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ADR- 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 USA normally have to undergo a series of regulations and paper work before going public and raise funds through common stock.  This can become a tedious process for the organizations. There is a privilege called ADR which helps such firms to raise capital from US markets. 

How does it work?
ADR are 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. ADRs 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 investor in market to convert back into cash. Banks profile details financials of such companies and the same are made available to the investors looking to invest in these ADRs. The ADRs are denominated in US dollars and even dividends are paid in dollars. In this way an 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 ADR, Philip Morris ADR, Samsung ADR and etc.

Types of ADRs

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 has the control over these instruments and such ADRs are categorized by what degree the accounting formalities are in line with the SEC. These ADRs are always trades in the exchanges. The person owning sponsored ADR will also give voting rights for the investor.

2. Unsponsored ADRs- Even these ADRs are issued by US banks but there is no charges of transaction and issuance which are charged to companies. As there is no single party bank authorised 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 doesn’t include voting rights.



Levels of ADR
Based on the level and depth of access for the foreign companies has to the US markets, ADRs are classified as three types as below.
Level I ADRs- ADRs categorised under this level requires the foreign company to follow minimum amount of compliance and regulatory formalities according to SEC. It is sufficient for such companies to fill in F-6 registration form and there is no mandate to file or follow the usual SEC filing reports. They are traded mostly OTC.
Level II ADRs- 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 financial to the US markets and such ADRs are listed in stock exchanges NYSE and NASDAQ. Level II ADRs can help raise funds to a large scale without even going public and filing for IPO in US markets.
Level III ADRs- 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
1. ADR stands for American Depository Receipts and GDR is Global Depository Receipts. ADRs are negotiable instruments issued and traded with in US markets while GDR as similar instrument traded globally.
2. ADR can be used by a foreign company to raise capital in US market where as GDR can be used by foreign companies to raise from any market globally.
3. ADRs are issue in US domestic Capital market, GDRs are issued in European capital markets.
4. ADR negotiation can happen in US only whereas GDR negotiation can happen all over the world.
5. SEC approval is mandatory for ADR but for GDR approval from ministry of Finance and FIPB (Foreign Investment Promotion Board) is a must.

Advantages of ADR
• Foreign companies looking to raise capital in denominations of dollars can do by opting for ADRs.
• Investor looking to diversify their portfolio can invest in ADR which are indirect investment in foreign and US non listed companies as a retail investor.
• Arbitrators whose purpose is to make profits from market imperfections can explore new opportunities through ADRs.
• Level III ADR can even raise funds through public offering.
• ADRs are cost effective compared to expensive litigations which raise due to IPOs.
• The information related to financials can be kept private by both the parties till earnings are realised, even after the outcome parties can choose not to disclose data.
• It is 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 case of any publicly traded US firm.

Disadvantages of ADR
• The unsponsored ADRs requires the foreign to file least possible filings with the SEC, which can be risky if the company is not legit.
• Retail investor looking to invest in ADR may not have same number of options to choose from as in case of common stock.
• Investor has access to least amount of financials from firms which can be a constraint to conduct their equity research.
• Dividends paid on ADRs may differ from the dividends paid on the common stock of same company.


Conclusion
ADRs are a means for foreign companies to raise funds from US markets. Foreign firms which has business in US and has awareness of brand in US may look to encash and raise funds in terms of dollars. This mean is a lot cheaper for such firms companies compared to firms raising capital from developing markets. ADR also requires companies to file 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 which are traded across markets in 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 ADR also provides liquidity to the investor and is a lot more flexible and



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