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ADR (American Depositary Receipt)

An American Depositary Receipt (ADR) is a certificate issued by a U.S. bank that represents shares of a foreign company.
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American Depositary Receipt (ADR) - Definition

An American Depositary Receipt (ADR) is a certificate issued by a U.S. bank that represents shares of a foreign company. ADRs allow U.S. investors to buy shares of overseas companies without dealing with cross-border transactions or foreign currencies. By trading ADRs on U.S. stock exchanges, investors access international markets within the familiar U.S. financial system.

ADRs act as substitutes for foreign shares on U.S. stock exchanges. A U.S. bank buys shares of a foreign company in its local market. The bank then issues ADRs representing a specific number of these foreign shares.

The ratio can vary; one ADR may equal one share, a fraction of a share, or multiple shares. ADRs are priced in U.S. dollars and trade like domestic stocks on platforms such as the NYSE or NASDAQ. Dividends from the foreign company are converted into U.S. dollars by the depositary bank and paid to ADR holders.

ADRs are divided based on their level of involvement and compliance with U.S. regulations:

Sponsored ADRs are issued with the cooperation of the foreign company and are usually listed on major U.S. exchanges. They come in three levels:

  • Level I: Traded over-the-counter (OTC) with minimal SEC reporting requirements. They are mainly used to establish a trading presence.
  • Level II: Listed on U.S. exchanges like the NYSE or NASDAQ, following more rigorous SEC reporting standards.
  • Level III: Allows foreign companies to offer ADRs to the public on U.S. exchanges and raise capital in the U.S. market.

Unsponsored ADRs are created by U.S. banks without direct involvement or formal agreements with the foreign company. They are typically traded OTC and do not provide voting rights to holders. Multiple unsponsored ADRs for the same foreign company can exist, often with different dividend policies.

ADRs provide several advantages for U.S. investors:

  • Convenience: Accessible through standard U.S. brokerage accounts, traded during U.S. market hours, and priced in U.S. dollars.
  • Liquidity: Many ADRs are actively traded on major U.S. exchanges, making buying and selling easy.
  • Transparency: Governed by U.S. securities regulations and reporting requirements, offering reliable financial information.
  • Dividend Payments in USD: Dividends are paid in U.S. dollars, removing the need for currency conversion.
  • Access to International Markets: Enables portfolio diversification by investing in global companies without directly engaging with foreign markets.

ADRs are priced in U.S. dollars and generally match the value of the underlying foreign stock through arbitrage. The depositary bank sets the ADR-to-share ratio to balance affordability and value perception. Investors might face additional fees, such as custody fees, typically ranging from one to three cents per share. These fees are either deducted from dividends or charged to the investor's brokerage account.

Investors holding ADRs receive dividends and realize capital gains in U.S. dollars. However, dividends may be subject to foreign taxes, which the depositary bank withholds. To avoid double taxation, U.S. investors may need to claim tax credits from the IRS or request refunds from foreign tax authorities. Consulting a tax professional is recommended to navigate the complexities of international taxation related to ADR investments.

ADRs were introduced in the 1920s to simplify investing for Americans interested in foreign stocks. Guaranty Trust, a predecessor of J.P. Morgan, launched the first ADR in 1927 for the British retailer Selfridges, listed on the New York Curb Exchange. This innovation made it easier for U.S. investors to participate in international markets. Over the years, major U.S. banks like J.P. Morgan and BNY Mellon have continued to be key players in the ADR market.

From 1988 to 2018, the German car manufacturer Volkswagen AG traded OTC in the U.S. as a sponsored ADR under the ticker VLKAY. In August 2018, Volkswagen ended its ADR program. J.P. Morgan then established an unsponsored ADR trading under the ticker VWAGY. Investors holding VLKAY ADRs could cash out, exchange ADRs for actual Volkswagen shares on German exchanges, or switch to the new VWAGY ADRs. This example shows how ADR structures can adapt to company strategies.

While ADRs are designed for the U.S. market, Global Depositary Receipts (GDRs) provide access to multiple international markets, including U.S. and European exchanges. GDRs allow companies to raise capital in different regions simultaneously, offering broader investor exposure compared to ADRs.

American Depositary Shares (ADS) are the actual shares held by the depositary bank that ADRs represent. An ADR bundles one or more ADSs, enabling trading on U.S. exchanges without directly handling the foreign shares.

  • Ease of Trading: ADRs are traded on U.S. exchanges or OTC markets, accessible through standard brokerage accounts.
  • Dollar Denomination: Removes the need for currency exchanges, simplifying transactions and dividend reinvestments.
  • Portfolio Diversification: Offers exposure to international markets, enhancing diversification and potential returns.
  • Transparency and Regulation: Complies with U.S. SEC regulations, ensuring reliable financial reporting and corporate governance.
  • Double Taxation: Earnings may be taxed in both the U.S. and the foreign country, reducing overall returns.
  • Limited Selection: Only a portion of foreign companies issue ADRs, limiting investment options.
  • Currency Risk: Even with dollar-denominated dividends, investments are still affected by foreign currency fluctuations.
  • Additional Fees: Custody and management fees by depositary banks can reduce investment gains over time.

American Depositary Receipts (ADRs) bridge U.S. investors to international companies effectively. They simplify cross-border investments, offering convenience, liquidity, and diversification within the U.S. financial framework. Despite certain risks and costs, ADRs are a valuable option for investors looking to expand their portfolios globally.

  • Simplified International Investment: ADRs let U.S. investors buy shares of foreign companies easily without handling foreign exchanges or currencies, making international diversification accessible.
  • Types and Levels of ADRs: Knowing the difference between sponsored and unsponsored ADRs, and understanding the levels (I, II, III) of sponsored ADRs, is important for choosing the right investment opportunities.
  • Benefits vs. Costs: While ADRs offer advantages like convenience, liquidity, and USD dividend payments, be aware of costs such as custody fees and possible double taxation, which can affect returns.
  • Regulatory and Tax Considerations: ADRs follow U.S. securities regulations, ensuring transparency and reliability. However, investors must manage complex tax implications, including foreign tax withholdings and potential tax credits.