An American depositary receipt (ADR) is a negotiable certificate, issued by a bank in the United States, that represents a set number of shares in a company based outside the United States. It is quoted and settled in US dollars and trades on American markets in the same way as a domestic share. ADRs let US investors hold foreign companies without opening an account abroad or dealing in a foreign currency, and they give non-US companies access to American capital.
An ADR is the American form of the depositary receipt; the equivalent offered to investors in several markets at once is the global depositary receipt (GDR). Strictly, the security itself is an American depositary share and the receipt is the certificate evidencing it, but the two terms are used interchangeably. The first ADR was created in 1927 by J.P. Morgan for the British retailer Selfridges.
How an ADR is created
A depositary bank in the United States arranges for ordinary shares of the foreign company to be bought in the home market and delivered to a local custody bank, which holds them on the depositary's behalf. Against those shares the depositary issues ADRs to the investor's broker. Each ADR represents a fixed ratio of underlying shares, for example one ADR for ten shares or two ADRs for one share, chosen so that the ADR price sits in a range familiar to US investors.
The process works in reverse as well. An investor can hand ADRs back to the depositary for cancellation and take delivery of the underlying shares in the home market. This two-way convertibility lets traders close gaps between the ADR price and the home-market price, adjusted for the exchange rate, so the two stay closely aligned.
Sponsored and unsponsored programmes
A sponsored programme is set up by the foreign company itself, which signs a deposit agreement with a single depositary bank. An unsponsored programme is set up by a depositary without the company's formal involvement, in response to investor demand; several banks may issue ADRs on the same shares. Sponsored programmes fall into levels that reflect how far the company engages with US securities law:
- Level I. The ADRs trade over the counter only. Disclosure requirements are light and the company cannot raise new capital.
- Level II. The ADRs are listed on a US stock exchange, such as the New York Stock Exchange or the Nasdaq. The company must register with the Securities and Exchange Commission (SEC) and file annual reports.
- Level III. The company lists and also raises capital by selling new shares in ADR form, for example through an initial public offering in the United States. This carries the fullest disclosure obligations.
A company can also place depositary receipts privately with large institutional buyers under Rule 144A, without a public listing.
Dividends, voting and fees
The depositary collects each dividend paid in the home currency, converts it into dollars and passes it on to ADR holders, net of its fees and of any withholding tax deducted in the company's home country. Holders may be able to recover part of that tax under a treaty, and many claim a foreign tax credit on their US return.
ADR holders are not registered shareholders of the company. Their rights come from the deposit agreement, under which the depositary normally passes on meeting materials and votes the underlying shares according to holders' instructions, in a process similar to proxy voting. Some rights available to local shareholders, such as taking part in a rights issue, may not be extended to ADR holders, in which case the depositary sells the rights and distributes the proceeds.
Depositaries charge fees for issuing and cancelling ADRs, for handling dividends and other corporate events, and often an annual service fee per ADR, which is usually deducted from dividend payments.
Risks and limitations
An ADR removes the mechanics of foreign investing, not its risks. The dollar price moves with the home currency as well as with the share price, so the holder carries currency risk even though no foreign exchange trade is visible. Political, legal and accounting differences in the home country still apply. Trading volume in some ADRs is thin, particularly unsponsored and Level I programmes, which widens the bid-ask spread.
There is also a risk that the programme ends. A company may terminate its ADR programme or be removed from a US exchange, leaving holders to sell or to convert into the underlying ordinary shares. US law allows trading to be prohibited in companies whose auditors cannot be inspected by the US audit regulator, a rule that put pressure on a number of foreign listings after 2020.