What is American Depositary Receipts ADR?
American Depositary Receipt or ADR is a negotiable certificate of shares of a foreign company. The U.S. Bank that owns these shares issues an ADR against them. ADR may comprise a portion of shares, a single share, or a bundle of shares. A bank branch may hold these shares in the home country of the company, the “foreign private issuer”. ADR trades in the U.S. financial markets like the NYSE, NASDAQ, AMEX, or maybe sold over-the-counter. It trades like a domestic share and investors receive the dividend in U.S. Dollars.
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U.S. investors can invest in non-U.S. companies through an ADR. Non-U.S. companies use ADRs to raise capital and get access to the U.S. capital markets through it. The U.S. regulatory body Securities Exchange Commission (SEC) introduced ADR to allow investors to diversify their investments. The first ADR was created in 1927 for a British department store. Since then, U.S. investors have invested in foreign companies without a foreign brokerage account. Over 2,000 ADRs trade in the U.S. today as well as they represent shares of companies from around 70 countries.
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How does American Depositary Receipt ADR work?
- A company, listed on its domestic stock exchange, sells its shares to U.S. banks. The bank trades them on the U.S. exchange.
- The U.S. bank analyzes the company’s financial health and issues American Depository Receipts based on their demand.
- Bank issues ADRs against the shares held by it. The American Depositary Receipts are available for trade on the major stock exchanges of America.
- Once the U.S. stock exchange lists the ADR certificates for trading, investors can buy them through brokers or dealers.
- Securities Exchange Commission (SEC) is the American regulatory body. It ensures compliance with U.S. and foreign trading policies during ADR trading.
What are the types of American Depositary Receipt ADR?
American Depository Receipts are of the following types:
1. Sponsored ADR: A U.S. depositary bank buys shares from a foreign company. They enter into an agreement to sell the issued shares in US markets. The U.S. bank issues Sponsored ADRs and lists them on the US stock exchanges. The bank undertakes responsibility for recordkeeping, sale of ADRs, and distribution of dividends to the public.
2. Non-Sponsored ADR: Brokers/dealers in the U.S. over-the-counter markets issue non-sponsored ADRs. These can be traded only in over-the-counter markets and there is no involvement of the foreign company. Till 2008 Brokers and dealers of non-sponsored ADRs used to apply with the Securities and Exchange Commission (SEC). Moreover, post the 2008 SEC amendment the Commission offered them an exemption from registration if they met the SEC regulatory criteria.
What are the different levels of American Depositary Receipt (ADR)?
ADRs are grouped based on the foreign company’s compliance with SEC regulations and access to the US trading market. American Depositary Receipt can be categorized in the following three levels:
Sponsored Level I:
Sponsored Level I ADRs are issued against the least reporting requirements with SEC. It is the lowest and most common level of trading in the U.S. for foreign companies. The shares of these companies are not listed on the U.S. security exchanges, as they do not qualify trading criteria. These companies have their stock listed on at least one exchange in their country of origin. Unlike publicly traded companies, level I companies are not required to submit quarterly or annual performance reports to SEC. Lastly, Level I sponsored ADRs are traded only in over-the-counter markets and can be upgraded to level II.
Sponsored Level II ADRs
The company must comply with SEC regulatory requirements to trade freely in U.S. Stock Markets. Sponsored Level II ADRs are issued to companies when they file a registration statement. Form-20-F (the equivalent of Form-10-K submitted by U.S.-based public companies). The company must also comply with GAAP (Generally Accepted Accounting Principles). Moreover, compliance with IFRS (International Financial Reporting Standards) standards also applies to Level II ADR. Compliance under the SEC guidelines is mandatory to maintain the company’s sponsorship level. Inability to comply with these norms may lead to the delisting of the company from U.S. stock exchanges. A non-compliance may also lead to a down gradation to Level I.
Sponsored Level III ADRs
Sponsored Level III ADRs demand the strictest level of compliance to SEC guidelines. It is the highest level of trading a foreign company can sponsor in the US stock markets. A Level III company can float a public offering of ADRs. It can raise capital from American investors by trading these ADRs in U.S. exchanges. Filing Form F-1 (prospectus) and Form 20-F (annual reports) are mandatory for companies at this level. All documentation should be as per GAAP or IFRS standards. Compliance with SEC guidelines is important to maintain this prestigious level. The company must submit all information shared with its shareholders in the origin country through Form 6-K.
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American Depositary Receipt Pricing
The U.S. depository bank decides American Depository Receipt (ADR) pricing based on the share value in its home country. An ADR may represent one share, its fraction, or multiple shares of the issuing company. The value must attract U.S. retail investors. Therefore, keeping the value too high or low may deter investors as they may deem it either costly or risky.
ADR’s daily price fluctuates with the value of issuing company’s stock on its home exchange. Investors get dividends and capital gains in U.S. dollars. The dividend payments received by holders are subject to deductions. Banks withhold currency conversion expenses and foreign taxes as deductions. American investors can seek tax credit from the IRS (Internal Revenue System). They may claim a refund from the foreign government’s taxing authority on realized capital gains.
What is a GDR?
GDR or a Global Depositary Receipt (GDR) is a negotiable bank certificate. International Depository Banks issue it against shares of a foreign company in multiple countries. They may also list in two or more securities markets. These instruments are useful for issuing companies intending to raise capital in their local markets, U.S. markets, and other international markets. The other most common markets for issuing GDR are European as well as Asian markets. In Euromarkets, they trade in Euros.
What is the difference between ADR and GDR?
Foreign companies use ADR and GDR to raise funds from foreign markets. The intent of issuing both certificates is the same. There are the following differences between ADR and GDR:
- ADR provides listing in the U.S. market only whereas GDR provides listing in two or more international markets.
- A U.S. depositary bank issues ADR but the International depository banks issue GDR.
- ADR is negotiable in the U.S. against USD but GDR is globally negotiable in the local currency of the trading country.
- Participation of retail investors is more in ADR. Institutional investors participate in GDR.