American Depositary Receipt

Description

ADR: Linking Investors to Markets Wherever in the Planet

With the present, interconnected world, investment across borders is easier to do now than ever before. However, this convenient facility is underpinned by a relatively obscure financial instrument: the American Depositary Receipt. The ADR allows American investors to purchase shares in any foreign company without having to go through a foreign bourse, foreign currency, and arcane rules.

What is an ADR?

ADR stands for American Depositary Receipt. If you’ve ever asked how it is possible that U.S. broking accounts everywhere in the country allow Americans to buy into companies including Samsung, Toyota, or Alibaba, ADRs are the secret. Let’s unpack what ADRs are, how they operate, and why they are vital for global investing.

A piece of negotiable paper is ADR by which U.S. investors know how many shares in a foreign company they own. So, in a nutshell, ADRs are what permit U.S. small investors to trade in and out of foreign shares through U.S. exchanges such as the NYSE or NASDAQ. It is in fact shares that are situated in other countries.

ADR is an “image” of the foreign stock. It is U.S. investors who trade ADRs in much the same way that they buy and sell U.S. stocks; they use U.S. dollars and their existing broking accounts rather than get involved with foreign currencies, settlement systems, or rules they are unfamiliar with.

Key Players in the ADR Process

• The Foreign Company: The issuer whose securities are going to be offered for sale usually a corporation, for example, from Europe or Asia.
• The Depositary Bank: A U.S. bank buys the shares of a foreign company in the U.S. and holds them there in safekeeping and later issues ADRs representing those shares.

American investors purchase the ADRs through American exchanges. In general, one ADR represents one or more foreign shares, or one fraction of a foreign share. If an investor acquires an ADR, he does not own foreign shares; he owns foreign shares in the form of an ADR. Usually, ADR holders do receive dividends and corporate actions with respect to shares and may exercise voting rights on these shares; however, this often functions in a dissimilar manner.

Various types of ADRs

There are three primary types of ADRs based on the mode of issuance and regulation:

• Sponsored ADRs: These are created with cooperation from the foreign company. The company designates a U.S. depositary bank to issue the ADRs. Normally, this bank furnishes financial information in English and observes US practice. Sponsored ADRs usually trade most of the time on major exchanges like NYSE or NASDAQ.
• Unsponsored ADRs: These are released without the participation of the foreign company. Unsponsored ADRs can be initiated by depositary banks themselves, and more than one bank can issue ADRs for one and the same foreign company. In fact, normally, unsponsored ADRs trade OTC rather than on major exchanges.

Levels of ADRs

Level 1, Level 2 and Level 3 ADRs: These levels provide an insight into the degree of compliance with the rules of the U.S. Securities and Exchange Commission (SEC) and the exchange where American Depository Receipts (ADRs) are traded by the foreign company.

• Level 1: The basic kind; it will only trade over-the-counter, very few rules regarding what information must be made available.
• Level 2: Traded on an exchange with some reporting but no public new shares offering.
• Level 3: Is the most comprehensive. It prescribes full SEC registration and allows a company to raise money in U.S. markets.

Importance of ADRs

There could be a number of reasons for ADRs to be taken into account with regard to global investing:

• Better Access: ADRs provide a much easier way of getting direct exposure to owning shares of a foreign company, which normally proves to be quite complex owing to different factors like dealing in different currencies, varied trading hours, unfamiliar rules, etc.
• Currency Convenience: Because they are traded in U.S. dollars, investing in ADRs shields investors from currency risk (though still, the stock is quite another form of foreign risk).
• Diversification: Through ADRs, the American investor gets an opportunity to diversify his investments internationally without moving away from his American broking account in great foreign growth.
• Liquidity: The U.S. is home to massive exchanges where ADRs are typically traded, thus assuring a great deal of liquidity when shares are sold or bought.

How ADRs work regarding dividends and voting

Dividends are paid by the foreign company to the depositary bank in foreign currency, which the depositary bank then converts into U.S. dollars and pays out to the ADR holders. The actual amount that gets received as dividends by the investors may, however, be influenced by differences in foreign tax laws.

ADR holders assign their voting rights to others but it proves more cumbersome since the depositary bank generally votes on their behalf. Investors must read the terms of each ADR to understand their voting rights.

Things to Think about and Risks ADRs Have

Many Good Points but Investors Should Know There Are Some Risks:

• Currency Risk: Though transactions may be denominated in U.S dollars, the return on investment could be affected by fluctuations in the foreign exchange rate.
• Political and Economic Risk: ADRs represent shares of a foreign company, which may be subject to various political, economic, and legal regulations.
• Risk of Liquidity: A drawback of ADRs & unsponsored/Level 1 ADRs is that some may not be liquid.
• Commissions: Sponsored banks impose charges to organize and keep ADRs bearable which a little shrink returns.

Some ADRs of Note

Various enormous worldwide corporations carry ADRs that relocate in the U.S. Here are a few cases:

• Alibaba Group Holding Ltd. (BABA): “China’s Amazon.com”
• Nestlé S.A. (NSRGY): food and drink company based in Switzerland
• BP plc (BP): British-based energy company with operations worldwide
• Sony Corporation (SONY): Japanese multinational company

Conclusion

That is, ADRs allow investors in the United States to benefit from global growth stories but using the investment platforms to which they are accustomed in the United States. In sum, American depositary receipts glue U.S. investors to the global economy investing across borders. That is, it’s easier for you to diversify and grow with companies from foreign soil.

If you wish to invest in markets across the world and are concerned about the hassle of trading on foreign exchanges, ADRs are an uncomplicated simple way to do so. They bring the world’s markets directly to your door.