financing in the international sector. The agencies are set up by the government of the developed countries of the world. The highly industrious agencies among this sector are – International Finance Corporation, EXIM Bank and Asian Development Bank. 

International Capital Markets

The budding organizations which include the multinational companies depend upon the fairly large amount of loans known as the foreign currency. The financial instruments which are used by these organizations include; American Depository Receipts, Global Depository Receipts, and Foreign Currency Convertible Bonds.

Depository Receipts; ADR, GDR, IDR

A depositary receipt (DR) is a negotiable financial instrument issued by a bank to represent a foreign company’s publicly traded securities. The depositary receipt trades on a local stock exchange. Depositary receipts facilitates buying shares in foreign companies, because the shares do not have to leave the home country.

Depositary receipts that are listed and traded in the United States are American depositary receipts (ADRs). European banks issue European depositary receipts (EDRs), and other banks issue global depository receipts (GDRs).

An investor needs to contact a broker in a local bank if he/she is interested in purchasing depositary receipts. The local bank in the investor’s home country, which is called the depositary bank, will assess the foreign security before making a decision to purchase shares.

The broker in the depositary bank will purchase the shares either on the local stock exchange that it trades in or purchase the shares in the foreign stock exchange by using another broker in a foreign bank, which is also known as the custodian bank.

After purchasing the shares, the depositary bank will request the shares to be delivered to the custodian bank.

After the custodian bank receives the shares, they will group the shares into packets, each consisting of 10 shares. Each packet will be issued to the depositary bank as a depositary receipt that is traded on the bank’s local stock exchange.

When the depositary bank receives the depositary receipts from the custodian bank, it notifies the broker, who will deliver it to the investor and debits fees from the investor’s account.

Types of Depositary Receipts

1. American Depositary Receipt (ADR)

It is listed only on American stock exchanges (i.e., NYSE, AMEX, NASDAQ) and can only be traded in the U.S. They pay investors dividends in U.S. dollars and are issued by a bank in the U.S.

ADRs are categorized into sponsored and unsponsored, which are then grouped into one of three levels.

2. European Depositary Receipt (EDR)

It is the European equivalent of ADRs. Similarly, EDRs are only listed on European stock exchanges and can only be traded in Europe. It pays dividends in euros and can be traded like a regular stock.

3. Global Depositary Receipt (GDR)

It is a general term for a depositary receipt that consists of shares from a foreign company. Therefore, any depositary receipt that did not originate from your home country is called a GDR.

Many other countries around the world, such as India, Russia, the Philippines, and Singapore also offer depositary receipts.

4. Indian Depository Receipt (IDR)

Indian Depository Receipt (IDR) is a financial instrument denominated in Indian Rupees in the form of a depository receipt. The IDR is a specific Indian version of the similar global depository receipts.

It is created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian securities Markets. The foreign company IDRs will deposit shares to an Indian depository. The depository would issue receipts to indian investors against these shares. The benefit of the underlying shares (like bonus, dividends etc.) would accrue to the depository receipt holders in India.

An international depository receipt (IDR) is a negotiable certificate issued by a bank. It represents ownership of a number of shares of stock in a foreign company that the bank holds in trust.

IDRs are purchased by investors as an alternative to the direct purchase of foreign stocks on foreign exchanges. For example, American traders can buy shares of the Swiss bank Credit Suisse Group AG or Swedish automaker Volvo AB directly from American exchanges via ADRs.

Advantages of DRs

1. Exposure to international securities

Investors can diversify their investment portfolio by gaining exposure to international securities, in addition to stocks offered by local companies.

2. Additional sources of capital

Depositary receipts provide international companies a way to raise more capital by tapping into the global markets and attracting foreign investors around the world.

3. Less international regulation

Since it is traded on a local stock exchange, investors do not need to worry about international trading policies and global laws.

Although investors will be investing in a company that is in a foreign country, they can still enjoy the same corporate rights, such as being able to vote for the board of directors.

Disadvantages of DRs

1. Higher administrative and processing fees, and taxes

There may be higher administrative and processing fees because you need to compensate for custodial services from the custodian bank. There may also be higher taxes.

For example, ADRs receive the same capital gains and dividend taxes as other stocks in the U.S. However, the investor is subject to the foreign country’s taxes and regulations aside from regular taxes in the U.S.

2. Greater risk from forex exchange rate fluctuations

There is a higher risk due to volatility in foreign currency exchange rates. For example, if an investor purchases a depositary receipt that represents shares in a British company, its value will be affected by the exchange rate between the British pound and the currency in the buyer’s home country.

3. Limited access for most investors

Sometimes, depositary receipts may not be listed on stock exchanges. Therefore, only institutional investors, which are companies or organizations that execute trades on behalf of clients, can invest in them.