What is an ADR?
ADR is formally known as American Depositary Receipt. It is a negotiable security that represents securities of a foreign company and allows that company’s shares to be traded in the US financial markets. ADR stocks trade on the US stock market just like how any other stock would. This allows US investors to invest in foreign companies easily as ADR is traded in US hours, through US brokers, and custody, currency, and local taxes issues are all managed by the depositary bank. The company’s stock price and dividend (if there is any) are also listed in USD. A lot of non-US companies are listed on the US stock exchange through ADR to gain more access and visibility to US investors.
There are also different levels of ADRs. Level 1 ADRs are the lowest level of sponsored ADRs that can be issued and are traded on the OTC (over-the-counter) market which is not an exchange. Level 1 company has minimal reporting requirements with the US Securities and Exchange Commission (SEC) and is not required to issue quarterly or annual reports in compliance with the US generally accepted accounting principles (GAAP). This makes investing in level 1 ADRs very risky as minimal information is available. Level 2 and 3 ADRs are required to file a registration statement with the SEC and are under its regulation. It is also required to file an annual report each year under the GAAP standards. Both level 2 and 3 companies can be listed on a US stock exchange, while level 3 companies can undergo an IPO process to issue shares and raise capital.
Most ADR stocks are also listed in their own country with another exchange (eg. ASX, TSX, NSE). For example, HDFC Bank (HDB), the largest bank in India, is listed on both the New York Stock Exchange (NYSE) and the National Stock Exchange of India (NSE). Stock prices on both exchanges are usually very similar (on a USD basis) but can be mis-priced due to the exchange rate (as it is priced with Rupee in India). This can make ADR prices a bit more volatile especially for companies that are based in a country with an unstable currency. Besides, some lesser-known ADR companies may also have a relatively low trading volume and higher bid-ask spread which reduces the liquidity of the stock. However, ADR is still by far the best option for local investors to invest in foreign companies and diversify their portfolio’s geographic exposure.
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