An American Depositary Receipt (ADR) is a U.S. bank-issued certificate representing shares in a foreign company, making it possible for these shares to be traded on American stock exchanges such as the NYSE or NASDAQ. ADRs provide American investors with a way to invest in foreign companies without the complexities of dealing with foreign stock exchanges and currencies.
Types of ADRs
Sponsored vs. Unsponsored ADRs
Sponsored ADRs are created when the foreign company actively participates in the issuance process. They typically involve a formal agreement between the U.S. depository bank and the foreign company.
Unsponsored ADRs, on the other hand, are created without the involvement of the foreign company. Instead, one or multiple U.S. banks can issue these ADRs based on existing outstanding shares.
Level I, II, and III ADRs
Level I ADRs are the simplest form and trade over-the-counter (OTC). They have the least regulatory requirements and typically do not require full adherence to U.S. GAAP.
Level II ADRs trade on U.S. exchanges and must meet more stringent regulatory requirements, including compliance with U.S. GAAP for financial reporting.
Level III ADRs also trade on U.S. exchanges but involve raising capital through a public offering in the U.S. They must adhere to the highest regulatory standards, including full disclosure and extensive reporting requirements.
Pricing of ADRs
The price of an ADR is influenced by the underlying foreign share’s price, currency exchange rates, and market demand. The ADR price may not always mirror the exact value of the foreign stock due to these variables.
Conversion Ratios
ADRs often represent multiple shares or a fraction of a share of the foreign company. For example, an ADR might represent 10 shares of a foreign stock or a half-share.
Fees Associated with ADRs
Depositary Fees
Deposit banks may charge ADR holders fees for custody, conversion, or distribution services. These fees can be directly deducted from dividends or other distributions.
Trading Fees
Standard trading fees, such as brokerage fees, apply when buying or selling ADRs on U.S. exchanges.
Tax Implications of ADRs
U.S. Taxation
Dividends received from ADRs are subject to U.S. federal income tax. Many investors are required to report these dividends on their tax returns and may be eligible for various treaties that reduce withholding taxes.
Foreign Taxes
Countries in which the foreign company is based may also tax dividends and capital gains. U.S. investors might be eligible for foreign tax credits to offset these taxes.
Historical Context
ADRs were first introduced in the 1920s to promote foreign investment among U.S. investors. The earliest ADR was created for British retailer Selfridges by JPMorgan Chase in 1927, revolutionizing cross-border investment.
Applicability of ADRs
ADRs are particularly useful for investors seeking international diversification without the complexities of direct foreign stock market participation. They also provide liquidity and ease of transaction through U.S. trading systems.
Comparisons and Related Terms
- Global Depositary Receipts (GDRs): Similar to ADRs but are traded outside the U.S.
- Foreign Stocks: Stocks listed directly on foreign exchanges, requiring international trading capabilities.
- Mutual Funds/ETFs with Foreign Holdings: Offer indirect exposure to foreign markets through pooled investments.
FAQs
What are the primary benefits of investing in ADRs?
Can ADRs be converted back into foreign shares?
References
- “American Depositary Receipts: A Guide for Investors” – Securities and Exchange Commission
- “Introduction to ADRs” – JPMorgan Chase & Co.
- “International Investing with ADRs” – Fidelity Investments
Summary
American Depositary Receipts (ADRs) are a valuable financial instrument that simplifies investing in foreign companies for U.S. investors. By understanding their types, pricing mechanisms, associated fees, and tax implications, investors can make informed decisions and effectively incorporate ADRs into their diversified investment portfolios.
