American Depositary Receipts (ADRs)

American Depositary Receipts (ADRs) are a financial instrument that allows investors to own shares of non-U.S. companies that trade on U.S. stock exchanges. ADRs were created in the 1920s as a way for U.S. investors to invest in foreign companies without having to deal with the complexities of trading foreign securities. Today, ADRs remain a popular way for U.S. investors to gain exposure to foreign companies.

How do ADRs work?

An ADR is essentially a certificate that represents a specific number of shares of a foreign company. The shares are held by a U.S. bank or other financial institution, which then issues the ADR to investors. The ADR trades on a U.S. stock exchange just like any other stock, and the price of the ADR is typically based on the price of the underlying foreign shares.

ADRs are denominated in U.S. dollars and are subject to U.S. securities laws, making them more accessible to U.S. investors than investing directly in foreign securities. ADRs also provide investors with access to foreign companies that may not be available on U.S. exchanges.

Types of ADRs

There are two main types of ADRs: sponsored and unsponsored.

Sponsored ADRs are issued by a foreign company that has made an agreement with a U.S. bank to issue the ADRs. The foreign company typically hires a depositary bank to manage the ADR program, which includes issuing the ADRs, managing the underlying shares, and providing investor relations services. Sponsored ADRs are more common than unsponsored ADRs and are subject to higher regulatory requirements.

Unsponsored ADRs, on the other hand, are issued without the involvement of the foreign company. Instead, a third-party bank buys shares of the foreign company on the open market and issues the ADRs based on those shares. Unsponsored ADRs are generally less expensive to issue, but they are also subject to fewer regulatory requirements and may not have the same level of investor relations services as sponsored ADRs.

Benefits of ADRs

One of the main benefits of ADRs is that they provide U.S. investors with access to foreign companies that may not be available on U.S. exchanges. This can provide investors with more diversification in their portfolio and the opportunity to invest in companies in countries with strong growth potential.

ADRs also provide U.S. investors with a convenient way to invest in foreign securities without having to navigate the complexities of foreign markets. ADRs are subject to U.S. securities laws, which can provide investors with a greater degree of protection than investing directly in foreign securities.

Finally, ADRs can provide investors with a way to invest in foreign companies without having to deal with currency exchange rates. ADRs are denominated in U.S. dollars, which means that investors do not have to worry about fluctuations in currency exchange rates.

Risks of ADRs

While ADRs can provide investors with many benefits, there are also risks to consider. One of the main risks of ADRs is that they may not be as liquid as U.S. stocks. This can make it difficult for investors to buy and sell ADRs at the prices they want.

Another risk of ADRs is that they may not be subject to the same level of regulatory oversight as U.S. stocks. While sponsored ADRs are subject to higher regulatory requirements, unsponsored ADRs may not have the same level of investor protections.