What is an American Depository Receipt (ADR)?

Analysis of American Depository Receipt (ADR):

ADR (American Depository Receipt) is a transferable certificate that represents foreign company securities traded in a country's securities market. These securities can be either stocks or bonds.ADR (American Depository Receipt) is a transferable certificate that represents foreign company securities traded in a country's securities market. These securities can be either stocks or bonds.ADR is a depositary receipt issued to American investors and traded on the US securities market.

In 1927, Morgan Bank first invented the depositary receipt.The purpose was to circumvent the then British law that did not allow domestic companies to register and list overseas, making it convenient for American investors to invest in and trade the shares of the British retailer SELFRIDGE..

According to US securities laws, a company listed in the US must be domiciled in the US. For companies registered abroad, the only way to enter the US capital markets is through depositary receipts. In addition, some US institutional investors, such as retirement funds and insurance companies, are unable to buy foreign stocks, but they can purchase ADRs listed in the US and registered with the SEC.

One ADR represents a certain number of shares of a non-US company (one ADR equals one original share, or one ADR equals multiple original shares). ADRs are traded in the US market, and the trading process is the same as for regular US stocks.ADRs are issued by US banks, with each representing a certain number of shares of a non-US company held in trust by a foreign custodian. The company must provide financial data to the bank issuing the ADR. ADRs cannot eliminate the currency and economic risks associated with the related company's stock. Both ADRs and Global Depositary Receipts (GDRs) facilitate cross-border trading and global equity offerings for US and non-US investors.From legal, operational, technical, and managerial perspectives, ADRs are equivalent to GDRs.

Classification of American Depositary Receipts:

1. ADR can be divided into two types: sponsored and unsponsored, with unsponsored ADRs being rarely used.

(1) Unsponsored ADRs can only be traded over-the-counter (OTC) and have no regulatory requirements. They are the lowest level of ADRs.

(2) Sponsored ADRs are divided into four types: Level 1 ADR, Level 2 ADR, Level 3 ADR, and Rule 144A ADR.

1) Rule 144A ADR is targeted at the U.S. private placement market and is typically not allowed to be held by U.S. public shareholders. This type of ADR sacrifices liquidity in exchange for lower issuance costs and broader disclosure requirements.

2) Level 1 ADR is the lowest level of sponsored ADR. When issuing ADRs, a depository institution needs to be designated, which also serves as the transfer agent for the ADR. Level 1 ADR is the simplest way to trade on the U.S. market, but can only be traded OTC. The SEC has minimal regulatory requirements for this level of ADR, no quarterly or annual reports are required, nor compliance with US GAAP. However, the company must have securities listed on one or more markets in its home jurisdiction and must disclose annual reports on its website in the format prescribed by the country's laws and regulations. Companies of this type can choose to upgrade to Level 2 ADR or Level 3 ADR for better exposure in the U.S. market.

3) Level 2 ADR is much more complex than Level 1 ADR. It requires registration with the SEC and compliance with SEC regulations. In addition, Level 2 ADRs must submit an annual Form 20-F report (equivalent to Form 10-K for U.S. listed companies) and comply with US GAAP or IFRS. The benefits of Level 2 ADRs include being able to trade on a stock exchange (not just limited to OTC), including NYSE, AMEX, and NASDAQ.

4) Level 3 ADR is the highest level of ADR and is subject to the strictest SEC regulations, similar to those for U.S. domestic companies. The biggest advantage of Level 3 ADR is the ability to raise funds, not just limited to trading on a stock exchange. To raise funds, the company must provide a Form F-1 (prospectus) and submit an annual Form 20-F report and comply with US GAAP or IFRS. In addition, companies of this type must submit information provided to shareholders in the local market to the SEC via Form 6-K; must meet public disclosure requirements and submit Form 8-K to the SEC.

Advantages of American Depositary Receipts (ADRs):

1. For issuing companies

(1) Expand the trading market for their stocks through a wider and more diverse range of promotional methods that help increase or stabilize stock prices.

(2) Improve the international market image of the company's products, services, and financing methods.

(3) Provide a mechanism for raising funds or conducting acquisitions.

(4) Facilitate the expansion of company employees' investments in the parent company.

2. For investors

(1) Like other transferable securities, ADRs are usually quoted and paid in US dollars for dividends or interest.

(2) Depositary receipts can overcome the obstacles that mutual funds, pension funds, and other institutional investors may have when buying and holding foreign securities. (3) Due to the elimination of custody fees for international custodian banks, depositary receipt investors can save 0.1%-0.4% of investment costs annually. (4) Dividends and other cash distributions can be converted into US dollars at competitive exchange rates.

(5) Depositary receipts have the same liquidity as the underlying stocks they represent because they can be exchanged for each other.

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