American Depositary Receipt
From Wikipedia, the free encyclopedia
An American Depositary Receipt (or ADR) represents the ownership in the shares of a foreign company trading on US financial markets. The stock of many non-US companies trades on US exchanges through the use of ADRs. ADRs enable US investors to buy shares in foreign companies without undertaking cross-border transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.
Each ADR is issued by a US depository bank and can represent a fraction of a share, a single share, or multiple shares of foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR is often close to the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares. In the case of companies incorporated in the United Kingdom, creation of ADRs attracts a 1.5% stamp duty reserve tax (SDRT) charge by the UK government.
Depository banks have numerous responsibilities to an ADR holder and to the non-US company the ADR represents. The first ADR was introduced by JPMorgan in 1927, for the British retailer Selfridges&Co. The largest depository bank is the Bank of New York Mellon.
Individual shares of a foreign corporation represented by an ADR are called American Depositary Shares (ADS).
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[edit] Types of ADR programs
When a company establishes an American Depository Receipt program, it must decide what exactly it wants out of the program and how much they are willing to commit. For this reason, there are different types of programs that a company can choose.
[edit] Unsponsored shares
- Unsponsored shares are a form of Level I ADRs that trade on the over-the-counter (OTC) market. These shares are issued in accordance with market demand. The foreign company has no formal agreement with a custodian bank and shares are often issued by more than one depositary. Each depositary handles only the shares it has issued.
- Due to a recent SEC rule change making it easier to issue Level I depositary receipts, both sponsored and unsponsored, hundreds of new ADRs have been issued since the rule went into effect in October 2008. The majority of these were unsponsored Level 1 ADRs, and now approximately half of all ADRs are unsponsored. The main SEC requirement for a depositary bank to issue a sponsored or unsponsored Level 1 ADR, is that the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile.
[edit] Level I
- Level 1 depository receipts are the lowest sponsored shares that can be issued. When a company issues sponsored shares, it has one designated depository acting as its transfer agent.
- A majority of American depository receipt programs currently trading are issued through a Level 1 program. This is the most convenient way for a foreign company to have its shares trade in the United States.
- Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile.
- Companies with shares trading under a Level 1 program may decide to upgrade their share to a Level 2 or Level 3 program for better exposure in the United States markets.
[edit] Level II (listed)
- Level 2 depository receipt programs are more complicated for a foreign company. When a foreign company wants to set up a Level 2 program, it must file a registration statement with the SEC and is under SEC regulation. In addition, the company is required to file a Form 20-F annually. Form 20-F is the basic equivalent of an annual report (Form 10-K) for a U.S. company. In their filings, the company is required to follow U.S. GAAP standards.
- The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX).
- While listed on these exchanges, the company must meet the exchange’s listing requirements. If it fails to do so, it will be delisted and forced to downgrade its ADR program.
[edit] Level III (offering)
- A Level 3 depository receipt program is the highest level a foreign company can have. Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies.
- Setting up a Level 3 program means that the foreign company is not only taking some of its shares from its home market and depositing them to be traded in the U.S.; it is actually issuing shares to raise capital. In accordance with this offering, the company is required to file a Form F-1, which is the format for an Offering Prospectus for the shares. They also must file a Form 20-F annually and must adhere to U.S. GAAP standards. In addition, any material information given to shareholders in the home market, must be filed with the SEC through Form 8K.
- Foreign companies with Level 3 programs will often issue materials that are more informative and are more accommodating to their U.S. shareholders because they rely on them for capital. Overall, foreign companies with a Level 3 program set up are the easiest on which to find information.
[edit] Restricted programs
- Foreign companies that want their stock to be limited to being traded by only certain individuals may set up a restricted program. There are two SEC rules that allow this type of issuance of shares in the U.S.: Rule 144-A and Regulation S. ADR programs operating under one of these 2 rules make up approximately 30% of all issued ADRs.
- 144-A
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- Some foreign companies will set up an ADR program under SEC Rule 144(a). This provision makes the issuance of shares a private placement. Shares of companies registered under Rule 144-A are restricted stock and may only be issued to or traded by Qualified Institutional Buyers (QIBs).
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- No regular shareholders will have anything to do with these shares and most are held exclusively through the Depository Trust & Clearing Corporation, so the public often has very little information on these companies.
- Regulation S
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- The other way to restrict the trading of depositary shares is to issue them under the terms of SEC Regulation S. This regulation means that the shares are not and will not be registered with any United States securities regulation authority.
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- Regulation S shares cannot be held or traded by any “U.S. Person” as defined by SEC Regulation S rules. The shares are registered and issued to offshore, non-US residents.
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- Regulation S shares can be merged into a Level 1 program after the restriction period has expired...
[edit] Sourcing ADRs
- One can either source new ADRs by depositing the corresponding domestic shares of the company with the depositary bank that administers the ADR program or, instead, one can obtain existing ADRs in the secondary market. The latter can be achieved either by purchasing the ADRs on a US stock exchange or via purchasing the underlying domestic shares of the company on their primary exchange and then swapping them for ADRs; these swaps are called crossbook swaps and on many occasions account for the bulk of ADR secondary trading. This is especially true in the case of trading in ADRs of UK companies where creation of new ADRs attracts a 1.5% stamp duty reserve tax (SDRT) charge by the UK government; sourcing existing ADRs in the secondary market (either via crossbook swaps or on exchange) instead is not subject to SDRT.
[edit] ADR Termination
- Most ADRs are subject to termination. Termination of the ADR agreement will result in cancellation of all the depository receipts, and a subsequent delisting from all exchanges where they trade. The termination can be at the discretion of the foreign issuer or the depository bank, but is typically at the request of the issuer. There may be a number of reasons why ADRs terminate, but in most cases the foreign issuer is undergoing some type of reorganization or merger.
- Owners of ADRs are typically notified in writing at least thirty days prior to the termination. Once notified, an owner can surrender their ADRs and take delivery of the foreign securities represented by the Receipt, or do nothing. If an ADR holder elects to take possession of the underlying foreign shares, there is no guarantee the shares will trade on any US exchange. The holder of the foreign shares would have to find a broker who has trading authority in the foreign market where those shares trade. If the owner continues to hold the ADR past the effective date of termination, the depository bank will continue to hold the foreign deposited securities and collect dividends, but will cease distributions to ADR owners.
- Usually one year after the effective date of the termination, the depository bank will liquidate any remaining foreign shares they hold. The proceeds, as well as other associated cash will be held at the depository bank as a credit. The ADR owner can collect their portion of the proceeds by surrendering their ADRs to the bank.
- Owners of ADRs who hold their positions in “street name” with a brokerage will usually be notified in a similar manner stated above. If no response is heard from the client, the brokerage will most likely surrender their ADRs to the depository bank for liquidation after one year from the termination date, and allocate the proceeds to those respective clients. Many US brokerages can continue to hold foreign stock, but lack the ability to trade it overseas.
