What is an American Depositary Receipt?
American Depositary Receipts (ADRs) are tradable certificates issued by U.S. depositary banks, each representing shares—usually one—of a foreign company’s stock. ADRs are traded on U.S. stock exchanges just like domestic shares.
ADRs provide U.S. investors a straightforward way to invest in foreign companies not listed on U.S. stock exchanges. Meanwhile, foreign firms benefit as ADRs enable them to attract American investors and capital without the complexities of U.S. stock exchange listings.
Key Highlights
- An ADR is a certificate issued by a U.S. bank that represents shares in foreign stock.
- These certificates are traded on American stock exchanges.
- ADRs and their dividends are priced in U.S. dollars.
- ADRs offer a liquid and efficient way for U.S. investors to own foreign stocks.
- Investments in ADRs may involve double taxation and offer a limited number of options.
How ADRs Work
ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution, often via an overseas branch. Priced and traded in dollars, these securities are cleared through U.S. settlement systems.
For issuing ADRs, a U.S. bank must first purchase shares on a foreign exchange, keep these stocks as inventory, and then issue ADRs for domestic trading. Options for such listings include the New York Stock Exchange (NYSE), Nasdaq, and over-the-counter (OTC) markets.
To ensure transparency, U.S. banks require foreign companies to furnish detailed financial information, aiding American investors in evaluating foreign firms’ financial health.
Types of ADRs
Sponsored ADRs: U.S. banks issue these in collaboration with the foreign company. Costs are usually covered by the foreign firm, which retains control, while the bank manages investor transactions. These are classified by compliance levels with SEC regulations and U.S. accounting standards.
Unsponsored ADRs: Issued without direct involvement or permission from the foreign company, these could be offered by various U.S. banks for the same foreign entity with potentially different dividends. Notably, only the sponsored ADRs listed on exchanges grant voting rights.
ADR Levels
Level I: Basic ADRs listed only on the OTC market, involving the least amount of reporting with the SEC. They’re riskier but allow foreign entities to gauge interest without significant expense.
Level II: Listed on American stock exchanges, these carry higher reporting requirements, offering better visibility and trading volume without raising capital directly.
Level III: These involve an issuer’s public offering through U.S. exchanges, establishing significant U.S. trading presence and attracting capital while adhering to full SEC reporting.
ADR Pricing and Costs
Conversion Ratios: ADRs may represent various ratios of the underlying share to make them appealing. If priced too high or low, market perception could be affected.
Arbitrage: Prices track the company’s stock closely due to arbitrage, offering traders opportunities to profit from market price differences.
Fees: ADRs involve custody fees covering creation and issuance costs, typically ranging between one to three cents per share, deducted from dividends or charged by brokers.
Taxes
Dividends and capital gains are realized in USD, but net of currency conversion expenses and foreign taxes. To avoid double taxation, U.S. investors need tax credits from the IRS or refunds from foreign tax authorities.
Advantages and Disadvantages of ADRs
Advantages:
- Easily trackable and tradable.
- Accessible through American brokers in USD.
- Provide portfolio diversification.
Disadvantages:
- Potential double taxation.
- Limited listing of foreign companies.
- Possible non-compliance with U.S. regulations for unsponsored ADRs.
- Currency conversion fees might apply.
History of ADRs
Before the advent of ADRs in the 1920s, trading international stocks was a significant challenge. Parent of J.P. Morgan, Guaranty Trust pioneered the first ADR for British retailer Selfridges on the New York Curb Exchange in 1927.
Real-World Example: Volkswagen
From 1988-2018, Volkswagen traded as a sponsored ADR under VLKAY. Post termination, J.P. Morgan issued an unsponsored ADR (VWAGY). Investors had options to cash out or exchange their old ADRs for new ones or the company’s stock directly in Germany.
FAQs
Is owning an ADR equivalent to owning shares in the company? ADRs reflect the essential value of a foreign company’s stock in USD without typical ownership rights like common stock.
Why list ADRs? Foreign companies overlook limitations of their market reach, gain visibility, and access broader investor pools via ADRs.
ADR vs. GDR: ADRs cater to one market; GDRs offer multi-market accessibility, frequently U.S. and Euro markets.
What is an ADS? American Depositary Shares (ADS) are the actual underlying stock for ADRs encountered in trading.
Conclusion
American Depositary Receipts allow U.S. investors to engage with international stocks conveniently while helping foreign firms raise capital and gain visibility in U.S. markets. Despite certain challenges involved, ADRs extend the horizon for investor portfolios, offering diversification and broader investment opportunities.
Related Terms: ADR, Global Depositary Receipts, American Depositary Shares, International Stocks.
References
- U.S. Securities and Exchange Commission. “Investor Bulletin: American Depositary Receipts”.
- Charles Schwab. “ADRs, Foreign Ordinaries, & Canadian Stocks”.
- Internal Revenue Service. “Memorandum: Depositary Receipts Program”. Pages 2-3.
- JPMorgan Chase. “JPMorgan Chase Celebrates 75th Anniversary of the ADR”.
- JPMorgan Chase. “History of Our Firm”.
- Citi. “Depositary Receipt Services: Volkswagen AG”.
- J.P. Morgan. “Volkswagen (VWAGY)”.
