American Depositary Receipts (ADRs) are certificates issued by U.S. banks that represent ownership in a foreign company’s stock. ADRs were created as a way for U.S. investors to invest in foreign companies without having to navigate the complexities of investing directly in foreign markets.
When a foreign company wants to issue ADRs, it first selects a U.S. bank to sponsor the ADR program. The bank then purchases the company’s shares in its home market and issues ADRs that represent a certain number of those shares. The ADRs are then traded on U.S. stock exchanges just like any other stock.
ADRs can be issued in two types – sponsored and unsponsored. A sponsored ADR program is created with the involvement of the foreign company, while an unsponsored ADR program is created without the company’s involvement. Sponsored ADRs are typically more common and have higher trading volumes.
Investing in ADRs allows U.S. investors to diversify their portfolios by investing in foreign companies without the need to navigate different regulations, currencies, and tax laws. However, investing in ADRs also comes with risks, such as currency fluctuations and political and economic instability in the foreign country where the company is based.
Types of American Depositary Receipts
There are three main types of American Depositary Receipts (ADRs):
1. Sponsored ADRs:
Sponsored ADRs are created with the involvement and cooperation of the foreign company whose shares are being represented by the ADRs. The foreign company typically pays for the expenses associated with the ADR program, such as the fees charged by the depositary bank. Sponsored ADRs are subject to more rigorous reporting requirements than unsponsored ADRs.
2. Unsponsored ADRs:
Unsponsored ADRs are created without the involvement of the foreign company whose shares are being represented by the ADRs. Instead, they are created by third-party entities, such as brokers, who purchase the underlying shares in the foreign market and create the ADRs. Unsponsored ADRs are typically less liquid than sponsored ADRs and are subject to fewer reporting requirements.
3. Rule 144A ADRs:
Rule 144A ADRs are a type of sponsored ADR that is only available to qualified institutional buyers (QIBs). Rule 144A is an SEC rule that allows for the sale of certain securities to QIBs without the need for registration with the SEC. Rule 144A ADRs allow foreign companies to tap into the U.S. institutional investor market without the need for a full SEC registration.
Investors should carefully consider the type of ADR they wish to invest in, as each type carries its own unique risks and benefits. Sponsored ADRs generally offer more transparency and liquidity but may be subject to stricter reporting requirements, while unsponsored ADRs may have lower liquidity but are subject to fewer requirements.
American Depositary Receipts Advantages and Disadvantages
American Depositary Receipts (ADRs) have several advantages and disadvantages for investors:
1. Access to foreign markets:
ADRs provide U.S. investors with a way to invest in foreign companies without having to navigate the complexities of investing directly in foreign markets.
ADRs are traded on U.S. exchanges, which makes them easy to buy and sell for U.S. investors.
3. Currency conversion:
ADRs allow U.S. investors to invest in foreign companies without the need to convert their dollars into the local currency of the foreign company, which can be costly and time-consuming.
Sponsored ADRs, in particular, can be highly liquid, which means that investors can buy and sell them quickly and easily.
Investing in ADRs allows investors to diversify their portfolios by gaining exposure to foreign markets and industries.
1. Foreign exchange risk:
ADRs are subject to currency fluctuations, which means that investors may lose money if the value of the foreign currency decreases against the U.S. dollar.
2. Political and economic risk:
Investing in ADRs also exposes investors to political and economic risks associated with the foreign country where the company is based.
Investing in ADRs may come with additional fees, such as depositary fees and foreign tax withholding, which can eat into investment returns.
4. Information asymmetry:
Some unsponsored ADRs may have limited information available to investors, which can make it difficult to make informed investment decisions.
5. Limited exposure:
ADRs may not provide the same level of exposure to foreign markets as investing directly in the foreign market, as some foreign companies may choose not to issue ADRs.
Investors should carefully consider the advantages and disadvantages of investing in ADRs before making investment decisions.
Suggested Read:- Global Depositary Receipts (GDR)