American Depositary Receipt (ADR)

Image: Moneybestpal.com

A negotiable security known as an American Depositary Receipt (ADR) represents a certain number of shares—typically one—of a foreign business that trades on a U.S. stock exchange. 

ADRs are issued by American banks or brokers who keep the real shares of the foreign company in a custodian account instead of holding them themselves.

Using ADRs spares U.S. investors from having to deal with foreign currencies, exchange rates, taxes, or restrictions when buying and selling international stocks. ADRs offer more liquidity and transparency than direct trading on international markets.

There are different types of ADRs, depending on the level of compliance with the U.S. Securities and Exchange Commission (SEC) rules and accounting standards. The most common types are:

• Level I ADRs: These ADRs are the most straightforward and unregulated ones. The foreign corporation is not required to submit any financial reports or disclosures to the SEC because they are traded over-the-counter (OTC). They have a low trade volume and liquidity and are mostly used for informational purposes.
• Level II ADRs: The foreign company must register with the SEC and adhere to some of its reporting and transparency requirements because they are more strictly regulated than Level I ADRs. They have a higher trading volume and liquidity than Level I ADRs and are traded on important U.S. stock exchanges like the Nasdaq and the New York Stock Exchange (NYSE).
• Level III ADRs: These ADRs are the most regulated and openly disclosed ones. They demand that the foreign business submit a comprehensive registration statement to the SEC and abide by all of its reporting and disclosure guidelines. They also entail issuing fresh shares of the foreign firm on the American market as opposed to using ones already in the possession of a custodian bank. They are the most liquid and have the biggest trading volume of all ADRs because they are traded on significant U.S. stock exchanges.

What are the benefits of ADRs?

Some of the benefits of investing in ADRs include:

• Diversification: ADRs give American investors access to international markets and sectors that might offer different growth prospects, risk appetites, or valuation standards than the domestic market.
• Convenience: ADRs make investing in overseas stocks easier by removing the need to deal with currency exchange, international taxes, and regulatory issues. ADRs are also more convenient to buy and sell than foreign stocks since they trade during American market hours and are settled through American settlement processes.
• Information: ADRs offer more openness and information than direct trading on foreign exchange markets, particularly for Level II and Level III ADRs that adhere to SEC regulations and accounting requirements. ADRs receive greater media and analyst publicity than foreign stocks.

What are the drawbacks of ADRs?

Some of the drawbacks of investing in ADRs include:

• Fees: For the purpose of producing, maintaining, and dispersing ADRs, the issuing bank or broker may impose fees. These costs may be subtracted from the foreign company's dividend payments or the money made from the sale of ADRs. According to the kind and quantity of ADRs involved, the fees change.
• Taxes: ADRs may be subject to double taxation since dividends paid by foreign companies may be subject to withholding taxes in both the U.S. and the foreign jurisdiction. Depending on the investor's nation of origin and residence, different tax rates and treaties apply. On their U.S. tax returns, investors might be eligible to claim a foreign tax credit or deduction to lower their tax obligations.
• Currency risk: While ADRs are issued in U.S. dollars, the value of each ADR is determined by the exchange rate between the dollar and the currency of the foreign firm. Even if the price of the foreign stock holds steady in its home market, the ADR's value will drop if the foreign currency declines in value relative to the US dollar. In contrast, the ADR's value will rise if the value of the foreign currency rises relative to the US dollar.

How to invest in ADRs?

A brokerage account that enables stock trading on American exchanges or over-the-counter markets is required in order to invest in ADRs. To research the performance, fundamentals, and news of international firms and their ADRs, you can also use online resources like Google Finance or Yahoo Finance.

You should conduct your research and become knowledgeable about the benefits and hazards of investing in foreign stocks before purchasing ADRs. Your investment goals, time frame, risk tolerance, and tax situation are all things to take into account. ADRs can be a good method to diversify your portfolio and expose yourself to international markets, but there are drawbacks and expenses to be aware of.