What You Need to Know About American Depositary Receipts (ADRs)

An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depositary bank that evidences American depositary shares (ADSs). Each ADS represents a specified number—or fraction—of a foreign issuer's underlying shares held by a custodian. ADR programs can make the foreign security tradable in U.S. dollars, either on an exchange or over the counter. The SEC's ADR investor bulletin explains the structure and its risks.

How American depositary receipts work

In a depositary program, the underlying foreign shares are held by a custodian for the depositary, which issues ADSs evidenced by ADRs. The deposit agreement states the ADS-to-underlying-share ratio, fees, voting process, distributions, and termination terms. Depending on the program, the ADSs trade on a U.S. exchange or over the counter.

When the foreign company pays a dividend, the depositary bank converts it into U.S. dollars and passes it along to ADR holders, usually after subtracting a custody or processing fee. Prices of the ADR and the underlying home-market shares generally track each other closely, because professional traders arbitrage away large gaps. You buy and sell an ADR through the same brokerage account you already use, during regular U.S. trading hours.

A related term is American Depositary Share (ADS). The ADS is the U.S. depositary security representing an interest in the deposited foreign shares; it is not the underlying foreign ordinary share itself. The ADR is the physical or electronic certificate that evidences one or more ADSs. Market participants often use “ADR” loosely for the traded ADS.

Types of American depositary receipts

ADRs come in two broad categories and three levels, and the differences matter for what information you get as an investor.

• Sponsored ADRs are created with the foreign company's cooperation. The company signs an agreement with one depositary bank and typically takes on reporting responsibilities.
• Unsponsored ADRs are created by banks without the company's direct participation. They trade over the counter, may have several banks issuing receipts for the same stock, and often come with thinner disclosure.

Sponsored programs are further split by level:

Exchange-listed foreign issuers file an annual report on Form 20-F, which you can pull for free from the SEC's EDGAR database. Reading the 20-F is the closest equivalent to reading a U.S. company's 10-K.

Benefits of investing in ADRs

The appeal of ADRs is convenience with familiar plumbing:

• Dollar-denominated trading. You buy, sell, and receive dividends in U.S. dollars, with no foreign brokerage account or currency conversion on your side.
• Familiar market hours and settlement. ADRs trade during U.S. sessions through your existing broker, with U.S.-style settlement and account statements.
• Access to global names. Many of the world's largest companies outside the U.S. are available as ADRs, which broadens the menu for diversification beyond domestic stocks.
• Dividend handling done for you. The depositary bank collects the foreign dividend, converts the currency, and credits your account.

For a long-term investor who simply wants some non-U.S. exposure in single names, ADRs remove most of the operational friction of investing abroad.

Risks and considerations when investing in ADRs

ADRs carry every risk of the underlying business plus a few layers of their own:

• Currency risk. Even though you trade in dollars, the underlying shares live in another currency. If that currency weakens against the dollar, your ADR's value and your dividend income can fall even when the stock is flat at home.
• Depositary fees. Banks commonly deduct a pass-through fee, often a few cents per share per year, from dividends or through your broker.
• Foreign dividend withholding tax. The home country may withhold tax before a distribution reaches the holder. A U.S. taxpayer may qualify for a foreign tax credit or deduction, but limits, treaty rates, account type, and documentation matter. See IRS Publication 514 and consult a tax professional for the specific program.
• Disclosure gaps. Unsponsored and Level I programs are not held to full SEC reporting, so financial information can be dated, less detailed, or presented under foreign accounting standards.
• Liquidity and delisting risk. Some ADRs trade thin volumes with wide spreads, and programs can be terminated, forcing holders to sell or convert to foreign shares.
• Political and regulatory risk. Sanctions, capital controls, or a regulatory dispute can disrupt an ADR program in ways that rarely affect a domestic stock.