What is ADR (American Depository Receipt)?
If you are interested in investing in foreign companies, you may have heard of ADRs or American Depository Receipts. But what are they and how do they work?
An ADR is a certificate that represents a certain number of shares of a foreign company. It is issued by a U.S. bank or broker that holds the actual shares in a custodian account in the foreign country. The ADR can be traded on U.S. stock exchanges or over-the-counter markets, just like any other U.S. security.
The main benefit of ADRs is that they allow U.S. investors to easily access foreign markets without having to deal with currency conversion, foreign taxes, or different accounting standards. ADRs also provide more liquidity and transparency than directly buying foreign shares.
There are different types of ADRs, depending on the level of compliance with U.S. securities regulations and reporting requirements. The most common ones are:
- Level I ADRs: These are the simplest and least regulated type of ADRs. They are traded only over-the-counter and do not require the foreign company to file any financial statements with the U.S. Securities and Exchange Commission (SEC). They are typically used by foreign companies that want to test the U.S. market or raise their profile among U.S. investors.
- Level II ADRs: These are more regulated than Level I ADRs and require the foreign company to register with the SEC and comply with some of its reporting and disclosure rules. They are traded on major U.S. stock exchanges, such as the New York Stock Exchange (NYSE) or the Nasdaq. They are typically used by foreign companies that want to raise capital or expand their shareholder base in the U.S.
- Level III ADRs: These are the most regulated and complex type of ADRs. They require the foreign company to file a full registration statement with the SEC and comply with all of its reporting and disclosure rules, as well as the Sarbanes-Oxley Act of 2002. They are also traded on major U.S. stock exchanges and are typically used by foreign companies that want to launch an initial public offering (IPO) or a secondary offering in the U.S.
In addition to these types, there are also sponsored and unsponsored ADRs. A sponsored ADR is issued by a U.S. bank or broker that has an agreement with the foreign company to act as its depository and handle all the administrative tasks related to the ADR program. An unsponsored ADR is issued by a U.S. bank or broker that does not have such an agreement and acts independently from the foreign company.
Some of the risks associated with ADRs include:
- Currency risk: The value of an ADR may fluctuate due to changes in exchange rates between the U.S. dollar and the foreign currency.
- Political risk: The value of an ADR may be affected by political instability, social unrest, or regulatory changes in the foreign country.
- Market risk: The value of an ADR may be influenced by market conditions, such as supply and demand, investor sentiment, or economic factors, in both the U.S. and the foreign country.
- Tax risk: The income from an ADR may be subject to withholding taxes by the foreign country and double taxation by both the U.S. and the foreign country, unless there is a tax treaty between them.
To summarize, an ADR is a certificate that represents a certain number of shares of a foreign company that is traded on U.S. markets. It offers several advantages for U.S. investors who want to diversify their portfolio and access global opportunities, but it also involves some risks that need to be considered carefully before investing.