A guide to American Depositary Receipts (ADRs)

ADRs are a common way for foreign companies to tap into US equity markets, and for US-based investors to access international assets. Learn what ADRs are and how they work.

What are ADRs?

ADRs are American Depositary Receipts, which is a certificate issued by a US depository bank that represents shares in a foreign company. It is an alternative means for non-US companies to trade on US stock exchanges.

ADRs were introduced by J.P. Morgan in 1927 after laws were passed prohibiting UK companies from listing abroad. To accommodate US demand for UK investments, the ADR was created. Today, ADRs are still one of the most popular routes for investors looking to buy stocks of internationally-listed companies.

American Depositary Receipts vs shares

While ADRs represent shares of foreign companies that trade on the US market, ordinary shares belong to US domestic companies.

It is important to note that an ADR is a depository receipt and not an outright share, but they do come with the same voting rights and dividend entitlements.

If you own an ADR, you have the right to obtain the foreign stock it represents, but an ordinary share cannot be converted into an ADR.

How do ADRs work?

ADRs work much the same way as any other shares. They’re listed on exchanges and are denominated in the US dollar, regardless of the company’s domestic currency. 

The process for listing an ADR is as follows:

1. A broker buys shares listed on a local exchange
2. The broker deposits the stock with a custodian bank
3. The bank informs the US depositary bank that they have the stock
4. The US depository bank issues ADRs and lists them on exchanges

At this point, ADRs can be bought and sold by investors in the same ways as common shares.

Types of ADR

Broadly, there are two types of ADRs:

1. Sponsored – these are agreements in which the foreign company agrees with a bank to bear the costs of issuance. The bank acts as a guarantor to assure investors of the legitimacy of the transactions. The company has to comply with all of the Securities and Exchange Commission guidelines
2. Unsponsored – a bank will issue an ADR without involvement from a foreign company. This means the company has no obligation to comply with SEC guidelines as they have no participation in the transactions

There are then three levels to ADRs that are issued, which tell investors how secure the certificates are:

• Level 1 ADRs are the most basic type, these are generally unsponsored so have no input from the company. They’re typically sold over the counter, as they don’t meet SEC guidelines, which makes them far less transparent and prone to lower liquidity
• Level 2 ADRs are listed on exchanges and means the company meets basic compliance levels
• Level 3 ADRs are the highest standard, they meet all compliance levels required

Example of ADR stocks

A typical example of ADR stock is GlaxoSmithKline, the global pharmaceutical and healthcare giant. The company is located in the United Kingdom, and its common stock trades on the London Stock Exchange (LSE). But it also has ADRs that trade on the NYSE under the code GSK.

Advantages of American Depositary Receipts

For American investors, ADRs can be a much easier way to access foreign assets because they can be bought and sold in the US, without needing to consider the implications of investing abroad. Especially given that some developing markets aren’t easily accessible to investors.

Plus, because ADRs are always USD-denominated, they can help in overcoming exchange-rate risk (currency risk), which is what occurs when you have to convert your foreign investment back into domestic currencies. However, the value of ADRs will still fluctuate due to currency rates.

For companies, ADRs create the opportunity to tap into US investor capital, and boost equity. It can also improve the firm’s standing on international markets because companies listed on the NYSE and NASDAQ have to go through rigorous checks and conform to certain financial standards. Meeting these criteria can be seen as a ‘stamp of approval’ on global markets.

Disadvantages of American Depositary Receipts

ADRs do come with certain tax implications. Although they’re subject to the same tax rules as US shares, you might also need to consider the tax laws of the company’s domestic country too.

For example, if the company belongs to a country that withholds tax on dividends, a certain portion of your income could be taken.

Companies belonging to countries that maintain tax treaties with the US can distribute dividends without foreign withholding if the accrued gains are in US dollars.