American Depositary Receipt
Encyclopedia
An American depositary receipt (ADR) is a negotiable security that represents the underlying securities of a non-U.S. company that trades in the US financial markets. Individual shares of the securities of the foreign company represented by an ADR are called American depositary shares (ADSs).
The stock of many non-US companies trade on US stock exchanges through the use of ADRs. ADRs are denominated, and pay dividends, in US dollars, and may be traded like shares of stock of US-domiciled companies.
The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges
. There are currently four major commercial banks
that provide depositary bank services: BNY Mellon, J.P. Morgan, Citi
, and Deutsche Bank
.
s (DRs) are negotiable securities that represent the underlying securities of foreign companies that trade in a domestic market. DRs enable domestic investors to buy the securities of a foreign company without the accompanying risks or inconveniences of cross-border and cross-currency transactions.
Each DR is issued by a domestic depositary bank when the underlying shares are deposited in a foreign custodian bank
, usually by a broker who has purchased the shares in the open market local to the foreign company. A DR can represent a fraction of a share, a single share, or multiple shares of a foreign security. The holder of a DR has the right to obtain the underlying foreign security that the DR represents, but investors usually find it more convenient to own the DR. The price of a DR generally tracks the price of the foreign security in its home market, adjusted for the ratio of DRs to foreign company shares. In the case of companies domiciled in the United Kingdom, creation of ADRs attracts a 1.5% stamp duty reserve tax (SDRT)
charge by the UK government. Depositary banks have various responsibilities to DR holders and to the issuing foreign company the DR represents.
(OTC) market. These shares are issued in accordance with market demand, and the foreign company has no formal agreement with a depositary bank. Unsponsored ADRs are often issued by more than one depositary bank. Each depositary services only the ADRs it has issued.
Due to a recent SEC rule change making it easier to issue Level I depositary receipts, both sponsored and unsponsored, hundreds of new ADRs have been issued since the rule came into effect in October 2008. The majority of these were unsponsored Level I ADRs, and now approximately half of all ADR programs in existence are unsponsored.
.
A majority of American depositary receipt programs currently trading are issued through a Level 1 program. This is the most convenient way for a foreign company to have its equity traded in the United States.
Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile.
Companies with shares trading under a Level 1 program may decide to upgrade their program to a Level 2 or Level 3 program for better exposure in the United States markets.
The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange
(NYSE), NASDAQ
, and the American Stock Exchange
(AMEX).
While listed on these exchanges, the company must meet the exchange’s listing requirements. If it fails to do so, it may be delisted and forced to downgrade its ADR program.
Setting up a Level 3 program means that the foreign company is not only taking steps to permit shares from its home market to be deposited into an ADR program and traded in the U.S.; it is actually issuing shares to raise capital. In accordance with this offering, the company is required to file a Form F-1, which is the format for an Offering Prospectus
for the shares. They also must file a Form 20-F annually and must adhere to U.S. GAAP standards or IFRS as published by the IASB. In addition, any material information given to shareholders in the home market, must be filed with the SEC through Form 6K.
Foreign companies with Level 3 programs will often issue materials that are more informative and are more accommodating to their U.S. shareholders because they rely on them for capital. Overall, foreign companies with a Level 3 program set up are the easiest on which to find information. Examples include the British telecommunications company Vodafone
(VOD), the Brazilian oil company Petrobras
(PBR), and the Chinese technology company China Information Technology, Inc. (CNIT).
Privately placed (SEC Rule 144A) ADRs
Some foreign companies will set up an ADR program under SEC Rule 144(a). This provision makes the issuance of shares a private placement
. Shares of companies registered under Rule 144-A are restricted stock and may only be issued to or traded by Qualified Institutional Buyer
s (QIBs). NYSE
US public shareholders are generally not permitted to invest in these ADR programs, and most are held exclusively through the Depository Trust & Clearing Corporation, so there is often very little information on these companies.
Offshore (SEC Regulation S) ADRs
The other way to restrict the trading of depositary shares to US public investors is to issue them under the terms of SEC Regulation S. This regulation means that the shares are not, and will not be registered with any United States securities regulation authority.
Regulation S shares cannot be held or traded by any “U.S. person” as defined by SEC Regulation S rules. The shares are registered and issued to offshore, non-US residents.
Regulation S ADRs can be merged into a Level 1 program after the restriction period has expired, and the foreign issuer elects to do this.
charge by the UK government; sourcing existing ADRs in the secondary market (either via crossbook swaps or on exchange) instead is not subject to SDRT.
Owners of ADRs are typically notified in writing at least thirty days prior to a termination. Once notified, an owner can surrender their ADRs and take delivery of the foreign securities represented by the Receipt, or do nothing. If an ADR holder elects to take possession of the underlying foreign shares, there is no guarantee the shares will trade on any US exchange. The holder of the foreign shares would have to find a broker who has trading authority in the foreign market where those shares trade. If the owner continues to hold the ADR past the effective date of termination, the depositary bank will continue to hold the foreign deposited securities and collect dividends, but will cease distributions to ADR owners.
Usually up to one year after the effective date of the termination, the depositary bank will liquidate and allocate the proceeds to those respective clients. Many US brokerages can continue to hold foreign stock, but may lack the ability to trade it overseas.
The stock of many non-US companies trade on US stock exchanges through the use of ADRs. ADRs are denominated, and pay dividends, in US dollars, and may be traded like shares of stock of US-domiciled companies.
The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges
Selfridges
Selfridges, AKA Selfridges & Co, is a chain of high end department stores in the United Kingdom. It was founded by Harry Gordon Selfridge. The flagship store in London's Oxford Street is the second largest shop in the UK and was opened on 15 March 1909.More recently, three other stores have been...
. There are currently four major commercial banks
Commercial bank
After the implementation of the Glass–Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S...
that provide depositary bank services: BNY Mellon, J.P. Morgan, Citi
Citibank
Citibank, a major international bank, is the consumer banking arm of financial services giant Citigroup. Citibank was founded in 1812 as the City Bank of New York, later First National City Bank of New York...
, and Deutsche Bank
Deutsche Bank
Deutsche Bank AG is a global financial service company with its headquarters in Frankfurt, Germany. It employs more than 100,000 people in over 70 countries, and has a large presence in Europe, the Americas, Asia Pacific and the emerging markets...
.
Depositary receipts
More generally, depositary receiptDepositary receipt
A depositary receipt is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. The depositary receipt trades on a local stock exchange....
s (DRs) are negotiable securities that represent the underlying securities of foreign companies that trade in a domestic market. DRs enable domestic investors to buy the securities of a foreign company without the accompanying risks or inconveniences of cross-border and cross-currency transactions.
Each DR is issued by a domestic depositary bank when the underlying shares are deposited in a foreign custodian bank
Custodian bank
A Custodian bank, or simply custodian, is a specialized financial institution responsible for safeguarding a firm's or individual's financial assets and is not likely to engage in "traditional" commercial or consumer/retail banking such as mortgage or personal lending, branch banking, personal...
, usually by a broker who has purchased the shares in the open market local to the foreign company. A DR can represent a fraction of a share, a single share, or multiple shares of a foreign security. The holder of a DR has the right to obtain the underlying foreign security that the DR represents, but investors usually find it more convenient to own the DR. The price of a DR generally tracks the price of the foreign security in its home market, adjusted for the ratio of DRs to foreign company shares. In the case of companies domiciled in the United Kingdom, creation of ADRs attracts a 1.5% stamp duty reserve tax (SDRT)
Stamp duty in the United Kingdom
In the United Kingdom, stamp duty is a form of tax charged on instruments , and requires a physical stamp to be attached to or impressed upon the instrument in question. The more modern versions of the tax no longer require a physical stamp.The scope of stamp duty has been reduced dramatically in...
charge by the UK government. Depositary banks have various responsibilities to DR holders and to the issuing foreign company the DR represents.
ADR programs (facilities)
When a company establishes an ADR program, it must decide what exactly it wants out of the program, and how much time, effort, and other resources they are willing to commit. For this reason, there are different types of programs, or facilities, that a company can choose.Unsponsored ADRs
Unsponsored shares trade on the over-the-counterOver-the-counter (finance)
Within the derivatives markets, many products are traded through exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk concerning the default of a member of the exchange. Products traded on the exchange must be well standardised to transparent trading....
(OTC) market. These shares are issued in accordance with market demand, and the foreign company has no formal agreement with a depositary bank. Unsponsored ADRs are often issued by more than one depositary bank. Each depositary services only the ADRs it has issued.
Due to a recent SEC rule change making it easier to issue Level I depositary receipts, both sponsored and unsponsored, hundreds of new ADRs have been issued since the rule came into effect in October 2008. The majority of these were unsponsored Level I ADRs, and now approximately half of all ADR programs in existence are unsponsored.
Sponsored Level I ADRs ("OTC" facility)
Level 1 depositary receipts are the lowest level of sponsored ADRs that can be issued. When a company issues sponsored ADRs, it has one designated depositary who also acts as its transfer agentTransfer agent
Public companies typically use transfer agents to keep track of the individuals and entities that own their stocks and bonds. Most transfer agents are banks or trust companies, but sometimes a company acts as its own transfer agent....
.
A majority of American depositary receipt programs currently trading are issued through a Level 1 program. This is the most convenient way for a foreign company to have its equity traded in the United States.
Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile.
Companies with shares trading under a Level 1 program may decide to upgrade their program to a Level 2 or Level 3 program for better exposure in the United States markets.
Sponsored Level II ADRs ("Listing" facility)
Level 2 depositary receipt programs are more complicated for a foreign company. When a foreign company wants to set up a Level 2 program, it must file a registration statement with the U.S. SEC and is under SEC regulation. In addition, the company is required to file a Form 20-F annually. Form 20-F is the basic equivalent of an annual report (Form 10-K) for a U.S. company. In their filings, the company is required to follow U.S. GAAP standards or IFRS as published by the IASB.The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
(NYSE), NASDAQ
NASDAQ
The NASDAQ Stock Market, also known as the NASDAQ, is an American stock exchange. "NASDAQ" originally stood for "National Association of Securities Dealers Automated Quotations". It is the second-largest stock exchange by market capitalization in the world, after the New York Stock Exchange. As of...
, and the American Stock Exchange
American Stock Exchange
NYSE Amex Equities, formerly known as the American Stock Exchange is an American stock exchange situated in New York. AMEX was a mutual organization, owned by its members. Until 1953, it was known as the New York Curb Exchange. On January 17, 2008, NYSE Euronext announced it would acquire the...
(AMEX).
While listed on these exchanges, the company must meet the exchange’s listing requirements. If it fails to do so, it may be delisted and forced to downgrade its ADR program.
Sponsored Level III ADRs ("offering" facility)
A Level 3 American Depositary Receipt program is the highest level a foreign company can sponsor. Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies.Setting up a Level 3 program means that the foreign company is not only taking steps to permit shares from its home market to be deposited into an ADR program and traded in the U.S.; it is actually issuing shares to raise capital. In accordance with this offering, the company is required to file a Form F-1, which is the format for an Offering Prospectus
Prospectus (finance)
In finance, a prospectus is a document that describes a financial security for potential buyers. A prospectus commonly provides investors with material information about mutual funds, stocks, bonds and other investments, such as a description of the company's business, financial statements,...
for the shares. They also must file a Form 20-F annually and must adhere to U.S. GAAP standards or IFRS as published by the IASB. In addition, any material information given to shareholders in the home market, must be filed with the SEC through Form 6K.
Foreign companies with Level 3 programs will often issue materials that are more informative and are more accommodating to their U.S. shareholders because they rely on them for capital. Overall, foreign companies with a Level 3 program set up are the easiest on which to find information. Examples include the British telecommunications company Vodafone
Vodafone
Vodafone Group Plc is a global telecommunications company headquartered in London, United Kingdom. It is the world's largest mobile telecommunications company measured by revenues and the world's second-largest measured by subscribers , with around 341 million proportionate subscribers as of...
(VOD), the Brazilian oil company Petrobras
Petrobras
Petróleo Brasileiro or Petrobras is a semi-public Brazilian multinational energy corporation headquartered in Rio de Janeiro, Brazil. It is the largest company in Latin America by market capitalization and revenue, and the largest company headquartered in the Southern Hemisphere by market...
(PBR), and the Chinese technology company China Information Technology, Inc. (CNIT).
Restricted Programs
Foreign companies that want their stock to be limited to being traded by only certain individuals may set up a restricted program. There are two SEC rules that allow this type of issuance of shares in the U.S.: Rule 144-A and Regulation S. ADR programs operating under one of these 2 rules make up approximately 30% of all issued ADRs.Privately placed (SEC Rule 144A) ADRs
Some foreign companies will set up an ADR program under SEC Rule 144(a). This provision makes the issuance of shares a private placement
Private placement
Private placement is a funding round of securities which are sold without an initial public offering, usually to a small number of chosen private investors...
. Shares of companies registered under Rule 144-A are restricted stock and may only be issued to or traded by Qualified Institutional Buyer
Qualified Institutional Buyer
A qualified institutional buyer , in law and finance, is a purchaser of securities that is deemed financially sophisticated and is legally recognized by security market regulators to need less protection from issuers than most public investors...
s (QIBs). NYSE
US public shareholders are generally not permitted to invest in these ADR programs, and most are held exclusively through the Depository Trust & Clearing Corporation, so there is often very little information on these companies.
Offshore (SEC Regulation S) ADRs
The other way to restrict the trading of depositary shares to US public investors is to issue them under the terms of SEC Regulation S. This regulation means that the shares are not, and will not be registered with any United States securities regulation authority.
Regulation S shares cannot be held or traded by any “U.S. person” as defined by SEC Regulation S rules. The shares are registered and issued to offshore, non-US residents.
Regulation S ADRs can be merged into a Level 1 program after the restriction period has expired, and the foreign issuer elects to do this.
Sourcing ADRs
One can either source new ADRs by depositing the corresponding domestic shares of the company with the depositary bank that administers the ADR program or, instead, one can obtain existing ADRs in the secondary market. The latter can be achieved either by purchasing the ADRs on a US stock exchange or via purchasing the underlying domestic shares of the company on their primary exchange and then swapping them for ADRs; these swaps are called crossbook swaps and on many occasions account for the bulk of ADR secondary trading. This is especially true in the case of trading in ADRs of UK companies where creation of new ADRs attracts a 1.5% stamp duty reserve tax (SDRT)Stamp duty in the United Kingdom
In the United Kingdom, stamp duty is a form of tax charged on instruments , and requires a physical stamp to be attached to or impressed upon the instrument in question. The more modern versions of the tax no longer require a physical stamp.The scope of stamp duty has been reduced dramatically in...
charge by the UK government; sourcing existing ADRs in the secondary market (either via crossbook swaps or on exchange) instead is not subject to SDRT.
ADR termination
Most ADR programs are subject to possible termination. Termination of the ADR agreement will result in cancellation of all the depositary receipts, and a subsequent delisting from all exchanges where they trade. The termination can be at the discretion of the foreign issuer or the depositary bank, but is typically at the request of the issuer. There may be a number of reasons why ADRs terminate, but in most cases the foreign issuer is undergoing some type of reorganization or merger.Owners of ADRs are typically notified in writing at least thirty days prior to a termination. Once notified, an owner can surrender their ADRs and take delivery of the foreign securities represented by the Receipt, or do nothing. If an ADR holder elects to take possession of the underlying foreign shares, there is no guarantee the shares will trade on any US exchange. The holder of the foreign shares would have to find a broker who has trading authority in the foreign market where those shares trade. If the owner continues to hold the ADR past the effective date of termination, the depositary bank will continue to hold the foreign deposited securities and collect dividends, but will cease distributions to ADR owners.
Usually up to one year after the effective date of the termination, the depositary bank will liquidate and allocate the proceeds to those respective clients. Many US brokerages can continue to hold foreign stock, but may lack the ability to trade it overseas.
External links
- Deutsche Bank's Depositary Receipt website
- Citi's ADR website
- The Bank of New York Mellon's ADR website
- ADR.com (JPMorgan's ADR website)
- Sheldon Capital Ltd website for crossbook swaps in ADRs of UK companies
- SEC guide to foreign investing for U.S. citizens(PDF)
- Tracks ADR parity prices to foreign list countries