An American Depositary Receipt (ADR) is a negotiable certificate that represents shares of a foreign stock owned and issued by a U.S. bank. It can be traded in US equity market. ADRs are denominated in dollars.
Advantages of ADRs:
- It enables US investors to trade in shares or invest in stocks of non-US companies (foreign companies) on a non- US stock exchange.
- Before the provision of ADRs, it was very difficult for an American investor to trade in shares of foreign companies as they had to go through many rules and regulation.
- Many foreign companies do not wish to go through the hassle of listing on US stock exchanges due to cost and other disadvantages. US Investors willing to invest in these companies take the route of ADRs.
- To the company issuing ADRs, it provides access to the American market and can raise additional resources.
- Huge operational, custodial and currency conversion issues can come into play if the ADR route is not used.
Disadvantages of ADRs:
- The number of options to invest in foreign companies is limited.
- ADRs are exposed to the risk associated with foreign exchange fluctuation.
- To generate good returns the investors needs to hold the shares for a long time.
- The foreign companies mostly transferred the charges for entire process of ADR on investors.
Types of ADRs:
There are two types of ADRS: Sponsored and non-sponsored.
- Sponsored ADRs are those in which foreign company actively participates in the process by entering into an agreement directly with US Depository Bank to make plans for recordkeeping, dividends etc.
- Unsponsored ADRs are setup without cooperation of the foreign company. These ADRs may be initiated by a broker-dealer that wants to establish a U.S. trading market.
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Commencement of ADRs:
- The ADRs were first offered in the US in 1920s by the SEC (the regulatory
- The first Indian company to use the ADR route was Infosys Technologies.
- ADRs are traded on NYSE, NASDAQ and AMEX in the United States.
ADS (American Depository Shares):
The terms ADR and ADS are often used interchangeably. The individual shares represented by an ADR are called American Depository Shares (ADS).
ADR’s issuance process with an example:
Let an Indian company (here Infosys) raises funds from the American Capital market.
Depository bank- located in
Custodian bank- located in India, chosen by Depository bank.
Broker- located in India, having
Foreign Stock Exchange- the exchange ultimately listing ADRs (here NYSE)