American Depositary Receipts (ADR) Meaning

The ADR was firstly created in 1927 by J.P. Morgan, in which Americans were allowed to invest in Selfridges’s shares, a British department store.

Presently, thousands of ADRs represent different companies’ shares in other countries. According to the Securities and Exchange Commission (SEC), it is more convenient for the investors to own ADRs in place of the foreign stock itself because they have protection and transparency in ADRs facilitated by the U.S. securities regulation.

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Types of ADRs

There are two basic types: –

Type #1 – Sponsored ADR

The bank issues the sponsored ADRs on behalf of the foreign company where the legal arrangement exists between the two parties. In this case, the bank will handle the transactions with the investors, while the cost of issuing and controlling ADRs will be of a foreign company.

These ADRs are registered with the Securities and Exchange Commission (SEC) (except sponsored ADRs lowest level) and traded on the major stock exchanges of the U.S.

Type #2 – Unsponsored ADR

Unsponsored ADRs are the shares that are traded on the over-the-counter market (OTC). A bank issues unsponsored ADRADRADR (American Depository Receipts) is a financial instrument traded in US markets and are issued by US banks. ADRs are listed on the stock exchange and can trade like other stocks. read more according to demand in the market where a foreign company under consideration has no participation or formal or legal agreement with a depository bank. Such ADRs are never included in voting rights.

Example of the American Depositary Receipts

Let us consider an example of the German company named Volkswagen shares which trades on the New York Stock Exchange. After compliance with various laws, it got listed on the American stock exchangeAmerican Stock ExchangeThe American Stock Exchange or AMEX, now known as the NYSE American, is a marketplace in New York City, New York, allowing traders to trade securities in small volumes. It lists more than 1,200 small-cap stocks and other trading instruments, including options, bonds, derivatives, and exchange-traded funds (ETFs).read more. Now, investors in America can invest in Volkswagen through the stock exchange. However, if Volkswagen’s shares are listed in other countries’ stock markets apart from the U.S. market, termed the GDR.

Advantages

  • The issuer of the ADRs can access the capital available in the market in the U.S. and get a diversified base of shareholders (U.S. shareholders).ADR makes it easy for the issuer to go for merger and acquisition activitiesMerger And Acquisition ActivitiesMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more as they can use ADR as the currency for the acquisition.For the investor, ADRs are easy to use as they can buy and sell the shares of the other country’s company like their own company. Also, there is no need for a new broker or to open a foreign  brokerage account Brokerage AccountA brokerage account is a taxable investment account in a brokerage company where a person deposits its assets and instructs the company to trade in shares or bonds on their behalf. In addition, the company deducts some brokerage or commission.read more as investors can use the same broker they normally deal with.Investor gets the opportunity to diversify their investment portfolio on a global scale.Everything is as per the U.S. working. The investors purchase ADRs in U.S. dollars; dividends are given in dollars, traded during the normal trading hours in the U.S., and are subject to settlement procedures as American stocks.It gives more accessibility of research and information to the investors, and investors can customize their portfolio according to their requirements like which countries they are interested in or which sector, etc.

Disadvantages

  • The unsponsored ADRs may not comply with the Securities and Exchange Commission (SEC).The investors might have limited companies for the selection as all the foreign companies are not available as ADRs.An investor needs enough capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.read more; otherwise, creating a properly diversified portfolio will not be possible.The investor might face double taxationDouble TaxationDouble Taxation is a situation wherein a tax is levied twice on the same source of income. It usually occurs when the same income is taxed both at corporate as well as at the individual level.read more if the dividend is taxed differently, as ADR dividends received may be subject to the tax in the company’s home country.

Important points

  • Before investing in ADRs, one should consult a tax advisor and the financial advisor to understand the implications of the portfolio in which the person is planning to invest their capital as it involves international investingInternational InvestingInternational investments are made outside of domestic markets and offer portfolio diversification as well as risk management opportunities. As a result, an investor can diversify his portfolio and extend his return horizon by making international investments.read more, one should initially go with a global mutual fund until one gets good knowledge about the same.There are several unique differences between American Depositary Receipts and foreign or traditional U.S. stocks, which one should consider before investing. Like taxes on the dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more may be charged differently. In the case of U.S. stocks, taxes charged will be in the U.S. only. Whereas, in the case of ADRs, dividends may also be subject to tax in the company’s home country. In that case, to avoid double taxation, investors might have to apply for either a refund from a foreign country or apply for credit against their U.S. taxes.

Conclusion

Thus, we can conclude that the American Depositary Receipts allow the investors of the U.S. to trade in the shares of foreign companies easily and conveniently. Furthermore, they also enable the investors to diversification of their portfolioDiversification Of Their PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more as they can invest in companies not based in their home country America.

With the help of American Depositary Receipts, investors invest in companies located in emerging markets where they can maximize their profit out of the money investedOut Of The Money Invested”Out of the money” is the term used in options trading & can be described as an option contract that has no intrinsic value if exercised today. In simple terms, such options trade below the value of an underlying asset and therefore, only have time value.read more. So, the American Depositary Receipts remove the restrictions of the Americans from investing only in their home country.

This article is a guide to American Depositary Receipts (ADRs). We discuss the American Depositary Receipts (ADRs) types, examples, and advantages with their disadvantages. You can learn more about investment banking from the following articles: –

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