Definition — what an ADR is
– An American Depositary Receipt (ADR) is a U.S.-dollar security issued by a U.S. depositary bank that represents one or more shares (or a fraction of a share) of a foreign company. ADRs let U.S. investors buy and sell ownership in non‑U.S. firms on American trading venues without trading directly on a foreign exchange.
How an ADR is created (step‑by‑step)
1. A U.S. depositary bank buys shares of a foreign company on its home market or accepts them from the issuer.
2. The bank places those shares into custody overseas.
3. The bank issues ADR certificates that correspond to the deposited shares. Each ADR represents a set ratio of underlying shares (e.g., 1 ADR = 1 share, 2 ADRs = 1 share, or 1 ADR = 0.5 share).
4. The ADR is listed either over‑the‑counter (OTC) or on an exchange such as the NYSE or Nasdaq, depending on the program.
Key terms
– Depositary bank: the U.S. bank that holds the foreign shares and issues ADRs.
– ADS (American Depositary Share): the actual share represented by an ADR; ADR commonly refers to the certificate and the program.
– GDR (Global Depositary Receipt): similar concept but designed to trade in multiple international markets (often Europe) rather than primarily in the U.S.
– Arbitrage: traders exploit small price differences between the ADR and the underlying share on its home exchange, which tends to keep prices aligned.
Sponsored vs. unsponsored ADRs
– Sponsored ADR: created with the cooperation of the foreign company. Usually only one sponsor per issuer; may be listed on a major U.S. exchange; the foreign company typically provides required financial disclosures and may retain voting and other corporate rights.
– Unsponsored ADR: issued by a depositary bank without the foreign company’s direct involvement. Multiple banks can issue unsponsored ADRs for the same company; these usually trade OTC and typically do not convey voting rights.
Three levels of ADR programs
– Level I: OTC trading; minimal U.S. filing requirements; used mainly to create U.S. trading presence. Cannot raise capital in the U.S.
– Level II: Exchange listing (NYSE, Nasdaq) allowed; requires more SEC reporting and reconciliations to U.S. GAAP or reconciliations in SEC filings. Still cannot be used to raise capital.
– Level III: Full U.S. public offering permitted (issuer can raise capital via ADR issuance); issuer must meet full SEC reporting obligations.
How pricing works
– ADR prices are quoted in U.S. dollars and generally track the foreign share price converted at the prevailing exchange rate multiplied by the ADR ratio set by the depositary bank.
– Because traders can convert between ADRs and the underlying shares (directly or via the depositary), arbitrage keeps the ADR price close to the equivalent home‑market price after currency conversion.
– The depositary bank chooses the ADR ratio to set a U.S. price per ADR that is marketable (not too high and not so low that it looks like a penny stock).
Fees and tax treatment
– Custody or issuance fees: depositary banks typically charge small custody fees (commonly a few cents per ADR or per share). These fees are disclosed in the ADR prospectus and may be deducted from dividends or billed through your broker.
– Currency conversion costs: dividends and sale proceeds are converted into U.S. dollars; conversion costs reduce net proceeds.
– Withholding taxes: foreign governments may levy withholding taxes on dividends. The depositary bank commonly withholds these taxes before paying dividends to ADR holders. U.S. investors may be able to claim a foreign tax credit on their U.S. tax return to avoid double taxation—follow IRS rules.
Advantages and disadvantages (summary)
Advantages
– Easier access: buy foreign companies through U.S. brokers in U.S. dollars.
– Domestic trading hours, U.S. settlement conventions, and consolidated data feeds make trading and tracking simpler.
– Some ADRs provide company disclosures in English and according to U.S. reporting formats (especially Level II/III), aiding analysis.
Disadvantages / warnings
– Additional costs: custody fees, conversion costs, and potential withholding taxes that you wouldn’t face with domestic stocks.
– Possible limited liquidity for OTC or unsponsored ADRs.
– Unsponsored ADRs generally do not include voting rights and may lack issuer cooperation for disclosures.
– Currency, political, and country risks still apply because underlying business and shares are foreign.
Short checklist before buying an ADR
– Is the ADR sponsored or unsponsored? (sponsored generally offers better disclosure)
– What level is the ADR (Level I, II, or III)?
– Where is it trading? (NYSE, Nasdaq, or OTC)
– What is the ADR-to‑share ratio?
– What are the explicit fees (custody fee, transfer fees) and how are they charged?
– How are dividends handled and what withholding tax rate applies?
– What is the liquidity like (average volume, bid‑ask spreads)?
– Do you need to consider currency risk or political risk for the issuer’s home country?
Worked numeric example
Assumptions:
– Underlying foreign share price on home exchange = 10 GBP.
– Exchange rate = 1 GBP = 1.30 USD.
– Depositary sets ratio = 2 ADRs per 1 foreign share (i.e., 1 ADR = 0.5 underlying share).
– Bank custody fee = $0.02 per ADR, deducted from dividend or paid via broker.
Step calculations:
1. Home price converted to USD: 10 GBP × 1.30 = $13.00 per foreign share.
2. Price per ADR before fees: since 1 share = 2 ADRs, 1 ADR = $13.00 / 2 = $6.50.
3. Suppose the company pays a dividend of 1.00 GBP per share. Converted dividend in USD = 1.00 × 1.30 = $1.30 per underlying share.
4. Dividend per ADR = $1.30 / 2 = $0.65. After custody fee = $0.65 − $0.02 = $0.63 net received per ADR.
5. If a 15% foreign withholding tax applies, the bank may withhold 15% of the gross dividend: 15% × $0.65 = $0.0975. Net dividend after withholding and custody fee = $0.65 − $0.0975 − $0.02 ≈ $0.5325 per ADR. You may be eligible for a foreign tax credit on your U.S. return for the $0.0975 withheld.
Other practical notes
– Liquidity matters: many ADRs, especially unsponsored and Level I, have low trading volumes and wider spreads.
– Voting rights: verify whether an ADR carries voting and how votes are cast (often limited or indirect, especially for unsponsored ADRs).
– Documentation: read the ADR prospectus (deposit agreement) to confirm fees, conversion mechanics, and dividend procedures.
Quick comparison: ADR vs ADS vs GDR
– ADR: the receipt traded in the U.S. that represents depositary shares.
– ADS (American Depositary Share): the actual U.S. share unit represented by an ADR—names are often used interchangeably.
– GDR (Global Depositary Receipt): analogous instrument intended to trade across multiple international markets rather than primarily in the U.S.
The bottom line
ADRs are a convenient bridge for U.S. investors to own foreign companies using U.S. dollars and U.S. brokers. They simplify trading and reporting access but can carry extra fees, withholding taxes, liquidity differences, and some restrictions (especially with unsponsored or Level I programs). Understanding the ADR type, level, ADR/share ratio, fee schedule, and tax treatment is essential before investing.
Reputable sources for further reading
– Investopedia — American Depositary Receipt (ADR): https://www.investopedia.com/terms/a/adr.asp
– U.S. Securities and Exchange Commission (SEC) — Fast Answers: American Depositary Receipts (ADRs): https://www.sec.gov/fast-answers/answersadrhtm.html
– Internal Revenue Service (IRS) — Foreign Tax Credit: https://www.irs.gov/individuals/international-taxpayers/foreign-tax-credit
– NYSE — Depositary Receipts and Listing Information: https://www.nyse.com/listings/faq-adrs
Educational disclaimer
This explainer is for educational purposes and does not constitute personalized investment advice, tax advice, or a recommendation to buy or sell any security. Consult a licensed financial, tax, or legal professional for advice tailored to your situation.