The mechanism involves a depositary bank holding ordinary shares of a foreign company and issuing receipts against them in the local market. One receipt may represent one share, several shares, or a fraction of one, with the ratio fixed at issue. That ratio explains why quoted prices for the receipt and the ordinary share frequently fail to correspond. In principle the two prices converge through arbitrage. Where a receipt trades at a discount or premium to the underlying, eligible participants can buy on one side and sell on the other. Conversion through the depositary captures the difference. This mechanism works in most circumstances and keeps the two prices close once adjusted for currency and ratio.
Convergence fails mainly when conversion is restricted. Where the home market caps foreign ownership, limits repatriation, or where the conversion channel is suspended, arbitrage cannot complete and a gap can persist and widen. Historical cases of receipts trading at large premiums to the underlying almost all involve restricted conversion. Receipts fall into two categories depending on whether the company sponsors them. Sponsored programmes generally come with fuller financial disclosure and regulatory requirements. Unsponsored programmes established by depositary banks do not, and their disclosure follows the rules of the original listing venue, giving local investors less transparency. Quotation systems rarely mark this distinction. Cost structures differ as well.
Depositary banks charge custody and service fees, usually deducted from dividends or levied periodically. The rates are not high individually and accumulate over long holding periods. Dividends are also typically subject to withholding in the original country, and whether any of it can be reclaimed depends on treaty arrangements and the investor's status. Liquidity is a further practical consideration. Most receipts trade at volumes well below the underlying shares, with wider spreads and higher market impact on large orders. This is generally immaterial for small investors, and for anybody building a sizeable position the real cost of trading may exceed what the quoted spread implies. Termination risk is specific to receipts.
Where a company ends a programme, or where regulatory conditions prevent continued listing, holders are required to convert into ordinary shares or accept a cash settlement. For investors unable to hold foreign shares directly, this can force a disposal at a time chosen by the company or the regulator rather than by them. Taken together, the value of receipts lies in convenience: foreign exposure obtained in a familiar currency, in a familiar market, through an existing account. The costs include fees, liquidity and occasional price gaps. Understanding that trade-off explains the actual conditions of ownership better than comparing the two quoted prices. One record-keeping point deserves mention.
Corporate actions such as splits, rights issues and special dividends pass through the depositary before reaching holders, sometimes with different treatment and always with some delay. Holders occasionally find that an entitlement available to ordinary shareholders was handled differently for receipts, and the terms governing that are set out in the deposit agreement rather than announced. One additional consideration involves voting. Receipt holders generally cannot vote directly and must instruct the depositary, which votes the underlying shares on their behalf. Instruction deadlines fall earlier than those for ordinary shareholders, and where no instruction arrives the depositary may vote at its discretion or not at all, depending on the agreement.