Full Form of ADR
The full form of ADR is American Depository Receipts. ADR is a type of financial instrument traded in US markets. These instruments are sponsored and issued by US banks. Any company which is non-local in US markets can raise funds from US markets through these ADRs. Foreign companies in the USA normally have to undergo a series of regulations and paperwork before going public and raise funds through the common stock. This can become a tedious process for organizations. There is a privilege called ADRADRAmerican Depositary Receipts (ADR) refer to negotiable certificate released by the US depository bank and comprise a certain number of stocks with atleast one foreign company's shares. It is freely traded on the US stock markets, just like the other domestic stocks., which helps such firms to raise capital from US markets.
How Does it Work?
- It is generally sponsored by US scheduled banks, which will buy shares from foreign exchange and hold as inventory and issue ADRs, which are linked to these underlying stocks. They are then traded domestically in US markets.
- The banks issued ADRs equal to the value of common shares deposited with the sponsoring bank. Investors, on the other side who want to invest in such companies and don’t have the option to buy common stocks, can invest in ADRs.
- These instruments can be liquidated by an investor in the market to convert back into cash. Banks profile details the financials of such companies, and the same is made available to the investors looking to invest in these ADRs.
- They are denominated in US dollars, and even dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company. are paid in dollars. In this way, a US investor can easily add foreign stock in his portfolio, and on the other side, foreign companies can raise funds in dollars from US investors. Examples: Volkswagen, Philip Morris, Samsung, etc.
Types of ADRs
The following are types of American Depository Receipts.
#1 – Sponsored ADRs
US banks and the company, upon mutual agreement, issues these types of ADRs. Banks issues ADRs as per agreement on behalf of the company. The bank charges a fee to the company for issuance and transaction it handles with the local investors. Firms have control over these instruments, and such ADRs are categorized by what degree the accounting formalities are in line with the SEC. These are always trades in the exchanges. The person owning sponsored ADR will also give voting rights to the investor.
#2 – Unsponsored ADRs
These are issued by US banks, but there are no charges of transaction and issuance which are charged to companies. As there is no single party bank authorized for the issuance and handling of such ADRs, there can be more than one bank issuing ADRs for the same foreign company under different dividend charges and denominations. Unsponsored ADRs are traded over the counter and don’t include voting rights.
Levels of ADR
Based on the level and depth of access for the foreign companies that have to the US markets, ADRs are classified into three types as below.
#1 – Level I
ADRs categorized under this level require the foreign company to follow the minimum amount of compliance and regulatory formalities, according to SEC. It is sufficient for such companies to fill in an F-6 registration form, and there is no mandate to file or follow the usual SEC filing reports. They are traded mostly OTCOTCOver the counter (OTC) is the process of stock trading for the companies that don't hold a place on formal exchange listings. The broker-dealer network facilitates such decentralized trading of derivatives, equity and debt instruments..
#2 – Level II
Companies wishing to list their ADRs under this level need to file all reporting’s as per SEC regulations, and apart from just the F-6 registration, companies also need to fill in SEC FORM 20-F and annual financials. Companies must disclose all their finances to the US markets, and such ADRs are listed in stock exchanges NYSE and NASDAQ. Level II ADRs can help raise funds on a large scale without even going public and filing for IPO in US markets.
#3 – Level III
Level II and Level III ADRs are similar in terms of reporting and filing regulations that SEC levies on them. The only add on level III has on to level II is that these can raise funds from US markets through public offering also. They just need to file the Form F-1 to be eligible for this with the securities exchange commission.
Difference between ADR and GDR
- ADR stands for American Depository Receipts, and GDR is Global Depository ReceiptsGlobal Depository ReceiptsGlobal Depository Receipt is a receipt in which a security certificate is issued by financial intermediaries such as a depository bank, which purchases foreign securities, creates a bank certificate consisting of such shares, and then sells them on the stock exchange.. ADRs are negotiable instruments issued and traded within US markets while GDR as a similar instrument traded globally.
- ADR can be used by a foreign company to raise capital in the US market, where GDR can be used by foreign companies to raise from any market globally.
- ADRs are issued in the US Domestic Capital marketCapital MarketA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets., GDRs are issued in European capital markets.
- ADR negotiation can happen in the US only, whereas GDR negotiation can happen all over the world.
- SEC approval is mandatory for ADR, but GDR approval from the Ministry of Finance and FIPB (Foreign Investment Promotion Board) is a must.
- Foreign companies looking to raise capital in denominations of dollars can do by opting for ADRs.
- An investor looking to diversify their portfolio can invest in ADR, which is an indirect investment in foreign and US non-listed companies as a retail investor.
- Arbitrators whose purpose is to make profits from market imperfectionsMarket ImperfectionsImperfect market structure is a part of microeconomics in which companies sell different products and services, as opposed to perfect competitive markets in which homogeneous products are sold. Companies in this sector have some pricing power with high barriers to entry, resulting in higher profit margins as each company tries to differentiate their products and services through innovative technology. can explore new opportunities through ADRs.
- Level III ADR can even raise funds through a public offering. They are cost-effective compared to expensive litigations, which raise due to IPOsIPOsInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes..
- The information related to financials can be kept private by both parties until earnings are realized. Even after the outcome, parties can choose not to disclose data.
- It is an easy and faster means to raise capital from the US markets, especially when the other process is very lengthy and time-consuming. Firms need not worry about filing the report up to date to the core, as in the case of any publicly traded US firm.
- The unsponsored ADRs require the foreign to file the least possible filings with the SEC, which can be risky if the company is not legit.
- A retail investorRetail InvestorA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. looking to invest in ADR may not have the same number of options to choose from, as in the case of common stock.
- The investor has access to the least amount of financials from firms, which can be a constraint to conduct their equity researchEquity ResearchEquity Research refers to the study of a business, i.e., analyzing a company's financials, performing Ratio Analysis, Financial forecasting in Excel (Financial Modeling), & exploring scenarios to make insightful BUY/HOLD/SELL stock investment recommendations. Moreover, the Equity Research Analysts discuss their findings & details in the Equity Research Reports. .
- Dividends paid on ADRs may differ from the dividends paid on the common stock of the same company.
- They are a means for foreign companies to raise funds from US markets. Foreign firms that have a business in the US and have an awareness of the brand in the US may look to encash and raise funds in terms of dollars. This means a lot cheaper for such firms companies compared to firms raising capital from developing markets.
- They also require companies to file the least filings with SEC, and the whole process can be done with ease. At the time of issuance of ADR, dollars from investors are converted into certificates that are traded across markets in the US.
- At the time of cancellation, the investor will surrender the ADR to get the amount to his bank account in terms of dollars. Thus they also provide liquidity to the investor and are a lot more flexible and handy from the foreign company’s perspective.
This has been a guide to the Full Form of ADR, i.e. (American Depository Receipts). Here we discuss how does ADR works with its types, levels, and differences. You may refer to the following articles to learn more about finance –