What is an American Depositary Receipt (ADR)?
American Depositary Receipt, or ADRs, is a negotiable certificate issued by a US depositary bank that evidences ownership of foreign equity shares held by the depositary bank. ADRs are listed on the US stock exchange and can be traded just like regular stocks. They provide investors with a convenient way to invest in foreign companies without worrying about the complicated and time-consuming process of buying and selling individual shares in foreign markets. ADRs can also offer investors greater exposure to international markets and increased liquidity and transparency. In this blog post, we'll take a closer look at what ADRs are, how they work, and some of the benefits they offer investors.
What is American Depositary Receipt (ADR)?
American Depositary Receipts (ADRs) are negotiable security instruments that represent the ownership of American Depositary Shares (ADSs). Each ADR represents a specified number of ADSs, which are shares of a foreign company that trades on a US stock exchange. ADRs are issued by US banks and broker-dealers and are traded on major US exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq Stock Market.
ADRs were created to make it easier for US investors to buy and sell shares of foreign companies. Prior to the creation of ADRs, investors interested in purchasing shares of a foreign company had to go through the cumbersome process of converting their currency into the foreign company's home currency, opening a brokerage account in the foreign country, and complying with that country's regulations.
Now, with ADRs, US investors can simply purchase the ADRs on a US exchange using US dollars and hold them in their existing brokerage accounts. When they want to sell their position, they can do so on the same exchange where they purchased the ADRs. This convenience has been a major factor in the globalization of the financial markets.
Types of American Depositary Receipts (ADR)
There are two different types of ADRs: Sponsored ADRs and Unsponsored ADRs.
Sponsored ADRs that have been issued pursuant to an agreement between a US depositary bank and the foreign issuer of the underlying securities. The depositary bank agrees to promote and maintain the listing of the Sponsored ADRs on a US stock exchange and provide certain other services specified in the legal agreement. Sponsored ADRs trade, clear, and settle in US dollars, just like any other listed US security, and are subject to the same SEC rules and regulations.
Non-sponsored ADRs are created by brokers and dealers without the involvement of a foreign company. They are sold over-the-counter markets, rather than on a stock exchange. Non-sponsored ADRs typically have lower trading volumes than sponsored ADRs, and they may be less liquid. However, they can still provide a way for investors to access foreign companies that do not have a direct listing on a US exchange.
Advantages and Disadvantages of American Depositary Receipts
Here are the advantages and disadvantages of ADRs:
Advantages of American Depositary Receipts
American Depositary Receipts (ADRs) offer a number of advantages to both foreign companies and American investors. For companies, ADRs provide an easy way to raise capital in the US market without having to go through the expense and hassle of a direct listing. And for investors, ADRs offer a convenient way to invest in foreign companies without having to open a foreign brokerage account. In addition, ADRs are often more liquid than their underlying shares, making them easier to buy and sell. As a result, ADRs provide a win-win solution for both companies and investors.
Disadvantages of American Depositary Receipts
One downside of ADRs is that they may trade at a premium or discount to the underlying stock. This means that an investor might pay more for an ADR than the actual value of the shares represented by the ADR. Additionally, ADRs are subject to currency risk since they are denominated in US dollars but the underlying shares may be priced in a foreign currency. If the value of the foreign currency falls against the dollar, the value of the ADR will also decline.
Another disadvantage of ADRs is that they may not be available for all foreign stocks. For example, a company might not want to go through the hassle and expense of complying with US securities regulations. As a result, investors interested in buying shares of such a company would need to do so through a foreign broker, which can be complicated and expensive.
Investors should carefully consider all factors before deciding whether or not to invest in ADRs.
Who issues ADR?
ADRs are issued by American banks or brokers on behalf of foreign companies. They trade just like regular stocks on major exchanges such as the New York Stock Exchange (NYSE) or Nasdaq. ADRs represent ownership in the underlying foreign company and each ADR corresponds to a certain number of shares of the foreign company’s stock. The issuer of an ADR is responsible for providing accurate and up-to-date information about the foreign company to investors, as well as ensuring that the ADR trades at a fair price. ADRs can be a convenient way for American investors to tap into foreign markets, but it’s important to remember that they come with unique risks.
What Is the Difference Between an ADR and a GDR (Global Depositary Receipts)?
ADRs and GDRs (Global Depositary Receipts) are both financial instruments that allow foreign companies to list their shares on American and international stock exchanges, respectively. ADRs are denominated in U.S. dollars and traded on US exchanges, while GDRs are traded in their local currency on international exchanges. ADRs are subject to US securities regulations, while GDRs are not.