July 18, 2007 @ 10.01p.m – Written by January
Last week Guaranty Trust Bank Plc placed an ad in the dailies offering a certain amount of units of shares in dollar denominated amount. It was called Global Depositary Receipts. A colleague of mine asked what the term meant.
According to Investopedia, GDR is a bank certificate issued in more than one country for shares in a foreign company. The shares trade as domestic shares, but are offered for sale globally through the various bank branches. From further research, which I conducted on the Internet, it is also a financial instrument used by private markets to raise funds denominated in U.S dollars or Euros.
A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.
Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and International DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in euros.
How Does the DR Work?
The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:
Based on a determined GDR ratio, each GDR may be issued as representing one or more of the Nigerian local shares, and the price of each GDR would be issued in U.S. dollars converted from the equivalent Nigerian price of the shares being held by the depository bank. The GDRs now represent the local Nigerian shares held by the depository, and can now be freely traded equity on the LSE.
After the process whereby the new GDR of the Nigerian oil and gas company is issued, the GDR can be traded freely among investors and transferred from the buyer to the seller on the LSE, through a procedure known as intra-market trading. All GDR transactions of the Nigerian oil and gas company will now take place in U.S. dollars and are settled like any other U.K. transaction on the LSE. The GDR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the GDR holder are stated on the GDR certificate.
Pricing and Cross-Trading
When any GDR is traded, the broker will aim to find the best price of the share in question. He or she will therefore compare the U.S. dollar price of the GDR with the U.S. dollar equivalent price of the local share on the domestic market. If the GDR of the Nigerian oil and gas company is trading at US$12 per share and the share trading on the Nigerian market is trading at $11 per share (converted from naira to dollars), a broker would aim to buy more local shares from Nigeria and issue GDRs on the U.S. market. This action then causes the local Nigerian price and the price of the GDR to reach parity. The continual buying and selling in both markets, however, usually keeps the prices of the GDR and the security on the home market in close range of one another. Because of this minimal price differential, most GDRs are traded by means of intra-market trading.
A U.K. broker may also sell GDRs back into the local Nigerian market. This is known as cross-border trading. When this happens, the depository cancels an amount of GDRs and the local shares are released from the custodian bank and delivered back to the Nigerian broker who bought them. The Nigerian broker pays for them in naira, which is converted into dollars by the U.S. broker.