Domestic investors are increasingly realizing the advantages of diversifying their portfolios by investing in foreign companies. One convenient avenue for achieving this is through American Depositary Receipts (ADRs). This financial product, traded on domestic exchanges like the NYSE and Nasdaq, represents shares in foreign companies while eliminating the need to navigate foreign markets and currencies.
Basics of ADRs
American Depositary Receipts, commonly referred to as ADRs, are a financial instruments issued by domestic depository banks and traded on U.S. exchanges. These instruments serve as proxies for shares in foreign companies. They offer a simplified and convenient means for domestic investors to gain exposure to international markets.
Depository Banks Behind ADRs
In the United States, numerous depository banks sponsor ADRs. Among them, the largest players are the Bank of New York Mellon (BNY), State Street (STT), and JPMorgan Chase (JPM). These depository banks play a pivotal role in establishing and operating depositary receipt programs for foreign companies. Surprisingly, many of these banks offer issuing services to companies for free, prompting questions about their motivations and benefits.
The Mechanics of ADRs
When a depository bank issues an ADR, it essentially purchases an equivalent amount of shares in the foreign company's local market. These shares are held by a local custodian bank on behalf of the depository bank. Subsequently, ADRs can be freely traded on domestic exchanges, just like any other stock.
Should a depositary receipt be canceled, it is delisted from the American market, and the ADRs are returned to the depository bank. Simultaneously, the shares held by the local custodian are released back into the foreign market.
The Benefits of Issuing ADRs
While depository banks go through substantial efforts to issue new ADRs, their tangible benefits do not arise from the foreign companies themselves. Instead, these banks reap rewards when ADRs are eventually sold in the market. Like any other trade, depository banks earn commissions on these transactions.
Furthermore, depository banks often deduct fees from the dividends payable to investors holding ADRs. Additionally, they may pass on expenses linked to currency conversion to investors. It is through these fees and expenses that depository banks profit from issuing ADRs.
American Depositary Receipts have emerged as a powerful tool for domestic investors seeking exposure to international markets. These financial instruments, issued by domestic depository banks and traded on U.S. exchanges, simplify the process of investing in foreign companies. While depository banks undertake substantial responsibilities in issuing ADRs, their true financial benefits materialize when these ADRs are traded, with commissions and fees constituting a significant portion of their income. As investors continue to diversify their portfolios and explore global opportunities, ADRs remain a valuable and accessible gateway to international markets.