The term American depositary receipt (ADR) refers to a negotiable certificate issued by a U.S. depositary bank that represents a predetermined number of shares of a foreign company's stock—typically one share. Similar to domestic shares, the ADR is traded on American stock exchanges. ADRs give American investors a chance to buy stock in foreign corporations that would not otherwise be possible. On the other hand, ADRs allow foreign corporations to draw in American money and investors without the difficulty and cost of going public on U.S. stock exchanges. ADRs are advantageous for both parties.
By purchasing American Depositary Receipts (ADRs), investors in the United States can acquire exposure to the performance of stocks listed on foreign stock exchanges without having to deal with the complexities of doing business in those markets directly. Common names in business such as Royal Dutch Petroleum (the company behind Shell fuel), and Unilever are all represented. These companies, along with many others based outside the US, use American Depositary Receipts (ADRs) to list their stock on US exchanges.
In order to reduce the complexity of overseas investment for U.S. investors, American Depositary Receipts (ADRs) were developed. A broker or bank in the United States issues an American depository receipt. It is the equivalent of one or more shares of stock in the foreign corporation traded on the stock exchange in the country where the bank is based. While the number of foreign shares represented by a single American depositary share (ADR) may vary from business to company, for any given company, one ADR will always be equivalent to one share. American Depositary Receipts (ADRs) can be exchanged either on a regulated exchange like the New York Stock Exchange or in an unregulated market (OTC). Those that make the list can be bought, sold, and held just like any other common stock issued by a company based in the United States.
Similarly to American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs) allow issuers to gain access to foreign financial markets. GDRs are typically used to solicit funding in the European and American financial markets. Denominated primarily in US dollars, ADRs and GDRs can also be issued in other currencies such as the euro.
Reporting and taxing
There are no stock transaction taxes for foreign ADR holders. The dividends are paid out in full, with no foreign withholding, to any countries that have a tax treaty with the United States. However, the proceeds from an ADR ownership may be subject to US income or capital gains taxes and may be subject to backup withholding, just like investment gains or income from domestic assets.
Financial reports issued by foreign corporations sponsoring US-listed ADR programs are typically written in English and adhere to US accounting standards. The Securities and Exchange Commission also receives disclosure statements from these companies.
For companies that are in compliance with US reporting and transparency laws, issuing additional shares of stock to be represented by ADRs is a viable option for raising funds directly from US investors. Only American Depositary Receipts (ADRs) representing previously issued shares in the home market may be sponsored by companies that meet a reduced set of SEC reporting requirements.
Assorted Dispute Resolution (ADR) Programs
There are three distinct options available to companies when they set up an ADR program. In terms of listed exposure and required reporting, levels vary.
The first and most basic tier of ADR is Level 1. Level 1 programs allow for over-the-counter (OTC) trading exclusively, and require minimum SEC reporting from issuers (SEC). There is no periodic reporting requirement for this company, but each year it must post an annual report on its website in the format mandated by its home country's regulations. This report must be written in English.
Investments in Level 2 ADRs are eligible for listing on a US stock exchange. However, stocks have to be registered with the SEC, and the corporation has to publish an annual report (on Form 20-F rather than Form 10-K) that follows US generally accepted accounting principles (GAAP). In addition, it needs to be eligible for listing on the exchange.
To participate in an ADR program at the third, and highest, level, the issuing business must adhere to reporting standards that are even more stringent than those maintained by U.S.-based corporations. It is not necessary for a company to already have shares listed on a US market in order to use a Level 3 program to issue new shares for capital raising purposes. The third-tier corporations often make up the bulk of the major ADR participants.
An ADR can be created by a US bank or broker without the consent of the issuing firm only in exceptional circumstances. These securities, called unsponsored ADRs, can't be sold to individual investors in the US unless the foreign company files relevant financial disclosures with the SEC or gets an exception under Section 12g3-2 (b). All companies that meet the criteria of Rule 12g3-2(b) are recorded in a database kept by the SEC.
Threats and Costs of ADR
Due to the fact that ADRs are issued by non-US corporations, they are subject to the risks associated with investing in a foreign company. Among these are:
The risk that the issuing company's home currency will weaken against the dollar due to fluctuations in exchange rates.
The possibility that political events or changes in the government of the country where the issuing company is based would have a negative impact on the value of the local currency or on the stability of the issuing company and its financial results is known as "
Inflation risk, or the possibility that the currency's purchasing power would decrease as a result of rising prices in the country of the issuing corporation.
Although Level 2 and 3 listings are subject to reporting requirements that approach those of domestic firms, investors may not have access to as much information as they would with a local company, depending on the level of the ADR program.
Pass-through fees, which are charged on a periodic basis, are meant to reimburse the agent bank for its custodial services and are associated with a select number of ADRs. Such costs, if applicable, typically range from $0.01 to $0.03 per share. The ADR prospectus should include information on any such costs. When applicable, this fee for ADRs may be included in the dividend payout or shown as a separate line item on your monthly account.