An American depositary receipt, or ADR, is a certificate issued in the United States that represents shares of a company listed in another country. It trades in US dollars on a US exchange, like any other US-listed stock, and it lets an investor buy part of a foreign company without opening an account on that company's home market. A global depositary receipt, or GDR, works in the same way, but it trades on exchanges outside the United States, often in London or Luxembourg.
This guide explains how ADRs and GDRs work, the different levels, the fees and currency issues, and the risks that remain. It is general information, not advice on any company or receipt.
How an ADR works
A US bank, called the depositary, holds the shares of the foreign company in a custody account in the company's home country. For each batch of those shares, the depositary issues a number of ADRs. Each ADR represents a fixed number of the underlying shares, which is called the ratio. A ratio of one ADR to ten shares means ten home-market shares sit behind each receipt.
The receipt carries the economic rights of the shares, including dividends and the value of the holding, but the holder usually does not hold the shares directly. The depositary collects dividends in the home currency, converts them into dollars and passes them on, less any fees.
Why ADRs exist
ADRs make foreign shares easier to buy for investors who do not have access to the home market. They trade during US market hours, in dollars, through a normal brokerage account, and they settle through familiar US systems. For the company, an ADR listing can broaden its investor base and raise its profile in the US market.
For the investor, an ADR can be the simplest route to a foreign company, especially where the home market is hard to access, expensive to trade in, or subject to foreign investment limits.
The levels
ADRs come in several levels, and the level tells you how much the company has committed to the US market.
Level I ADRs trade over the counter, in the US, and have the lightest reporting requirements. They are often unsponsored, meaning the company has not entered into a formal arrangement with the depositary.
Level II ADRs are listed on a US exchange, with fuller reporting and a sponsored arrangement. They are more visible and more liquid than Level I.
Level III ADRs are listed and raise new capital in the US market. They carry the most reporting requirements and are the most closely regulated.
A sponsored ADR has a formal agreement between the company and the depositary, which usually covers the cost of distributions and communications. An unsponsored ADR is set up by the depositary without the company's agreement, and it can carry different fees and less information for holders. Check which kind you are buying.
Fees and costs
ADRs carry costs that do not apply to ordinary shares. The depositary charges fees, typically for issuing and cancelling receipts, for handling dividends and for other services. These are often deducted from the dividend or charged to the account. There may also be a fee for the custody of the underlying shares.
Your broker may charge its usual commission, and conversion costs apply when dividends are paid in dollars from a home currency. Add all of these costs to the purchase price before you judge the return.
Currency
An ADR is priced in dollars, but the underlying company earns and reports in its own currency. A change in the exchange rate between the dollar and the home currency affects the value of the receipt, even if the company's shares do not move in the home market. The effect works in both directions. A weaker dollar can raise the ADR price, and a stronger dollar can lower it.
The guide on currency risk for foreign stocks explains how to measure this effect on your return.
A worked example
Suppose a foreign company's ADR represents 10 home-market shares. The home shares trade at 100 units of the home currency, so the underlying value of one ADR is 1,000 units of the home currency. The exchange rate is one dollar for 10 units of the home currency. The ADR should therefore trade near 100 dollars, before any premium or discount.
If the home shares rise 10 percent to 110 units, the ADR's value in home currency rises to 1,100, and at the same exchange rate it trades near 110 dollars. If instead the home currency weakens so that one dollar now buys 11 units, the ADR's value in dollars falls to about 91 dollars, even though the home shares did not move at all in their own currency. The example shows how the ADR carries both risks: the company's share price and the currency.
Premiums and discounts
An ADR price can differ from the value of its underlying shares, because of supply and demand in the US market, the fees and the timing of trading. A premium means the ADR trades above the implied value of its shares, and a discount means below. Large gaps are unusual but can appear in less liquid receipts or during market stress.
Check the implied value of the receipt against the home-market price and the exchange rate before buying, especially for an unsponsored or thinly traded ADR.
Risks that remain
Holding an ADR does not remove the risks of the company itself. The business, the management, the home-country regulation and the economy all still apply. Some home markets have different rules on disclosure, shareholder protection and corporate governance than the US market, so the information you receive may differ.
Withdrawing the underlying shares, where it is possible, can be slow and expensive. Some holders also lose the right to vote directly, and must rely on the depositary's procedures for voting.
Common mistakes
Assuming an ADR is the same as the home share. It has extra fees, a currency exposure and sometimes a different level of information.
Ignoring the level. An unsponsored Level I ADR can offer less information than a sponsored Level II or III.
Overlooking the fees. Depositary fees can reduce dividends each year.
Forgetting the currency. A dollar move can change your return even when the company does well.
Buying a thin receipt without checking the implied value. A large premium or discount can cost you on entry and exit.
Checklist
- Check the level, and whether the ADR is sponsored or unsponsored.
- Check the ratio, and work out the implied value per ADR in your currency.
- Read the depositary's fee schedule, and the dividend treatment.
- Check the trading volume and the gap to the home-market value.
- Read the company's results and disclosures, and consider the home-country rules.
- Measure the currency exposure, as you would for any foreign holding.
Key takeaways
An ADR is a dollar-denominated certificate on a US exchange that represents shares of a foreign company held by a US depositary bank. Levels range from over-the-counter Level I to the fully listed Level III, and sponsored receipts usually carry more information than unsponsored ones. Fees, premiums and discounts, and the currency all affect the return, and the company's own risks remain. Compare the ADR with the home shares, and check the fees and the implied value before buying.
This guide is for general information, not financial advice. See the disclaimer.