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Mutual funds and exchange-traded funds (ETFs) offer American investors opportunities to diversify a portfolio through foreign securities and are the most common way for investors to gain global exposure; however, for people who prefer to purchase individual stocks of foreign companies, their options can be limited.
While some foreign companies are allowed to list their stocks on U.S. stock exchanges, very few meet the strict requirements of securities regulations or want to pay dual-listing fees. One alternative for U.S. investors looking to bypass the somewhat costly obstacles of purchasing a foreign company's stock on an overseas exchange is by investing in an American depositary receipt (ADR).
An ADR is a certificate representing shares of foreign company stock held in a bank within the United States and denominated in U.S. dollars. Most are sponsored ADRs, meaning the foreign company is involved in creating the investment for U.S. investors.
An ADR may represent the underlying shares on a one-for-one basis, or it can also represent a fraction of a share or multiple shares. The ratio of U.S. ADRs per home-country share is set by the depository bank at a value that appeals to investors. Although unsponsored ADRs exist, they are rare.
ADRs are offered to investors as either a level-I, level-II, or level-III issue. Each ADR category meets different regulatory standards and is offered to investors through different outlets.
A sponsored ADR listed as a level-I issue requires the least amount of compliance and regulatory oversight, and investments are originated by the foreign company wishing to offer shares. An F-6 registration statement must be filed to meet the requirements of a level-I ADR offering, but the company is exempt from full Securities and Exchange Commission (SEC) reporting requirements.
An ADR issued under a level-I program is controlled by the foreign company and the single depository bank it selects. Because of the minimal oversight and exemption from reporting requirements, level-I ADR issues are only traded on the over-the-counter market. Note that a level-I ADR may also be unsponsored, meaning the foreign company does not have direct involvement in the ADR.
Foreign companies issuing level-II ADRs are mandated to fulfill all registration and reporting requirements imposed by the SEC. This includes submitting the company's F-6 registration statement, SEC Form 20-F, and annual financial reports prepared in line with either generally accepted accounting principles (GAAP) or international financial reporting standards.
Companies must also comply with the Sarbanes-Oxley Act, which requires accounting and financial disclosure, as well as other reporting standards. Level-II ADRs are allowed to be listed on a major U.S. stock exchange such as the New York Stock Exchange or the Nasdaq Stock Market. Level-II ADRs provide the issuing foreign company greater exposure in the United States without needing to complete a public offering.
Level-III ADRs are similar to level-II issues in terms of reporting requirements and listing on U.S. exchanges; however, foreign companies issuing level-III ADRs can also raise capital through a public offering of the ADR within the United States. This additional step requires the company to file a Form F-1 with the SEC to properly register the public offering.
Investors should be aware that ADRs may come with fees. This could make them more costly than investing in domestic companies. These fees are custody fees, also known as Depository Service Fees, paid to the depository bank for the work it performs on the creation and maintenance of the ADR. The fees are either deducted from the dividends that the foreign company pays or if the company does not pay a dividend, the fees are charged to the broker, which then charges them to the investor.
American depository receipts (ADRs) are shares of a foreign company issued in the U.S. while global depository receipts (GDRs) are shares of a foreign company issued in multiple countries. Issuing via an ADR allows a foreign company to issue its shares only in the U.S., whereas a GDR allows a company to issue its shares in many countries all at once as part of a GDR program.
An example of an ADR would be the Chinese company, Alibaba. The company is publicly traded in China on the Hong Kong Stock Exchange but also trades in the U.S. on the New York Stock Exchange with the ticker BABA. It trades on the NYSE as an ADR, through which U.S. investors can buy or sell the stock.
ADRs allow U.S. investors access to foreign markets, giving them the ability to diversify their portfolios and gain access to strong, foreign investments. ADRs remove the difficulty of having to go through foreign exchanges and the concern of navigating foreign exchange rates.
ADRs allow U.S. investors to invest in the stocks of foreign companies. The differences in regulatory requirements for level-I, level-II, and level-III ADRs, determine how much oversight the ADR has as well as the way in which to invest in it. It also reflects how much time and regulatory compliance the foreign company wants to put into setting up an ADR.