What it means
Many foreign companies want US investors but do not want to deal with a foreign settlement system. An ADR solves this: a US depositary bank holds the company's local shares and issues receipts that trade, pay dividends and settle in dollars like ordinary US stocks.
In a sponsored ADR, the foreign company takes part. It pays for the programme, chooses a depositary bank and agrees to provide regular financial reports.
An unsponsored ADR, by contrast, is set up by a bank without the company's involvement. Sponsored ADRs come in levels.
Level I trades over the counter with minimal reporting, Level II lists on a US exchange with fuller reporting, and Level III also allows the company to raise new money from US investors. The higher the level, the more rules the company must follow.
For the investor, one ADR usually stands for a set number of underlying shares, known as the ratio. The ADR price therefore follows the local share price multiplied by the ratio and the current exchange rate, which means an investor takes currency risk as well as business risk.
The depositary bank typically charges small fees, often deducted from dividends, and the foreign company's local taxes may apply to payouts. These costs are modest but worth noting when comparing the ADR with buying the local shares directly.
From the company's side, the decision involves cost, disclosure and control. A listing means additional filings, audit work and legal advice, and the company must keep its US investors informed.
In return it gains a wider shareholder base, which can improve liquidity, support the share price and make it easier to use shares as currency in deals.
In practice
Real-world examples.
Example
A mining company based in Australia launches a sponsored Level II ADR so that American pension funds can buy its shares through their normal US brokerage accounts. The company agrees to file regular reports in line with US exchange rules.
Example
A Japanese electronics maker wants to raise fresh capital from US investors and sets up a Level III sponsored ADR. It sells new shares through the programme and uses the proceeds to build a plant in North America.
Example
A US asset manager with a mandate to hold only dollar-traded securities buys a sponsored ADR of a Brazilian bank. The manager gains exposure to Brazil without opening a local custody account.
Formula
Calculation
ADR price = local share price x shares per ADR x exchange rate (dollars per unit of local currency)
A European company's shares trade at 50 euros. Each ADR represents 2 shares, and 1 euro is worth $1.10. ADR price = 50 x 2 x 1.10 = $110. If the euro strengthens to $1.20 while the local share price stays at 50 euros, the ADR price becomes 50 x 2 x 1.20 = $120, a rise of about 9.1% caused purely by currency movement.Case study
Seen in the real world.
Eastgate Brewing is an illustrative, fictional foreign beverage company that decided to launch a sponsored ADR to widen its investor base. Its finance director compared the cost of a Level II listing, around $600,000 a year in fees and compliance, with the benefits of access to US capital.
The programme required quarterly reporting reconciled to US rules and an annual audit that met US standards. The team accepted this because US investors were willing to pay a higher valuation than local investors for the same earnings.
After the launch, trading volume doubled in the first year. The illustrative lesson is that a sponsored ADR is a long-term commitment to disclosure, so the company needs to budget for the work as well as the fees. Management also set up a US investor relations function, including roadshows twice a year, to make sure the new shareholders understood the business.
Watch out
Common mistakes.
- Assuming an ADR is priced exactly like the local share, when the ratio and exchange rate change the price.
- Ignoring currency risk, when a weakening local currency can reduce the ADR's dollar value even if the company performs well.
- Mixing up sponsored and unsponsored ADRs, when only the sponsored type involves the foreign company's agreement and reporting.
Questions
People also ask.
Who pays for a sponsored ADR programme?
The foreign company pays most of the set-up and running costs, although the depositary bank may also charge small fees to investors, often deducted from dividends.
Can anyone buy a sponsored ADR?
Yes, those on a US exchange can be bought through a normal brokerage account, while Level I ADRs trade over the counter and may be harder to trade in size.
What happens to the real shares?
The depositary bank holds them in custody and issues the receipts against them, so every ADR is backed by actual shares.
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