Published: Mar 4, 2022, 2:58pm
First introduced by J.P. Morgan nearly a century ago, the concept of the American Depository Receipt (ADR) is a widely accepted and one of the most popular routes for investors to buy stocks of companies that are listed outside the U.S.
The term ADR refers to a receipt or certificate issued by a U.S.-based depository bank that represents a fixed number of shares of the foreign company. It is a way for non-U.S. companies to trade on U.S. stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ via ADRs.
Through an ADR, any U.S. investor can purchase stock in foreign companies that would otherwise be unavailable. ADRs trade on the U.S. stock markets akin to domestic shares and, they function on the U.S. dollar, i.e. ADRs and their dividends are priced in US dollars. It is important to note that an ADR is very literally a depository receipt and not an outright share.
To initiate the process of an ADR, a broker buys an INR-denominated stock — which is usually listed on a local exchange in the company’s home country. For example, say Infosys wants to issue ADRs. A U.S. broker will buy shares of Infosys on the National Stock Exchange (NSE).
Once this is done, the broker deposits this Infosys stock with a local custodian bank in India i.e. any reputed financial institution that can hold the securities on behalf of the broker. From here on, the local custodian bank takes on the responsibility to inform the US-based depository bank that they have purchased the INR denominated stock.
Once the U.S.-based depository bank has confirmed that the local custodian bank is indeed holding the stock, they issue the ADRs. This is how the ADRs are introduced to U.S.-based investors and are listed on the NYSE or NASDAQ.
For companies, ADRs offer them the opportunity to expand their international footprint by attracting the attention of a vast cohort of US investors. It also lends credibility to a company as getting listed on the NYSE or NASDAQ requires detailed checks and transparency of information.
Hence this can lead credibility to good companies based out of developing countries; being cleared by the guidelines laid down by foreign exchanges is a sort of stamp of approval that can help companies gain acceptance in the global financial markets.
ADRs present a slew of benefits for investors:
Chief among the benefits for investors is the ease of use that ADRs bring along with them. Take for instance an investor in the US who is interested in investing in a German company. To start with, the investor would have to have a German brokerage account, then, there would need to be a mechanism in place to convert the U.S. dollars into euros. The investor would also have to bear the foreign exchange rate risk and other hassles that come along with exchanging currencies.
Furthermore, these securities would eventually need to be held in a German account and the dividends would need to be converted from Euros to US dollars. Exacerbating this would be the difference of time zones and the fact that the exchange rate on the US dollar would fluctuate throughout the whole process.
ADRs trade in strict accordance with U.S. market regulations and this leads to greater transparency and, in the event of any corporate action against the foreign companies, US ADR holders can receive immediate notifications in English, as opposed to receiving delayed mail notifications in a different language.
From a U.S.-based investor standpoint, they can have equity exposure to several international companies across global markets such as India, Japan and even South Korea, however, their dividends are still in dollars, facilitating hassle-free transactions.
Meanwhile, from an Indian investor’s point of view, ADRs translate to two sources of return, one via capital appreciation in the U.S. market and two, via the U.S. dollar appreciating with respect to the Indian rupee. As a result, both the dividend payouts as well as the capital gains stand to be augmented as and when they are converted to INR.
The most important thing to remember is that ADR holders have the same voting rights and dividend entitlements as any common stockholder.
There are two different types of ADRs: Sponsored and Unsponsored.
An ADR is categorised as sponsored when a foreign company complies with all the stringent requirements and guidelines laid down by the Securities and Exchange Commission (SEC).
However, several U.S. banks can issue these un-sponsored ADRs directly and the dividend offers may consequently vary.
There are three different levels of ADRs: Level 1, Level 2 and Level 3.
Level 1: Being the most basic type wherein the foreign company either doesn’t qualify for or doesn’t wish for their ADR to be listed on the exchange. These are the kind that are sold over-the-counter and don’t adhere to the SEC’s regulations.
Level 2: ADRs are utilised to establish a trading presence on the stock exchange and they have a slightly higher level of compliance.
Level 3: These have the best level of compliance and are the gold standard when it comes to ADRs.
When it comes to fees and taxes, ADRs function differently than traditional stocks. Although ADRs are subject to the same US capital gains and dividend taxation rules and regulations, there are taxation laws of a foreign country that might come into play.
For example, several countries automatically withhold taxes on dividends that are paid by companies within their geographical boundaries. This would mean that a certain amount of dividend would be withheld by the broker to deposit with the government, depending on what the taxation rates and rules of the foreign country are.
Furthermore, the U.S. does have tax treaties with many countries and this could dictate what U.S. investors would pay. Hence, it is best for investors to consult tax experts who have knowledge of several financial markets and tax laws of different countries.
For an Indian company, an ADR provides it great access to investors in a different market, allows it to create a brand in the U.S. and gives its U.S. clients comfort on the quality of books and compliance. This is particularly relevant for companies where most of its business is in the U.S. Infosys, Wipro, Dr Reddy’s, MakeMyTrip, Yatra, among others have ADRs and have large U.S.-based businesses and ADRs are most relevant for them.
Going forward, we can see the importance of ADRs reducing as regulations make it easier to invest cross border, Indian markets become deep enough to raise money here and compliance improves. Further, there are multiple other ways to list in the U.S. now – direct listing and special purpose acquisition companies (SPACs) where depositary receipts may reduce in importance.
Kanika Agarrwal is the co-founder of Upside AI, a fintech start-up focused on using machine learning for the investment sector. Kanika is a Chartered Accountant, a CFA charter holder and a commerce graduate from Mumbai University. She has over 11 years of experience in finance and investing.
Aashika is the India Editor for Forbes Advisor. Her 15-year business and finance journalism stint has led her to report, write, edit and lead teams covering public investing, private investing and personal investing both in India and overseas. She has previously worked at CNBC-TV18, Thomson Reuters, The Economic Times and Entrepreneur.
Published: Mar 4, 2022, 2:58pm