Recently, the market regulator Securities and Exchange Board of India (SEBI) barred 13 entities from the securities market for five years. They were accused of manipulating Global Depository Receipts (GDRs) issued by Indian companies.
But what are GDRs? Here is a look:
1. Foreign investment: Global Depository Receipts (GDRs) is a mechanism which allows one to buy and sell shares of a foreign company without having to bother about opening a foreign brokerage account. Simply put, a GDR allows investors of any country to purchase and sell shares of a company in any other country, entitling the shareholders to partake in the dividend and capital gains of that foreign company. GDRs, thus, offer investors a way to diversify their portfolios.
2. How does the GDR work? A GDR is set up when a company from one country intends to list its publically-traded shares in another country. These need not be shares alone; they could also be debt securities. Before this is allowed by a foreign country’s stock exchange, stiff conditions have to be met like the backing of a depository bank, and so on.
3. Depository banks: GDRs are usually backed by depository banks that provide companies, investors and traders opportunities to make global investments. These are banks whose primary task is to hold shares of companies based in another country. Such banks essentially sell the GDRs. They also ensure that investors receive their dividends and capital gains. Depository banks also handle all tax-related issues in the company’s home country. Since all GDR transactions have to go through a depository bank, investments made in them are safe. However, their valuations are always associated with normal market risks.
4. So why should you invest in GDRs? Foreign companies can help diversify your portfolio. However, it is not easy to invest in foreign shares. Currently, only ICICI Direct allows Indian investors to invest abroad. GDRs can help you go around this. Moreover, they help you invest in other countries when stocks in your country are under-performing. However, not many GDRs are listed in India. It is most often used by foreign investors looking to invest in India or other emerging markets like China or Brazil.
5. Diversification: Instead of being stuck up with fewer investment opportunities in a domestic market, especially at a time when the business cycle is on a downturn, GDR’s can create a space for diversifying the investment portfolio. Owning shares in a foreign company can increase returns on account of favorable currency conversions for dividends or bonus share issues declared from time to time by the company.
6. Risks associated with GDRs: Not all GDRs are safe investments. Country’s prone to political unrest or geopolitical conflicts can severely impact the valuations of a company, resulting in GDR valuations losses for an investor who may have been betting on that particular company. GDRs are prone to the same risks as domestic investments like credit issues, currency risks or inflation.
7. Since 1927: GDRs evolved and came to be accepted as a safe way of making global investments after the success of American Depositary Receipts (ADRs), which first made their appearance in the US market in 1927. This was the time when the US stock market had slumped and was heading for the Great Wall Street Crash of 1929.