A CREST Depository Interest (CDI) is a UK security that represents a stock traded on an exchange outside the UK. They offer a straightforward, cost-effective way to trade in a number of overseas stocks and are the main means of foreign dealing provided by a number of UK international stockbrokers.
In many ways, CDIs resemble American depository receipts (ADRs) and global depository receipts (GDRs). The underlying legal structure and process is very different, but little of this will directly affect the investor.
To understand CDIs, you first need to know a little about CREST, the UK and Ireland central securities depository (CSD) and settlement system. Briefly, CREST is responsible for recording the ownership of dematerialised securities – those that do not have paper certificates – and transferring title between the buyer and seller when stocks are traded.
CREST also distributes dividends, implements corporate actions such as rights issues and carries out many other important function. In short, it’s the centre of the paperless trade processing system that has replaced certificates.
Why CDIs are necessary
Under UK law, international shares cannot be handled directly in CREST, so CDIs were created to allow trades in some overseas stocks to be settled in the same way. Essentially, for each stock available as a CDI, CREST has the required number of shares in shares held in its name (or the name of an intermediary acting for it) at the central securities depository in the company’s home country (these are the foreign equivalents of CREST – for example, DTCC in the US, Euroclear in much of Europe, Clearstream in Germany, SIS in Switzerland).
CREST issues CDIs representing these shares – one CDI for each share of underlying stock. These CDIs are an English law instrument and trades in them can be settled through CREST, just like a regular share. The underlying shares are held on trust for the owners of the CDI, who have full economic rights over them.
Issuing a CDI does not mean that the stock is listed on the London Stock Exchange – when CDIs are traded in London, they are usually traded off-exchange through market makers. But they can be bought and sold through most UK stockbrokers, often – though not always – for the same trading fee as a UK share.
Advantages and disadvantages of CDIs
The main advantage of the CDI is simply to make settlement of trades and custody of stocks easier for foreign securities. The broker doesn’t need to make any arrangements for this in the stock’s home country, but can simply rely on the CREST infrastructure in the same way they would for a UK stock.
Settlement of trades can be done in sterling and dividends are also paid in sterling, so you and your broker don’t need to worry about foreign currencies. The CREST system also offers the option of making and receiving payments in euros and US dollars, although not all brokers will offer this.
The most obvious disadvantage of CDIs is that only a limited number of international stocks are available in this way. The CDI arrangements are geared towards larger stocks in major Western economies and even where a market is covered, not all companies listed there will be available. Markets covered by the system are Australia (extremely limited), Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the USA.
It’s also worth being aware that since CDIs of a foreign stock will usually be traded through a UK market maker, the price that the market maker quotes will not be the same as is available on the overseas exchange, since they need to earn a profit on the transaction.
When quoting the sterling price for a foreign security, the mark-up will usually range from 0.5% for smaller trades to about 0.25% or lower for larger ones. When trading through some stockbrokers, the mark-up will be larger (up to 1% is some cases) and in these cases, the market maker is usually sharing a part of it with your broker.
This is not a deficiency of the CDI system itself, just a reality of the market. Using CDIs can still be cost-effective relative to the costs of trading directly overseas, since your broker does not need to incorporate other costs of an international service.
Security of CDIs
At first glance, it looks as if owning a CDI means that you are further removed from owning the underlying stock – but the difference is smaller than you might think. Although the structure of the CDI means that the underlying stock is held in the name of CREST rather than in your name being on the register of shareholders, the same is true for most share ownership today.
Foreign securities bought through a UK broker and held overseas with CDIs are almost invariably held “in nominee” (i.e. in the name of a subsidiary of the broker that holds stocks on its clients’ behalf). The same is true of most UK stocks, unless you have CREST personal membership through your broker.
As with any stock held in nominee, you still have economic rights over the share underlying the CDI. You will receive dividends and CREST will process corporate actions such as stock splits and rights issues.
The safety of brokerage account holdings is an extremely complicated topic, and just as with all nominee holdings there are some theoretical risks. However, the fact that CDIs are issued by the central securities depository – a crucial part of the financial infrastructure – means that they are unlikely to be the weakest link in the custody chain.
CDIs and tax
In general, the tax treatment of CDIs is the same as applies to the underlying shares. In particular, this means that:
- CDIs can be held in an Individual Savings Account (ISA), subject to the underlying share trading on a recognised stock exchange, in line with the ISA rules.
- Dividends on CDIs will be subject to the same withholding taxes as dividends paid directly. CREST is a Qualified Intermediary, meaning that it can pay US dividends at the lower rate due under the US-UK double taxation agreement, if your broker is set up to take advantage of this, but reclaiming tax on other dividends will be your responsibility, as usual.
- There is no stamp duty due for trades in most CDIs, because the underlying share is not listed in the UK (but other transaction taxes may apply where shares is listed in countries that apply their own levies).