American Depositary Receipt (ADR)

Posted on by user

American Depositary Receipt (ADR)

What is an ADR?

An American Depositary Receipt (ADR) is a U.S.-dollar–denominated certificate that represents shares in a foreign company and trades on U.S. exchanges or over-the-counter (OTC). ADRs let U.S. investors buy and sell foreign equity without directly dealing with foreign exchanges, currencies, or local settlement systems.

How ADRs work

  • A U.S. depositary bank purchases and holds underlying foreign shares (or arranges custody locally).
  • The bank issues ADRs (and the associated American Depositary Shares, or ADSs) that represent a specified number of the underlying foreign shares.
  • ADRs trade in U.S. dollars and settle through U.S. markets (NYSE, Nasdaq, or OTC).
  • The depositary bank collects dividends and passes them to ADR holders (typically after converting to dollars and withholding any foreign taxes).

Types of ADRs

  • Sponsored ADRs: Issued with the cooperation of the foreign company. The issuer usually pays issuance costs and provides financial information required by U.S. regulators. Sponsored ADRs are more likely to be listed on major exchanges and may offer voting rights.
  • Unsponsored ADRs: Issued by a depositary bank without the foreign company’s direct involvement or consent. They typically trade OTC, do not usually include voting rights, and multiple banks can issue unsponsored ADRs for the same company.

ADR Levels

ADRs are also classified by level, which reflects the issuer’s reporting obligations and whether the ADR can be used to raise capital in the U.S.

  • Level I: OTC trading with the fewest SEC reporting requirements. Used mainly to establish a U.S. trading presence; cannot be used to raise capital in the U.S.
  • Level II: Listed on an exchange, requires greater disclosure than Level I, but still cannot be used to raise capital.
  • Level III: Full SEC reporting and registration; companies can conduct public offerings and raise capital in U.S. markets.

Pricing and costs

  • Ratio: An ADR can represent one foreign share, a fraction of a share, or multiple shares; the depositary bank sets the ratio to produce an attractive ADR price.
  • Price alignment: ADR market prices generally track the underlying home-market share through arbitrage opportunities.
  • Fees: Depositary banks often charge custody or service fees (commonly a few cents per share), which may be deducted from dividends or charged via the broker.
  • Other costs: Currency conversion spread and potential broker fees.

Tax considerations

  • Dividends and proceeds are delivered in U.S. dollars after conversion and after any foreign withholding taxes the depositary bank applies.
  • U.S. investors may be subject to foreign withholding tax on dividends and should consider the U.S. foreign tax credit to avoid double taxation.
  • Capital gains taxes apply under the investor’s domestic tax rules; consult a tax advisor for specifics.

Benefits and drawbacks

Advantages
– Easy access: Trade foreign companies through U.S. brokers and U.S. exchanges.
– Dollar-denominated: Simplifies transactions and recordkeeping.
– Liquidity and convenience: Eliminates the need to trade on foreign exchanges directly.
– Diversification: Provides exposure to international companies and sectors.

Disadvantages
– Currency exposure: ADR values reflect movements in the foreign currency vs. the dollar; exchange-rate risk remains.
– Additional fees: Custody/service fees and currency conversion costs.
– Tax complexity: Potential foreign withholding and need to claim credits.
– Limited universe: Not all foreign companies have ADR programs; unsponsored ADRs may lack company cooperation and SEC compliance.

History and evolution

ADRs originated in the 1920s to give U.S. investors easier access to foreign companies. J.P. Morgan (through Guaranty Trust) introduced the first ADRs and helped popularize the structure as a way for foreign issuers to access U.S. capital and investors. Today, thousands of ADRs represent companies from many countries, and major banks continue to act as depositaries.

Case example: Volkswagen

Volkswagen once traded in the U.S. as a sponsored ADR (ticker VLKAY). When that program ended in 2018, an unsponsored ADR (VWAGY) was established by a depositary bank. Holders of the former ADRs had options to cash out, exchange for underlying German shares, or move to the new ADR—illustrating how ADR programs can change and how holders are affected.

Common questions

  • Is owning an ADR the same as owning the underlying share?
    ADRs represent economic ownership in the underlying foreign shares, but ownership is via the depositary bank’s custody arrangement rather than direct ownership on the foreign register. Rights (such as voting) depend on the ADR program.

  • What is an ADS?
    An American Depositary Share (ADS) is the U.S.-registered security that represents a specific number of underlying foreign shares. The ADR is the physical or electronic receipt evidencing ownership of ADS(s). In practice, “ADR” and “ADS” are often used interchangeably.

  • How do ADRs differ from GDRs?
    Global Depositary Receipts (GDRs) typically provide access to multiple markets (e.g., U.S. and Europe) with a single, fungible security. ADRs are focused on the U.S. market.

Bottom line

ADRs make it simpler for U.S. investors to access foreign equities by providing dollar-denominated, U.S.-traded certificates backed by underlying foreign shares. They offer convenience and diversification but carry currency risk, possible additional fees, and tax considerations. Evaluate the type and level of the ADR, associated costs, and tax implications before investing.