In the present globalized financial environment, investors are always on the lookout for opportunities outside their home market. Yet, foreign stock trading directly through foreign exchanges is complicated because of variations in regulations, currencies, and procedures.
To facilitate foreign investment by U.S. investors, American Depositary Receipts (ADRs) came into existence. ADRs make international investing easier by enabling U.S. investors to purchase stocks of foreign companies through U.S. stock exchanges. also you can read about when is the asian stock market open.
What Are American Depositary Receipts
An American Depositary Receipt (ADR) is a U.S. bank-issued negotiable certificate representing ownership in a foreign company. It allows U.S. investors to buy holdings of foreign companies without having to work with foreign currencies or exchanges.
Every ADR is worth one or more shares—or even a fraction—of the stock of a foreign corporation. Such receipts are listed on American exchanges such as the New York Stock Exchange (NYSE) or NASDAQ, similar to U.S. stocks. also you cam read about South india paper mills stock price
Example:
Suppose an Indian firm like Infosys places ADRs for sale. An American investor can purchase Infosys ADRs on the NYSE rather than acquiring shares directly from the Indian bourse (NSE/BSE). Understanding American Depositary Receipts
The Process of Creating ADRs
The ADR process entails a number of main institutions:
- The Foreign Company (Issuer)
- The U.S. Depositary Bank
- The Custodian Bank (in the foreign country)
- U.S. Investors
Let’s describe the step-by-step process through which ADRs are issued and traded:
Step 1: Selection and Agreement
A foreign company wishing to offer its shares to the U.S. enters an agreement with a U.S. depositary bank (for example, JPMorgan Chase, Citibank, or Bank of New York Mellon).
This contract specifies the rights, obligation, and ratio of ADRs to the firm’s ordinary shares.
Step 2: Deposit of Shares
The firm’s shares are deposited with a custodian bank in the firm’s domicile country. The custodian holds these shares as collateral for the ADRs being issued.
Step 3: Issuance of ADRs
Upon receiving confirmation of the deposited shares, the U.S. depositary bank then distributes ADRs to American investors. One ADR is used to represent a definite number of underlying foreign shares.
Step 4: Trading in the U.S. Market
These issued ADRs are subsequently listed and traded on U.S. exchanges such as NYSE, NASDAQ, or the Over-The-Counter (OTC) market.
U.S. investors are able to purchase or sell ADRs in U.S. dollars at regular trading hours, similar to any American stock.
Step 5: Dividend Payments and Conversion of Currency
Upon declaration of a dividend by the foreign company, the foreign currency amount is received by the custodian bank.
The depositary bank converts it into U.S. dollars and pays it to ADR holders after deducting fees and taxes involved.
Step 6: Transfer and Cancellation
If an investor desires to reverse ADRs into the underlying foreign stocks, they can surrender their ADRs to the depositary bank.
The equivalent number of shares is then released by the custodian bank into the domestic country’s market.
Types of ADRs
There are primarily three levels of ADRs, with different access levels to U.S. markets and regulatory requirements.
Level I ADRs
- Only traded on the Over-The-Counter (OTC) market.
- Easiest and cheapest to establish.
- Used primarily for visibility and not fundraising.
Level II ADRs
- Traded on the major exchanges such as NYSE or NASDAQ.
- Require adherence to U.S. Securities and Exchange Commission (SEC) rules and reporting standards.
- Facilitate companies to obtain greater liquidity and exposure among U.S. investors.
Level III ADRs
- Enable foreign companies to raise money directly from U.S. investors through public offerings.
- Need to comply with rigorous SEC requirements, including quarterly and annual reports.
- Symbolize the ultimate level of compliance and investor reach.
Advantages of ADRs
To Investors:
- Convenient access to foreign corporations without conversion of currency.
- Prices and dividends quoted in U.S. dollars.
- Clear trading that is U.S. law-regulated.
To Companies:
- Greater global awareness and company brand.
- Wider investor base and possible access to U.S. capital.
- Improved liquidity and valuation with international visibility.
Risks and Challenges
Although ADRs make cross-border investment easier, there are some risks involved:
- Currency Risk: Exchange rate fluctuations can impact returns.
- Political or Economic Instability: Events in the foreign company’s home country have the potential to influence ADR performance.
- Regulatory Differences: Compliance fees and varying accounting standards present difficulties.
Conclusion
The American Depositary Receipt system serves as a bridge between international companies and U.S. investors. It offers convenience, transparency, and accessibility for global investing.
With ADRs, emerging market companies are able to access the enormous U.S. capital market, and U.S. investors are able to diversify their holdings with international exposure—without the bother of going through foreign exchanges.
Simply put, ADRs simplify global investing, making it safer and more efficient for companies and investors alike.