REPORT

Global depositary receipts (GDR) & Special Drawing Rate (SDR)

By, Puneeth Munoth

Global Depositary Receipts

Global depositary receipt is a certificate issued by a depository bank, which purchases shares of foreign companies and deposits it on the account. GDRs represent ownership of an underlying number of shares. Global depository receipts are commonly used to invest in companies from developing or emerging markets. Several international banks issue GDRs, such as JPMorgan Chase, Citigroup, Deutsche Bank, Bank of New York where they are traded on the International Order Book (IOB). Normally 1 GDR = 10 Shares, but not always. It is negotiable instrument which is denominated in some freely convertible currency.

Functioning of SDR:
Every publicly traded company issues shares and these shares are listed and traded on various stock exchanges. Thus, companies in India issue shares which are traded on Indian stock exchanges like BSE, NSE, etc. These shares are sometimes also listed and traded on foreign stock exchanges like NYSE or NASDAQ. But to list on a foreign stock exchange, the company has to comply with the policies of those stock exchanges. Many times, the policies of these exchanges in US or Europe are much more stringent than the policies of the exchanges in India. This deters these companies from listing on foreign stock exchanges directly. But many good companies get listed on these stock exchanges indirectly using ADRs and GDRs.

Procedures:
The company deposits a large number of its shares with a bank located in the country where it wants to list indirectly. The bank issues receipts against these shares, each receipt having a fixed number of shares as an underlying (Usually 2 or 4). These receipts are then sold to the people of this foreign country (and anyone who are allowed to buy shares in that country). These receipts are listed on the stock exchanges. They behave exactly like regular stocks their prices fluctuate depending on their demand and supply, and depending on the fundamentals of the underlying company. These receipts, which are traded like ordinary stocks, are called Depository Receipts. Each receipt amounts to a claim on the predefined number of shares of that company. The issuing bank acts as a depository for these shares that is, it stores the shares on behalf of the receipt holders.

How can one use GDR?

GDRs are not for investors in India they can invest directly in the shares of various Indian companies. GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian financial market since GDRs are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts.

Benefits of GDR:
For the Company A company may opt to issue a GDR to obtain greater exposure and raise capital in the world market. Issuing GDRs has the added benefit of increasing the shares liquidity while boosting the companys prestige on its local market (the company is traded internationally). Global Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with

emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a GDR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face. For the Investor Buying into a GDR immediately turns an investors portfolio into a global one. Investors gain the benefits of diversification, while trading in their own market under familiar settlement and clearance conditions. More importantly, GDR investors will be able to reap the benefits of these usually higher-risk, higherreturn equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.

Special Drawing Rate

The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. SDRs are allocated to member countries in proportion to their IMF quotas. The SDR also serves as the unit of account of the IMF and some other international organizations. Its value is based on a basket of key international currencies.

Basket of Key International Currencies:

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine goldwhich, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. It is calculated as the sum of specific amounts of the four basket currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market. The basket composition is reviewed every five years by the Executive Board, or earlier if the Fund finds changed circumstances warrant an earlier review, to ensure that it reflects the relative importance of currencies in the worlds trading and financial systems. In the most recent review (in November 2010), the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services and the amount of reserves denominated in the respective currencies that were held by other members of the IMF. These changes become effective on January 1, 2011. The next review will take place by 2015.

SDR allocations:
Under its Articles of Agreement (Article XV, Section 1, and Article XVIII), the IMF may allocate SDRs to member countries in proportion to their IMF quotas. Such an allocation provides each member with a costless, unconditional international reserve asset on which interest is neither earned nor paid. However, if a member's SDR holdings rise above its allocation, it earns interest on the excess. Conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall. The Articles of Agreement also allow for cancellations of SDRs, but this provision has never been used. The IMF cannot allocate SDRs to itself or to other prescribed holders.

Procedures:

IMF members often need to buy SDRs to discharge obligations to the IMF, or they may wish to sell SDRs in order to adjust the composition of their reserves. The IMF may act as an intermediary between members and prescribed holders to ensure that SDRs can be exchanged for freely usable currencies. For more than two decades, the SDR market has functioned through voluntary trading arrangements. Under these arrangements a number of members and one prescribed holder have volunteered to buy or sell SDRs within limits defined by their respective arrangements. Following the 2009 SDR allocations, the number and size of the voluntary arrangements has been expanded to ensure continued liquidity of the voluntary SDR market. The number of voluntary SDR trading arrangements now stands at 32, including 19 new arrangements since the 2009 SDR allocations. In the event that there is insufficient capacity under the voluntary trading arrangements, the Fund can activate the designation mechanism. Under this mechanism, members with sufficiently strong external positions are designated by the Fund to buy SDRs with freely usable currencies up to certain amounts from members with weak external positions. This arrangement serves as a backstop to guarantee the liquidity and the reserve asset character of the SDR.