American Depositary Share (ADS)

An American Depositary Share (ADS) is a U.S. dollar-denominated equity share of a foreign-based company available for purchase on an American stock exchange. Each ADS represents one or more shares of a foreign stock or a fraction of a share. The terms “American Depositary Shares” and “American Depositary Receipts” (ADR) are often used interchangeably.

ADSs are a way for American investors to invest in non-U.S. companies without dealing with foreign stock exchanges or currencies. They are particularly common for firms from countries where capital controls or other restrictions make it difficult for foreign investors to purchase shares directly.

History of ADS

The concept of American Depositary Shares was introduced in the 1920s as a mechanism to facilitate the trading of foreign stocks on U.S. exchanges. JPMorgan Chase & Co. is credited with creating the first ADR, which was for the British retailer Selfridges in 1927. Since then, the popularity of ADSs has increased significantly, especially as globalization has connected the world’s financial markets.

How ADS Works

When a foreign company wants to list its shares on a United States exchange, it typically partners with a U.S. bank to issue ADSs. The process begins in the foreign company’s home country, where the company deposits its shares with a local custodian bank associated with a U.S. bank. The U.S. bank then issues the ADSs, which represent the shares held by the custodian bank.

Each ADS can represent one share, multiple shares, or fractions of a share of the foreign company’s stock. This allows the ADS to be priced at a level that is attractive to U.S. investors.

Types of ADS Programs

There are three main types of ADS programs:

  1. Sponsored ADRs: These are created when a foreign company selects a U.S. bank to serve as the ADR depositary. The foreign company provides financial statements and other information necessary to comply with U.S. regulations. Sponsored ADRs can be further categorized into three levels based on their complexity and regulatory requirements:
    • Level I: These are the simplest form, traded over-the-counter (OTC). They require minimal reporting to the SEC.
    • Level II: These ADRs are listed on U.S. stock exchanges (e.g., NYSE or NASDAQ) and require more stringent reporting to the SEC, including compliance with U.S. GAAP or IFRS.
    • Level III: These involve the same level of SEC reporting as Level II but also include a capital-raising transaction in the U.S. public markets.

  2. Unsponsored ADRs: These ADRs are created without the involvement of the foreign company. Instead, a U.S. broker or investment bank creates them based on existing shares trading in the foreign market. Unsponsored ADRs do not require the foreign company to provide financial information or comply with U.S. regulations.

  3. Global Depositary Receipts (GDRs): These are similar to ADRs but are traded in multiple international markets, including non-U.S. exchanges. They are often used for capital raising outside the issuer’s home country, covering both Europe and the U.S. markets.

Advantages of ADS

ADSs offer several advantages to both investors and foreign companies:

For Investors:

  1. Diversification: ADSs provide U.S. investors with an opportunity to diversify their portfolios internationally without dealing with foreign brokers or currency conversions.
  2. Simplicity: Investing in ADSs is as straightforward as investing in U.S. stocks. They are traded on U.S. exchanges, and transactions are settled in U.S. dollars.
  3. Accessibility: ADSs are available through conventional brokerage accounts, and investors can leverage standard tools and platforms used for U.S. equities.
  4. Transparency: ADSs of foreign companies listed on major U.S. exchanges are subject to the same financial disclosure requirements as U.S. companies, providing investors with access to detailed information.
  5. Dividends: Any dividends paid on the underlying shares are converted into U.S. dollars and distributed to ADS holders.

For Foreign Companies:

  1. Access to Capital: By listing ADSs in the U.S., foreign companies can tap into the largest capital market in the world, potentially increasing their funding opportunities.
  2. Increased Visibility: A U.S. listing can enhance a foreign company’s visibility and reputation among global investors.
  3. Broader Investor Base: Foreign companies can diversify their investor base beyond their home country, attracting U.S. institutional and retail investors.
  4. Liquidity: ADSs offer foreign companies a way to increase the liquidity of their shares, making them more attractive to investors.

Risks of ADS

Despite their advantages, investing in ADSs carries certain risks:

For Investors:

  1. Currency Risk: While transactions are in U.S. dollars, the underlying shares are priced in the foreign country’s currency. Exchange rate fluctuations can affect the value of the ADS.
  2. Political Risk: Investments in foreign companies are subject to the political environment of the issuer’s country, including changes in laws, regulations, or government stability.
  3. Economic Risk: The economic conditions in the foreign company’s home country can impact its performance and, consequently, the value of the ADS.
  4. Liquidity Risk: Some ADSs may have lower trading volumes compared to U.S. stocks, potentially leading to larger bid-ask spreads and difficulty in buying or selling shares quickly.
  5. Regulatory and Compliance Risk: Foreign companies may be subject to different accounting standards and regulatory environments, posing challenges in accurately assessing financial health.

For Foreign Companies:

  1. Regulatory Compliance: Foreign companies must adhere to SEC regulations and may need to provide more extensive disclosures, which can be time-consuming and costly.
  2. Costs: Listing ADSs involves fees related to issuance, regulatory compliance, and ongoing reporting requirements.
  3. Market Scrutiny: A U.S. listing subjects foreign companies to greater scrutiny from investors and analysts, potentially impacting stock prices based on earnings reports and news.

Examples of ADS

Numerous foreign companies have successfully issued ADSs to gain exposure to the U.S. market. Here are a few examples:

Alibaba Group Holding Limited

Alibaba, the Chinese e-commerce giant, issued ADSs on the New York Stock Exchange (NYSE) under the ticker symbol BABA. Each ADS represents eight ordinary shares of Alibaba.

Royal Dutch Shell

Royal Dutch Shell, a global energy and petrochemical company, has ADSs traded on the NYSE under the ticker symbol RDS.A and RDS.B. Each ADS represents two ordinary shares of Shell.

Baidu, Inc.

Baidu, a leading Chinese internet search provider, lists its ADSs on NASDAQ under the ticker symbol BIDU. Each ADS represents 10 Class A ordinary shares of Baidu.

Toyota Motor Corporation

Toyota, the Japanese automotive manufacturer, has ADSs traded on the NYSE under the ticker symbol TM. Each ADS represents two ordinary shares of Toyota.

Regulatory Environment

ADSs are subject to regulations in both the issuer’s home country and the United States. The primary U.S. regulatory body overseeing ADSs is the Securities and Exchange Commission (SEC). Key regulatory requirements include:

  1. Registration: Foreign companies must file a registration statement with the SEC, typically using Form F-6, to describe the terms of the ADR program.
  2. Reporting: Foreign companies with Level II and III ADR programs must file annual reports (Form 20-F or Form 40-F) and timely updates (Form 6-K) with the SEC, providing financial statements and other disclosures.
  3. Sarbanes-Oxley Act Compliance: Foreign companies listed on U.S. exchanges must comply with the Sarbanes-Oxley Act, which mandates internal control assessments, management certifications, and auditor independence rules.

Conclusion

American Depositary Shares serve as a crucial bridge between international companies and U.S. investors, enabling cross-border investments and global market integration. They provide a convenient and reliable method for U.S. investors to gain exposure to foreign equities while offering foreign companies access to the vast liquidity and capital of the U.S. financial markets. Nonetheless, potential investors should be aware of the inherent risks associated with foreign investments and conduct thorough due diligence before investing in ADSs.