Buying shares in a foreign company normally requires an account in that market, in that currency, under that country's settlement rules. Depositary receipts exist to remove all three requirements.
The custody problem receipts solve
Foreign share ownership involves local registration, local settlement cycles and dividends paid in local currency. Each step adds cost and administrative friction for an outside investor.
A depositary bank absorbs that work. It holds the underlying shares with a custodian in the home market and issues certificates that trade locally in local currency.
The holder buys and sells the certificate through an ordinary domestic broker. Dividends arrive converted, and corporate actions are handled by the depositary.
How a receipt is created and cancelled
Creation begins when a broker buys shares in the home market and delivers them to the custodian. The depositary then issues new receipts against them.
Cancellation reverses the process, with receipts surrendered and the underlying shares released for sale locally. This two-way mechanism keeps the receipt price tethered to the home market price.
Where creation is unrestricted, gaps between the two prices are quickly closed. Where the home market limits foreign ownership, receipts can trade at a durable premium.
Why the ratio is not always one to one
A receipt may represent several underlying shares, or a fraction of one. The ratio is chosen so the certificate trades in a price range familiar to local investors.
A company whose shares trade at a very low local price will bundle many into one receipt. One trading at a very high price will do the opposite.
Ratios can be changed later by the depositary, which produces a price change resembling a stock split. The economic position of the holder is unaffected by the adjustment.
Sponsored and unsponsored programmes differ
A sponsored programme is established with the company's participation, which brings disclosure arrangements and a single depositary. An unsponsored one is created by a bank without company involvement.
Unsponsored receipts can have several competing programmes on the same company, with different fees and inconsistent handling of shareholder communications. Voting rights are often the first thing to be diluted.
Programmes are also tiered by how much disclosure the company accepts. The tiers that permit raising new capital carry the heaviest reporting requirements, and those requirements differ by jurisdiction.
What the holder gives up
Depositary fees are deducted from dividends or charged periodically, which reduces income relative to direct ownership. Withholding tax still applies under the home country's rules.
Liquidity in the receipt is usually far below that of the underlying line. Price discovery happens in the home market, and the receipt follows, with tax treatment varying by jurisdiction and changing over time.
Programmes can be terminated by the depositary or the company, forcing holders to take the underlying shares or accept a cash sale. That decision sits outside the holder's control.