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Suppose you heard that Adidas was setting up a network for 50,000 college athletes to be paid to represent its brand and you wanted to buy stock in the company because of the potential profits. Then you find out that Adidas stock is trading in Frankfurt and you are in the USA.

You enter an American Depositary Receipt, commonly known as an ADR. ADRs are a mechanism by which you can turn international securities into US securities that can be traded on major US exchanges. In other words, the ADR will allow you to buy Adidas like any other stock traded in the US.

“It can act as a wrapper around the underlying foreign stock if you want,” said Jason Paltrowitz, executive vice president of corporate services at OTC Markets Group, which facilitates the trading of U.S. and global securities, including ADRs. “You create a receipt or wrapper and turn it into a dollar-denominated security that is traded and settled in the United States.”

How does ADR work?

The first ADR was issued in 1927, allowing American investors to invest in British department stores, according to the SEC. There are more than 2,000 ADRs traded on U.S. exchanges, representing companies located in more than 70 countries.

ADRs are negotiable certificates held by American Depositary Shares, representing holdings of non-U.S. company stock deposited with U.S. banks. Think of it as a stock certificate, representing a portion of the stock. ADRs are traded in US dollars and cleared through the US settlement system. This allows holders to avoid the need to trade foreign currencies and the complexities of doing business abroad.

The ratio of foreign stocks to ADRs varies from company to company. For example, one ADR of Chinese online retailer Alibaba is equivalent to one underlying Alibaba share, while one ADR of Toyota is equivalent to 10 underlying shares of the Japanese automaker. Some ADRs can even represent a fraction of a company’s shares. The use of such an index allows the pricing of ADRs to be more in line with US market prices.

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ADRs are issued by a bank when a non-U.S. company or an investor holding shares in a foreign company delivers them to the bank or the bank’s custodian in the foreign company’s home country. Owning these shares can allow banks to change things around and issue U.S. depositary receipts to U.S. investors. ADRs are then traded on major stock exchanges, such as the New York Stock Exchange and Nasdaq, or can be sold over the counter.

Over the past decade, the demand for ADRs in more developed markets has declined as the cost and complexity of transacting international securities has decreased. However, developing countries like India and Brazil still see a lot of demand from institutional investors who want to use ADRs to avoid the complexities of their local markets.

Different Types of American Depositary Receipt Programs

ADRs can be classified as either “Sponsored” or “Unsponsored”.

Sponsored ADRs are issued in partnership with foreign companies. According to the SEC, the foreign company will work directly with U.S. banks to arrange record keeping, forward notices to shareholders, pay dividends and other services.

An unsecured ADR is an ADR established without the assistance of a foreign entity, such as an ADR issued by a broker-dealer seeking to establish a U.S. exchange market. According to Patrowitz, most UAWs have no sponsorship.

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While ADRs can be issued without the cooperation of a foreign company, ADRs cannot be created unless a non-U.S. company is subject to or specifically exempted from the reporting requirements of the Securities Exchange Act of 1934.

ADR value

In addition to being classified as sponsored and non-sponsored, ADRs are also classified based on the degree to which the subject foreign entity has entered the U.S. market. These tiers vary according to their listing risks and reporting requirements.

  • Tier 1 ADRs can only be traded on the over-the-counter market and cannot raise funds for foreign companies. As the only type of ADR that cannot be sponsored, reporting requirements are minimal and information about the issuer is only available on their website.
  • Tier II ADRs can be listed on U.S. exchanges, but cannot be used to raise capital. The target company must register with the SEC and file an annual report.
  • Tier III ADRs can be listed on U.S. exchanges and used to raise capital for foreign issuers. Reporting requirements are similar to U.S. companies, so this level represents most well-known foreign companies.

According to Paltrowitz, about 70% of ADRs are level 1. This is the best deal for the company as the rules basically exempt you from SEC registration, Sarbanes-Oxley compliance, etc. For example, French food company Danone was listed on the New York Stock Exchange but was delisted when Sarbanes-Oxley was passed.

“In their view, the French disclosure was as good or better than the U.S. disclosure,” Patrowitz said. “The reality is that now with this connectivity, you know the world is getting smaller and they don’t want to take on the extra cost, extra risk and duplicate reporting requirements of two regulators.”

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ADR-related fees

As with any investment, investing in ADRs has associated costs. In addition, there are fees charged by custodian banks, commonly known as custodial fees. Custody fees typically include custodian fees for non-US stock, registration, compliance and other records. These fees are usually 1 to 3 cents per share and can sometimes be paid through a dividend withholding tax, in which the custodian deducts the fee from the total dividends the bank pays to ADR holders.

According to Holmes Osborne, director of Osborne Global Investors, your brokerage may charge fees in addition to the bank holding the ADR
money management
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Dividends paid by ADRs are also sometimes subject to double taxation, but the IRS has a foreign tax credit that U.S. taxpayers can use to offset any taxes paid to foreign governments. In addition, any investment income in ADRs will be subject to capitalist turn.

Pros and Cons of American Depositary Receipts

As our Toyota example shows, the biggest advantage of investing in ADRs is that investors can easily invest in foreign companies. Some of the biggest names in business are foreign companies, and ADRs allow U.S. investors to pursue new and different investment opportunities abroad.

However, the nature of alternative dispute resolution mechanisms also poses certain risks. Because ADRs represent foreign investments, you are inevitably exposed to exchange rate risk, which may affect the value of your underlying investment. In addition to exchange rate issues, political and inflationary risks abroad must also be considered.

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दोष
  • Easy access to foreign investment opportunities in the form of U.S. securities
  • You don’t have to buy foreign currency or deal with volatility
  • Dividends are paid in US dollars and the custodian handles all background currency conversion tasks
  • Inflation risk in the country where the company is located
  • Potential currency volatility and political risk in the company’s home country
  • Risks of repatriating the majority of dividends to the company’s home country without a tax treaty with the U.S.

When and how to invest in ADRs

ADR is your gateway to the world without the hassle of actually doing the work of buying foreign currencies. Holmes emphasized that even if the cost is higher, if you avoid ADRs, you will avoid companies like Nestlé, the world’s largest food company.

“It’s the only way to invest in some of the best companies in the world — Diageo, Heineken, Volkswagen, Toyota,” Holmes said. “The list goes on.”

ADRs can also help Americans diversify their investment portfolios.

“It does make sense given that there are only 350 million people in the U.S. compared to 7 billion globally,” said Christine Armstrong, executive director of wealth management and financial advisor at Morgan Stanley Wealth Management. “If you Do the math, the U.S. may be an economic powerhouse, but we’re just a small piece of the pie. There are many benefits to going out of the U.S.”

If you want to get involved, it’s as easy as buying stocks through your brokerage account. Just make sure to study the ADR carefully before buying to make sure it fits your investment objectives and risk tolerance. When in doubt, consult an investment professional.

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