American Depositary Shares and American Depositary Receipts
American investors that desire to easily add foreign companies to their investment portfolio should become familiar with American depositary shares (ADSs) and American depositary receipts (ADRs). These two terms are oftentimes used interchangeably as there are similarities between the two it is important to understand the differences. The following will cover a general outline of the key differences, benefits, and potential issues of ADSs and ADRs.
What are American Depositary Shares?
ADS are the shares issued by American depositary banks that represent ownership in foreign companies that are denominated in US dollars and are available to be traded on US stock exchanges.
What are American Depositary Receipts?
To highlight the key differences between ADRs and ADSs, it is first important to understand that ADRs are what allow the stock issued by the American depositary banks to be traded on US markets and ADSs represent the shares themselves. ADRs act as a gateway for US investors to invest in foreign companies. Essentially, an ADR lets foreign companies put their shares on US stock exchanges or over-the-counter (OTC) markets so that US investors can invest in their companies.
American depositary banks can either issue a sponsored ADR or an unsponsored ADR. A sponsored ADR issued by a US bank allows a foreign company to trade on a US stock exchange or an OTC market. Unlike a traditional US stock exchange, an OTC market is a market that is not listed on a traditional exchange and allows brokers and dealers to deal directly with each other online. Unsponsored ADRs issued by a US depositary bank are only traded on an American OTC market.
Why are ADSs and ADRs important?
ADSs and ADRs are important to US investors because they allow investors to easily invest in foreign companies without having to worry about the hassles of cross-border investing. They are also important to foreign companies because they allow a foreign company to trade in their own country as well as US stock exchanges and OTCs.
Here is an example to help put it into perspective. Company A is a large German company and was issued a sponsored ADR from an American depositary bank. Investor B is an American investor who wants to invest in Company A. Since Company A was issued a sponsored ADR, Company A can now trade on an American stock exchange. Since the shares are issued by the American depositary bank, the ADSs are denominated in US dollars. Thus, Investor B can invest in Company A without having to deal with currency exchanges of the stock.
Potential issues
Although ADSs and ADRs can be very helpful for US investors and foreign companies, they do have their disadvantages. One issue is that US shareholders need to have their income payments converted to US dollars. While it is generally beneficial that US investors are purchasing the stocks in US dollars, there are still issues that can arise with fluctuations in the exchange rate between the foreign currency and US dollars. A disadvantage for the foreign companies is that there are strict compliance requirements that are enforced by the SEC and a foreign company that violates any compliance requirements will likely face repercussions.