What it means
An American depositary receipt (ADR) is a certificate issued by a US bank that represents a number of shares in a company based abroad. The bank holds the actual shares in a custody account in the home country and issues the certificates against them.
Investors buy and sell the certificates in US dollars, which avoids opening a foreign brokerage account. In a sponsored ADR the foreign company agrees to the programme, signs a deposit agreement with a bank and usually helps to pay the costs.
In an unsponsored ADR a depositary bank sets up the programme on its own because it sees demand from US investors. The foreign company has no contract with the bank and may not even know about it.
Unsponsored ADRs trade over the counter, which means directly between dealers and not on a major exchange. They usually offer less information to investors, because the company has no duty to provide reports in the United States.
Different banks can also issue separate unsponsored programmes for the same company, which splits trading and can make prices harder to compare. Costs are passed on to holders.
The depositary typically charges small fees per certificate, taken from dividends or charged annually, and the holder carries currency risk because the underlying shares are priced in foreign currency. Dividends are paid in foreign currency and converted into dollars by the bank, which can create a difference between what the company declares and what the investor receives.
Finance professionals should understand the structure when valuing foreign investments. The price of an ADR follows the home-market share price, adjusted for the ratio of shares per certificate and the exchange rate.
Voting rights are also more limited than for sponsored programmes, because the bank, not the company, handles communications. A practical point for analysts is that data on unsponsored ADRs can be patchy.
Annual reports may be available only in the home language, and the company may not hold calls with US investors. Anyone relying on such a holding should read the home-market filings directly and treat the ADR price as a convenient wrapper around them.
In practice
Real-world examples.
Example
A US retail investor wants exposure to a Japanese electronics maker but does not want to open a foreign account. She buys an unsponsored ADR through her usual broker, which trades over the counter in dollars. She sees that the company publishes little English-language information.
Example
A fund manager comparing two programmes for the same Brazilian bank finds that each is issued by a different depositary. The ratios of shares per ADR differ, so the two prices are not directly comparable. He chooses the programme with greater trading volume.
Example
A foreign mining company discovers that a US bank has launched an unsponsored ADR on its shares. The company's finance director decides to convert it into a sponsored programme with its own bank. The change lets the company supply reports and handle shareholder communications directly.
Formula
Calculation
ADR price = home share price x shares per ADR x exchange rate (dollars per unit of foreign currency)
Suppose a European company's shares trade at EUR 20 each, and one ADR represents 2 shares. The exchange rate is $1.10 per EUR 1. ADR price = 20 x 2 x 1.10 = $44. If the depositary then charges an annual fee of $0.02 per ADR and the investor holds 1,000 ADRs, the fee is 1,000 x 0.02 = $20, which is deducted from dividends or billed separately.Case study
Seen in the real world.
Tasman Foods is an illustrative, fictional Australian dairy exporter. One year it noticed that a US bank had begun issuing unsponsored ADRs over its shares, and American investors had started to buy.
The investor relations manager worried because the company had no control over the information given to US holders. She also found that the dividend paid to the ADR holders was about 1% lower than expected after currency conversion and bank fees.
After a review the board decided to sponsor a programme with a single bank and pay for it. The illustrative lesson is that an unsponsored programme can raise a company's profile, but sponsoring one gives the company control over costs, information and shareholder relations.
Watch out
Common mistakes.
- Assuming that an unsponsored ADR has the company's approval, when the company may know nothing about it.
- Ignoring currency movements, when the dollar value of the ADR and its dividends moves with the foreign exchange rate.
- Comparing two ADR prices without checking the ratio of shares per ADR, which can differ between programmes.
Questions
People also ask.
Where do unsponsored ADRs trade?
They trade over the counter and not on a major US exchange, which usually means lower liquidity and wider spreads.
Who pays the fees?
Holders normally pay them, through deductions from dividends or separate annual charges, rather than the company.
Can an unsponsored ADR be turned into a sponsored one?
Yes, the company can sign a deposit agreement with a bank, and the existing programme is usually replaced or converted.
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