ADR Investing in U.S. Stocks: A Comprehensive Guide to American Depositary Receipts for International Companies

Summary: An ADR (American Depositary Receipt) is a financial instrument that lets investors buy and sell shares of foreign companies on U.S. exchanges. With ADRs, you can participate in global markets without opening an overseas account or dealing with foreign currency exchange.

Want to invest in foreign companies but don’t want to handle the hassle of opening overseas accounts? ADRs might be one of your options. As a bridge to global markets, ADRs allow investors to buy and sell shares of companies from around the world on U.S. exchanges in U.S. dollars. According to the U.S. Securities and Exchange Commission (SEC), there are over 2,000 ADRs on the market, representing companies from a wide range of countries. This article will explain in detail the definition, operation, classifications, and risk factors of ADRs.

Basic Definition and Operating Principles of ADRs

An ADR is a transferable security issued by a U.S. depositary bank that represents a specified number of shares in a foreign company. These shares are held by the depositary bank and stored at a custodian bank in the foreign company’s home country.

How ADRs Work

When a non-U.S. company wants its stock to be traded in the U.S., it partners with a U.S. depositary bank. The depositary bank buys shares of the company in its home market, holds them with a local custodian bank, and then issues corresponding ADRs that are listed on U.S. exchanges.

Each ADR can represent one share, multiple shares, or a fraction of a share of the foreign stock. For example, some ADRs represent foreign shares on a 1:1 basis, while others might have a 1:10 or 10:1 ratio. This flexibility enables stocks of different price ranges to trade on the U.S. market at reasonable prices.

Sponsored and Unsponsored ADRs

ADRs fall into two categories: Sponsored and Unsponsored.

Sponsored ADRs: The foreign company actively signs an agreement with the depositary bank, authorizing the issuance of ADRs. The company must regularly provide financial statements and fulfill certain disclosure requirements. Sponsored ADRs can be listed on major U.S. exchanges.

Unsponsored ADRs: These are issued by depositary banks or brokers independently, who buy foreign shares without the direct participation of the company. Typically, unsponsored ADRs can only be traded over-the-counter (OTC) and have lower disclosure requirements.

The Three Levels of ADRs

Sponsored ADRs are divided into three levels according to SEC regulations:

Level I ADRs

Level I ADRs are the entry level, with the least strict regulatory requirements. These ADRs can only be traded OTC, and the issuing company does not need to fully comply with U.S. Generally Accepted Accounting Principles (GAAP), but must publish English-language annual reports on its website. Due to lower liquidity, Level I ADRs often have wider bid-ask spreads.

Level II ADRs

Level II ADRs can be listed on major exchanges such as the New York Stock Exchange or NASDAQ. Issuing companies must register with the SEC and submit annual reports (Form 20-F) in accordance with GAAP or International Financial Reporting Standards (IFRS). Improved transparency and liquidity make Level II ADRs more attractive to institutional investors.

Level III ADRs

Level III is the most stringent. Issuers must meet all Level II requirements and can also raise capital through public offerings of ADRs. This means the company must comply with standards similar to U.S. domestic listed companies, including more detailed financial disclosures and ongoing compliance obligations.

Advantages of Investing in ADRs

There are a number of advantages to investing in ADRs:

Simplified Trading Process

With ADRs, investors can use their existing U.S. brokerage accounts to buy and sell shares in foreign companies, without the need to open overseas trading accounts or convert currencies. All transactions and dividends are settled in U.S. dollars.

Diversified Investment Portfolio

ADRs allow investors to access companies from different countries and regions, thereby spreading geographic risk. Whether you want to invest in European consumer companies, Asian tech firms, or financial institutions in emerging markets, they can all be included in your portfolio via ADRs.

Lower Transaction Costs

Compared to direct investment in foreign markets, ADRs generally involve lower transaction costs. Investors avoid certain foreign market taxes and additional cross-border transaction expenses.

Risks to Consider When Investing in ADRs

Although ADRs simplify overseas investing, investors should still be mindful of the following risks:

Exchange Rate Risk

The value of an ADR is linked to the underlying foreign stock. If the foreign currency depreciates against the U.S. dollar, the value of the ADR in dollars may fall even if the stock price in local terms remains unchanged. Such currency fluctuations can significantly affect investment returns.

Political and Regulatory Risk

Changes in the foreign company’s home country, such as political instability, regulatory changes, or capital controls, can affect the value of ADRs. Investors should pay close attention to the relevant country’s economic and political developments.

Liquidity Risk

Some ADRs, especially Level I ADRs, have low trading volumes. Low liquidity can result in wider bid-ask spreads and may put investors at a disadvantage when buying or selling.

ADR Custodian Fees

Depositary banks charge ADR holders custodial fees, typically USD 0.01 to USD 0.05 per share. These fees may be deducted from dividends or charged separately by your broker. Be sure to understand the fee structure before investing.

Comparing ADRs and Direct Purchase of Foreign Stocks

Choosing between ADRs and direct purchase of foreign stocks depends on several factors:

Convenience: ADRs are traded on U.S. exchanges and settled in U.S. dollars, making them easier to buy and sell. Direct purchases require opening an account in the foreign market and dealing with currency exchange.

Cost Structure: ADRs come with custodial fees, while direct purchases may involve higher commissions and currency conversion charges. Investors should compare the total cost of each option.

Shareholder Rights: Some ADR holders may not have full voting rights. Purchasing shares directly usually entitles you to complete shareholder rights.

Access to Information: Level II and III ADRs must comply with U.S. financial reporting standards, offering more transparency. Direct share purchasers may need to read reports in the local language.

If you’d like to learn more about investment products, you can further explore options across different markets.

Frequently Asked Questions

What is the difference between ADRs and ordinary shares?

ADRs are not stocks themselves but are depositary receipts representing shares of a foreign company. ADRs are traded on U.S. exchanges in U.S. dollars, whereas the underlying shares are traded on foreign exchanges in local currencies. ADR holders enjoy similar dividends and economic rights to ordinary shareholders, but voting rights may be limited.

What fees are involved when investing in ADRs?

The main fees include custodial fees charged by the depositary bank (usually USD 0.01 to USD 0.05 per share), brokerage commissions, and potential foreign withholding taxes. Some brokers automatically deduct custodial fees from dividends. Check with your broker for specific fee arrangements before investing.

Can ADRs be terminated?

ADRs may be terminated for various reasons, including at the request of the foreign company, the depositary bank’s decision, or company restructuring. Upon termination, ADR holders will usually receive written notice and may choose to convert their ADRs to the underlying foreign shares or sell their ADRs.

Conclusion

ADRs offer investors a relatively convenient way to participate in global markets. By understanding the operating mechanisms, classifications, and related risks, investors can more effectively assess if this investment tool suits their portfolio.

The best investment tool depends on your goals, risk tolerance, market views, and experience. Regardless of your choice, you must fully understand its mechanisms, risk profile, and trading rules, and establish sound risk management practices. You can learn more investment knowledge through the Longbridge Academy or by downloading the Longbridge App.