American depositary receipts (ADRs) are shares of foreign companies that are traded on US stock exchanges. They were specifically created to give US investors access to foreign stocks without the added step of dealing in foreign stock markets. They also give foreign companies exposure and sometimes a chance to raise capital in the US.
When a foreign company wants to list on a US stock exchange but avoid the hassle and fees of listing, they can enter into an agreement with a US bank or an institution known as the depository. This bank works with the foreign company and its custodian bank abroad to issue ADR shares in the US stock markets.
However, the US bank doesn’t always have to have an agreement with the foreign company. The bank — or another institution — can issue ADRs without the foreign company’s approval.
Types of ADRs
Depending on whether the foreign company and the ADR-issuing bank have agreements, there are two types of ADRs:
- Sponsored ADRs are issued by a US bank on behalf of a foreign company. Typically, these two entities enter into a legal agreement where the foreign company pays the cost of issuing the ADR, while the US bank handles transactions with US investors. These ADRs are often registered with the SEC and are available on US exchanges.
- Unsponsored ADRs can be issued by one or multiple US banks or brokers without direct involvement from the foreign company. Because multiple banks can issue unsponsored ADRs from the same company, there can be multiple ADRs from the same company, sometimes even with different dividends.
Note: Unsponsored ADRs are often traded over-the-counter (OTC) and cannot be offered to individual investors unless they file financial reports with the SEC or unless the company is 12g3-2(b)-qualified.
Depositary is the US institution — either a bank or a broker-dealer — that works with the foreign company and their custodian bank to register and issue the ADRs on the US stock exchange. The depositary also registers the trades and distributes dividends to US shareholders.
ADR levels explained
Based on the ADR’s access to the US stock exchanges, there are three categories:
- Level I: It’s the most basic type of ADR where foreign companies are only listed on the OTC market. These are often highly speculative — similar to penny stocks — and don’t have to meet SEC requirements.
- Level II: Mostly traded OTC, but sometimes can be traded on US stock exchanges. Unlike Level I, Level II must be registered with the SEC and must file an annual report (Form 20-F).
- Level III: The most prestigious of all ADRs. These are typically offered on a US stock exchange and foreign companies can use Level III to raise capital via initial public offering (IPO). Because of that, Level III ADRs have to report in full to the SEC.
Buy ADRs on US stock exchanges the same as any other traditional stock. But here are some differences between the two.
|One ADR share can represent:
- One share of the foreign company
- A fraction of a share
- Multiple shares
|One share is always one share
|You may have to pay dividend taxes from the foreign country, as well as US dividend taxes
|You get the full dividend payment minus US taxes on the dividend
|The ADR price may be influenced by currency fluctuations between the US dollar and the foreign country’s currency
|No direct currency risks
|Investors may not have full access to the company’s financial information if the ADR is Level I
|Full company financial information available
ADRs follow the same taxation rules as traditional stocks. This means you’ll pay taxes on any dividend payment you receive. However, the foreign home country may withhold some percentage of the dividend as tax. This can be anywhere from 15% to 35%.
Luckily, the IRS offers tax credits, so your dividend doesn’t get double-taxed. To get the tax credit, you’ll need to fill out Form 1116. This will help you offset the amount you already paid to the foreign country. However, if the foreign country tax is higher than the one in the US, you can only get a tax credit for the amount taxed by the IRS. For example, you pay 15% tax in the US but 35% in the foreign country. The IRS can only give you credit for the 15%, thus the foreign country keeps the remaining 20%
Important: You can’t get tax credits for ADRs held in tax-deferred accounts, such as IRAs.
Benefits and drawbacks of ADRs
American depositary receipts are a hassle-free way to invest in foreign stocks. But there are some drawbacks to keep in mind.
|Directly invest in foreign stocks
|Not all ADRs are listed on the major US exchanges
|You don’t need to open a new brokerage account
|Unsponsored ADRs don’t give you voting rights
|Get dividend payments if the company pays dividends
|Dividends from ADRs may be double-taxed
Buy ADRs like you would buy any other stock.
- Open a brokerage account if you don’t have one.
- Search for the foreign company you want to buy.
- Find the company ticker symbol either using Google, using a website that lists ADRs or using your broker.
- Enter the ADR symbol in your brokerage account.
- Enter the number of shares you want to buy and submit.
Note: Some ADRs trade over-the-counter (OTC). Unless your broker allows buying OTC stocks, you won’t be able to buy the ADR you want.
We selected the 10 most popular ADRs trading on various US stock exchanges.
|Royal Dutch Shell
|JP Morgan, BNY, Citibank, Deutsche Bank
|Nintendo Co Ltd
|JP Morgan, BNY, Citibank, Deutsche Bank
The only alternative to buying an ADR is to open an account with a broker that offers access to foreign stocks, such as Interactive Brokers. However, this often comes with additional fees and conversion rate fluctuations.
If the stock you want to buy has an ADR, it’s often cheaper to buy it in that form. Otherwise, brokers that offer access to foreign markets can offer a higher variety of foreign stocks that may not have an ADR.
ADRs are an excellent option for investors looking to buy foreign stocks without the complexity of accessing foreign markets. Buy ADRs like you would buy any other stock on the US market.
But be aware of the pros and cons before you invest. And compare your options to find the right broker when looking to invest in ADRs.
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