Pomegra Wiki

American depositary receipt

An American depositary receipt (ADR) is a US-traded security that represents shares of a foreign company held in custody by a bank. ADRs allow US investors to own foreign stock without opening accounts in foreign markets. Each ADR represents one or more shares of the underlying foreign company. ADRs are denominated in US dollars and trade on US exchanges (NYSE, NASDAQ) or over-the-counter, making foreign stock accessible to American investors.

How ADRs work

A Swiss pharmaceutical company’s shares trade on the SIX Swiss Exchange. A US investor wants to own shares but cannot easily open a Swiss brokerage account. Instead:

  1. Bank as depositary: The company appoints a US bank (typically J.P. Morgan, Citibank, or BNY Mellon) as the “depositary.”

  2. Shares deposited: Shares of the Swiss company are deposited with a custodian in Switzerland; the US bank holds a custodial claim.

  3. ADRs issued: The US bank issues ADRs to US investors, each ADR representing (say) 2 shares of the Swiss company.

  4. US trading: ADRs trade on the NYSE or NASDAQ in US dollars. US investors can buy/sell ADRs like any US stock.

  5. Conversions: Investors can ask the bank to convert ADRs back into the underlying shares (for a fee) or vice versa, creating arbitrage opportunities that keep ADR price and underlying share price in parity.

  6. Dividends: When the Swiss company pays a dividend, the bank collects it in Swiss francs, converts to USD, and distributes to ADR holders.

Level I, II, and III ADRs

ADRs come in three “levels” based on regulatory oversight and trading venue:

Level I (OTC):

  • Trades over-the-counter (not on an exchange).
  • Minimal SEC reporting; company does not need to file with SEC.
  • Cheapest and simplest for the company.
  • Smallest investor base.

Level II (Exchange-listed):

  • Trades on NYSE or NASDAQ.
  • Company must file with SEC; financial statements must be reconciled to US GAAP.
  • Larger investor base and more liquidity.
  • More expensive for the company but higher visibility.

Level III (Listed with capital raising):

  • Trades on exchange.
  • Company can raise capital via ADR offerings (IPO or follow-on).
  • Highest regulatory burden on the company.
  • Largest investment potential; typically used by major multinational companies planning significant US expansion.

Most ADRs are Level I (OTC) or Level II (exchange-listed). Level III is for companies committed to the US market long-term.

Sponsored ADRs:

  • Company initiates and sponsors the ADR program.
  • Company appoints the depositary and controls the terms.
  • Company is responsible for regulatory compliance and investor relations.
  • More common for major companies.

Unsponsored ADRs:

  • Depositary bank creates ADRs without company approval.
  • Company has no direct role.
  • Less common; used for small or mid-cap foreign companies.
  • Investors have limited recourse if company mismanages.

Sponsored ADRs are preferred by institutional investors because the company is directly accountable.

ADR pricing and arbitrage

ADR prices should track the underlying share price (adjusted for currency exchange rates). If ADRs trade at a premium to the underlying:

  • Arbitrageurs buy shares in the foreign market.
  • Convert to ADRs (pay depositary fee).
  • Sell ADRs in the US market.
  • Pocket the spread.

This arbitrage keeps prices in parity. Small deviations (1–2%) are normal due to transaction costs and time zone trading differences.

Currency fluctuations

ADR prices are sensitive to currency exchange rate movements. A Swiss company whose shares rise 5% in Swiss francs but whose franc weakens 3% against the dollar will see ADR price rise only ~2%.

This currency risk is borne by ADR investors; some investors hedge via currency forwards.

Dividends and tax treatment

When the foreign company pays a dividend, the depositary:

  1. Collects the foreign-currency dividend.
  2. Converts to USD at the depositary’s rate (which includes a spread).
  3. Distributes to ADR holders (net of any withholding).

For tax purposes, US ADR holders typically receive a Form 1099 reporting the dividend in USD. Some foreign jurisdictions impose dividend withholding taxes (e.g., 15% Swiss dividend tax), which may be creditable to US taxpayers.

Conversion ratio and nominal value

ADRs often have a “conversion ratio” (e.g., 1 ADR = 2 shares) to manage the per-share price. If a foreign company’s shares are worth only a few cents, the depositary might create 1 ADR = 100 shares to make the ADR price more investor-friendly.

The conversion ratio is fixed and rarely changes, but it affects the nominal price per ADR.

GDRs and other depositary receipts

Global Depositary Receipts (GDRs) are similar to ADRs but are issued outside the US and denominated in other currencies. ADRs are US-specific; GDRs are for global issuance.

Regulatory oversight and risks

ADR programs are overseen by the SEC (for exchange-listed programs), the depositary bank, and the foreign company’s regulators. However, the regulatory environment varies:

  • Some foreign companies have stricter corporate governance and financial disclosure (major European or Japanese companies).
  • Others are subject to weaker oversight (emerging markets) and carry higher investor risk.

Institutional investors typically scrutinize the foreign company’s accounting and governance before investing in ADRs.

Withdrawal and conversion

ADR holders can typically withdraw the underlying shares (convert ADRs to shares) by:

  1. Instructing their broker to request withdrawal.
  2. Paying a depositary fee.
  3. Receiving the underlying shares, which can then be sold on the foreign exchange.

This “two-way conversion” mechanism allows arbitrage and keeps ADR prices aligned with underlying shares.

Trading advantages for US investors

  • Convenience: Buy and sell in US market; no need for foreign broker.
  • Liquidity: Many major ADRs are highly liquid (trades volume comparable to foreign exchange).
  • USD pricing: Prices are in dollars; no need to convert currencies yourself.
  • SEC oversight: Exchange-listed ADRs have SEC oversight and reporting.

For institutional investors managing US portfolios, ADRs are simpler than holding foreign securities directly.

Wider context