For investors seeking exposure to foreign companies without the complexity of buying shares on international exchanges, American Depositary Shares (ADS) are a convenient solution. These securities, issued by U.S. banks and representing a specific number of shares in a foreign company, trade on American stock exchanges like any domestic stock.
The acronym ADS is often used interchangeably with American Depositary Receipts (ADR). While ADRs refer to the physical certificates issued by the depositary bank, ADSs represent the individual shares of the foreign company held by the depositary bank.
Key Takeaways
- American depositary shares (ADS) are shares in foreign companies held by U.S. depositary banks and traded on major U.S. exchanges.
- The terms American depositary shares and American depositary receipts are often used interchangeably.
- ADSs allow foreign companies access to a broader investor base and the American financial markets.
- The main drawback of ADSs is that, even though they are denominated in U.S. dollars, there is still some currency risk.
Understanding American Depositary Shares
An ADR is a negotiable certificate issued by a U.S. bank under an agreement with a foreign company. It’s much like a stock certificate that signifies ownership of ADSs.
ADSs simplify share trading for foreign companies. Depending on their compliance with U.S. regulations, they can trade over the counter (OTC) or on a major exchange like the New York Stock Exchange or the Nasdaq. Listing on a major exchange usually requires complying with U.S. reporting standards and adhering to the generally accepted accounting principles (GAAP).
What Is an American Depositary Receipt?
An American Depositary Receipt (ADR) is a financial instrument used by non-US companies to offer their shares to American investors and raise capital in the U.S. market. ADRs simplify the investment process for American investors by bypassing the complexities associated with foreign stock exchanges, different currencies, and trade practices.
ADRs too are issued by U.S. depositary banks and represent a specified number of shares of a foreign company’s stock. Dividends for ADR holders come in U.S. dollars, though originally valued in the company’s native currency.
Types of ADRs
ADRs primarily come in two forms:
- Sponsored ADRs: Officially supported by the foreign company, involve formal agreements, and are usually listed on major U.S. exchanges.
- Unsponsored ADRs: Set up without the company’s direct involvement and typically trade OTC.
Sponsored ADRs come under the regulation of the U.S. Securities and Exchange Commission (SEC), requiring particular financial disclosures and statements often using U.S. GAAP.
The Benefits of ADSs
Foreign companies listed on U.S. exchanges benefit from a larger pool of investors, reducing the costs associated with raising capital. For U.S. investors, ADSs provide an opportunity to invest in foreign entities without dealing with currency conversions and other cross-border complexities.
The Downsides of ADSs
Holding ADSs comes with currency risk. Exchange rate fluctuations between the U.S. dollar and the foreign currency can affect the share price and income payments, which must be converted to U.S. dollars.
Taxes on ADS dividends also vary. Countries often withhold taxes on dividends issued from ADRs. For example, Chile and Switzerland withhold about 35%, and France can withhold as much as 75% for some EU countries. U.S. investors can mitigate these taxes using foreign tax credits by filling out the appropriate forms such as Form 1116.
Real-World Examples
A single ADS often represents multiple shares of common stock. The trading hours of foreign companies can cause ADSs to gap up or down based on trading activities in their home country.
Taiwan Semiconductor Manufacturing Company Limited (TSM) serves as a pertinent example, showcasing fluctuations in its ADS prices in U.S. markets due to varying international trading boundaries.
Differences Between an ADS and ADR
ADS
- Represents actual shares of a foreign company.
- Kindles easier U.S. investor access to foreign equities.
ADR
- A negotiable certificate.
- Simplifies trades involving ADSs.
ADSs and ADRs are closely related and simplify the trading of foreign company shares on U.S. exchanges. Here’s a comparison of the two:
- Definition: ADS represents the actual foreign company shares, while ADR is a negotiable certificate issued by a U.S. bank.
- Trading: ADRs facilitate the trading of ADSs. Investors trade ADRs on U.S. exchanges; ADRs represent ownership of ADSs, which in turn correlate to foreign shares.
- Purpose: ADS permits a foreign company’s stock to trade in the U.S., essential for issuing ADRs.
What Are F Shares?
“F Shares” are foreign company shares traded on U.S. stock exchanges but not through ADRs. Instead, these shares are directly listed and include an “F” at the end of their ticker symbol to indicate their foreign nature.
Is Arbitrage Trading Done With ADSs?
Arbitrage involving ADSs arises from market inefficiencies and currency exchange rates. Successfully executing arbitrage strategies involves navigating transaction costs, market risk, and intra-market operational complexities.
What Are Depositary Banks?
Depositary banks are crucial for issuing and managing ADSs, ADRs, and related securities. These banks bridge U.S. investors with foreign companies to facilitate easier access to foreign investments. Major players include JPMorgan Chase & Co., Citigroup, Bank of New York Mellon, and Deutsche Bank.
The Bottom Line
ADSs are U.S. dollar-denominated equity shares of foreign companies available for trading on American stock exchanges. Issued by U.S. depositary banks, they represent a specific number of shares of a foreign entity. They offer convenient access to foreign stocks without the need to engage in overseas exchanges, while ADRs serve as negotiable certificates representing particular ADS units.
Related Terms: ADS, ADR, Depositary Bank, Foreign Investment.
References
- U.S. Securities Exchange Commission. “American Depositary Receipts”.
- Reinhard Marsch-Barner, et al. “Handbuch Börsennotierte AG: Aktien- und Kapitalmarktrecht”. Verlag, 2017. Section 11.40.
- Internal Revenue Service. “Foreign Tax Credit”.
- Corporate Finance Institute, “American Depositary Shares (ADS)”
- R. Dubil. “An Arbitrage Guide to Financial Markets.” John Wiley & Sons, 2020. Pages 110-111, 129-130.
