ADR Basics: What Is An ADR?
American Depositary Receipts (ADRs) are stocks that trade in the U.S. but represent a specified number of shares in a foreign corporation – such as Alibaba (BABA). Like regular stocks, ADRs are bought and sold on U.S. markets. They also trade in U.S. dollars and clear through U.S. settlement systems – allowing ADR investors to avoid transacting in a foreign currency.
ADRs were developed because of the complexities involved in buying shares in foreign countries and the difficulties associated with trading at different prices and currency values. ADRs allow U.S. banks to purchase a bulk lot of shares from a foreign company, bundle the shares into groups and reissue them on U.S. stock markets – namely, the New York Stock Exchange and NASDAQ.
J.P. Morgan’s (JPM) predecessor firm Guaranty Trust Co. pioneered the ADR concept. In 1927, it created and launched the first ADR, enabling U.S. investors to buy shares of famous British retailer Selfridges and helping the luxury depart store tap into global markets. The ADR was listed on the New York Curb Exchange (the precursor to the American Stock Exchange). A few years later, in 1931, the bank introduced the first sponsored ADR for British music company Electrical & Musical Industries (also known as EMI), the eventual home of the Beatles. Today, J.P. Morgan and another U.S. bank – BNY Mellon – continue to be actively involved in the ADR markets. (For more, see: J.P. Morgan Biography.)
Sponsored and Unsponsored
ADRs can be sponsored or unsponsored. With sponsored ADRs, the foreign company enters into an agreement directly with the U.S. depositary bank to make plans for recordkeeping, distribution of shareholder communications, payment of dividends (some ADRs are dividend-paying stocks) and other services. Sponsored ADRs can be listed on major exchanges.
An unsponsored ADR, on the other hand, is set up without the cooperation of the foreign company. These ADRs may be initiated by a broker-dealer that wants to establish a U.S. trading market. The number of unsponsored ADRs skyrocketed in 2008 after the SEC amended an exemption that applied to foreign issuers. The amendment got rid of the written application and paper submission requirements by providing automatic exemption to foreign issuers that meet certain conditions. This makes it possible for non-U.S. companies to have their securities traded in the U.S. OTC market without the registration previously required under the Securities and Exchange Commission Act of 1934. Note that unsponsored ADRs can only trade on over-the-counter markets.
Either way, an ADR may not be established unless the foreign company is either subject to the reporting requirement under the Securities and Exchange Act of 1934 or exempt under the Act.