how american depositary receipts adrs work
american depositary receipts are denominated in u s dollars the underlying security is held by a u s financial institution often by an overseas branch these securities are priced and traded in dollars and cleared through u s settlement systems to begin offering adrs a u s bank must purchase shares on a foreign exchange the bank holds the stock as inventory and issues an adr for domestic trading adrs can be listed on the new york stock exchange nyse the nasdaq and over the counter otc 1u s banks require that foreign companies provide them with detailed financial information this requirement makes it easier for american investors to assess a company s financial health types of american depositary receiptsamerican depositary receipts come in two basic categories a bank issues a sponsored adr on behalf of the foreign company the bank and the business enter into a legal arrangement the foreign company usually pays the costs of issuing an adr and retains control while the bank handles the transactions with investors sponsored adrs are categorized by what degree the foreign company complies with securities and exchange commission sec regulations and american accounting procedures 1a bank also issues an unsponsored adr however this certificate has no direct involvement participation or even permission from the foreign company theoretically several unsponsored adrs for the same foreign company could be issued by different u s banks these different offerings may also offer varying dividends with sponsored programs only one adr is issued by the bank working with the foreign company one primary difference between the two types of adrs is where they trade all except the lowest level of sponsored adrs register with the sec and trade on major u s stock exchanges unsponsored adrs will trade only over the counter unsponsored adrs never include voting rights 1the number of adrs available which represent companies from more than 70 different countries 1adrs are additionally categorized into three levels depending on the extent to which the foreign company has accessed the u s markets this is the most basic type of adr where foreign companies either don t qualify or don t want their adr listed on an exchange this type of adr can be used to establish a trading presence but not to raise capital level i adrs found only on the over the counter market have the loosest requirements from the securities and exchange commission sec and are typically highly speculative while they are riskier for investors than other types of adrs they are an easy and inexpensive way for a foreign company to gauge the level of u s investor interest in its securities as with level i adrs level ii adrs can be used to establish a trading presence on a stock exchange and can t be used to raise capital level ii adrs have slightly more requirements from the sec than level i adrs but they get higher visibility and trading volume level iii adrs are the most prestigious with these an issuer floats a public offering of adrs on a u s exchange they can be used to establish a substantial trading presence in the u s financial markets and raise capital for the foreign issuer issuers are subject to full reporting with the sec 1american depositary receipt pricing and costsan adr may represent the underlying shares on a one for one basis a fraction of a share or multiple shares of the underlying company 1 the depositary bank will set the ratio of u s adrs per home country share at a value that they feel will appeal to investors if an adr s value is too high it may deter some investors conversely if it is too low investors may think the underlying securities resemble riskier penny stocks because of arbitrage an adr s price closely tracks that of the company s stock on its home exchange remember that arbitrage is buying and selling the same asset at the same time in different markets this allows traders to profit from differences in the asset s listed price investing in an adr may incur additional fees that are not charged for domestic stocks the depositary bank that holds the underlying stock may charge a fee known as a custody fee to cover the cost of creating and issuing an adr this fee will be outlined in the adr prospectus and typically ranges from one to three cents per share the fee will be either deducted from dividends or passed on to the investor s brokerage firm adrs and taxesholders of adrs realize any dividends and capital gains in u s dollars however dividend payments are net of currency conversion expenses and foreign taxes usually the bank automatically withholds the necessary amount to cover expenses and foreign taxes 2since this is the practice american investors would need to seek a credit from the irs or a refund from the foreign government s taxing authority to avoid double taxation on any capital gains realized 3if you re interested in learning more about adrs there are many investing courses available that can get you started advantages and disadvantages of american depositary receiptsas with any investment there are distinct advantages and disadvantages of investing in adrs here are some of them adrs are just like stocks this means they trade on a stock exchange or over the counter making them fairly easy to access and trade investors can also easily track their performance by reviewing market data purchasing adrs is easy because they re available directly through american brokers this eliminates the need to go through foreign channels to buy stock in a company you may be interested in since they re available domestically shares are denominated in u s dollars but that doesn t mean you avoid any direct risks associated with fluctuations in currency rates it is a common misconception that since the adr is traded in u s dollars in the united states there is no exchange rate risk adrs have currency risk because of the way they are structured the global bank that creates the adrs establishes a conversion rate meaning that an adr share is worth a certain number of local shares to preserve this conversion rate over time movements in the exchange rate of the home country vs the adr price must be reflected in u s dollars one of the most obvious benefits of investing in adrs is that they provide investors with a way to diversify their portfolios investing in international securities allows you to open your investment portfolio up to greater rewards along with the risks the main problems associated with adrs are that they may involve double taxation locally and abroad and how many companies are listed unlike domestic companies there are a limited number of foreign entities whose adrs are listed for the public to trade some adrs may not comply with sec regulations these are called unsponsored adrs which have no direct involvement by the company in fact some companies may not even provide permission to list their shares this way although investors can avoid any direct risks that come with currency exchange they may incur currency conversion fees when investing in adrs these fees are established to directly link the foreign security and the one traded on the domestic market easy to track and tradeavailable through u s brokersdenominated in dollarsoffer portfolio diversification