American Depositary Receipt Details

The purpose of ADRs is to simplify the process of investing in foreign stock. The denomination of ADRs is in US Dollars. Their underlying securities are held by a US Bank with an overseas branch. As an ADR holder, you do not have to worry about exchange rates or foreign currency transactions.

To invest in American Depositary Receipts, you can buy them from dealers or brokers. Dealers and brokers can create new ADRs or obtain them by purchasing those already in the financial market. To create a new ADR, brokers buy the stocks of a foreign company in the issuer's home market and deposit the acquired shares in a depository bank in the overseas market. This bank will then issue ADRs that are equal to the value of the shares.

The dealer/broker then takes the ADR to the US financial markets to sell them. ADRs are beneficial to foreign firms because they can attract investors without having to list in the US stock exchange. They also enable you to invest in foreign companies that you otherwise would not be able to. Responsible for listing available ADRs are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).

Real World Example of American Depositary Receipt

Siemens is an energy company with its headquarters in Germany. It specializes in automation, digitization, and electrification. In May 2014, Siemens delisted from the New York Stock Exchange. It, however, still maintains an ADR program on a Level I basis and continues to trade in the US on an over-the-counter basis. Over–the–counter refers to a trading market for unlisted securities that involve direct negotiation over a communication network such as a call or email.

As earlier explained, an ADR represents a number of the regular stock shares of the foreign company. To express this number, you use multiple shares or a fraction of a foreign company's share. For example, in 2018, two Siemens ADRs traded in US dollars equals one Siemens ordinary share. To convey the above expression, you can use a ratio of 2:1. This ratio means that one ADR could represent half of an ordinary share of the Siemens Company.

Typically, the price of an ADR will reflect that of its parent company even in the US financial market. As in this example, the price of a Siemens ADR will mirror that of the Siemens shares in the Frankfurt Stock Exchange in Germany.

Types of American Depositary Receipts

In the US, there are two categories of ADRs financial market: sponsored ADRs and non-sponsored ADRs

  • Sponsored ADRs: for this type of ADR, a foreign company will agree with a US bank to sell its shares in the US market. This bank will, in turn, be responsible for the sale, record keeping, and distribution of dividends and shares. New York Stock Exchange lists Sponsored ADRs.
  • Non-Sponsored ADRs: dealers and brokers create these ADRs without the foreign company's involvement in issuing the shares. Non-sponsored ADRs do not require registration with the Securities Exchange Commission (SEC) and are therefore only traded in over-the-counter markets. A great example of a non-sponsored ADR is that of the Siemens Company in the example above.

History of American Depositary Receipts

Guaranty Trust Co., J.P Morgan's predecessor firm, introduced the first ADR concept in 1927. They created this first ADR to enable US investors to purchase shares of the then-popular British retailer Selfridges and help them explore other profitable global markets. Before introducing ADRs, American investors who wanted to purchase stocks in foreign companies had to buy stocks at international exchange points. This factor prevented the average person from investing.

While the internet has made it easier to buy shares on international exchange points, investors can still face difficulties in calculating currency exchange rates and their related costs while trading on International exchange points.

They also have to learn the regulatory differences between the US financial market and that of the company they wish to invest in. Using ADRs enables you to diversify your investment portfolio by purchasing foreign firms' stock while avoiding the inconvenience of using international exchange points.