ADRs - How to Invest in Foreign Companies
American Depositary Receipts allow investors to buy shares of foreign companies on U.S. exchanges, priced in U.S. dollars, and settled through the standard U.S. clearing system. Without ADRs, investing in Toyota, Alibaba, or Nestlé would require opening a brokerage account with access to the Tokyo, Hong Kong, or Swiss stock exchanges, transacting in foreign currencies, and navigating unfamiliar settlement and tax systems. ADRs eliminate that friction by packaging a foreign company's shares into a U.S.-listed security.
More than 2,000 companies from over 70 countries have ADR programs in the United States. Some of the largest companies in the world by market capitalization, including Taiwan Semiconductor Manufacturing Company (TSM), ASML Holding (ASML), and Samsung Electronics, are accessible to U.S. investors primarily through ADRs.
How ADRs Are Created
The ADR mechanism begins with a depositary bank, typically JPMorgan, Bank of New York Mellon, Citibank, or Deutsche Bank. The depositary bank purchases shares of the foreign company on the company's home exchange and holds them in a custodian account in the home country. It then issues ADR certificates representing those shares, and these certificates trade on a U.S. exchange or in the over-the-counter (OTC) market.
One ADR does not always equal one share of the foreign company. The ratio is set to produce a share price that falls within a range comfortable for U.S. investors, typically between $20 and $100. If a Japanese company's shares trade at 3,000 yen (roughly $20), the ADR might represent one share. If a Swiss company's shares trade at 400 Swiss francs (roughly $450), the ADR might represent one-tenth of a share, producing a U.S. price around $45.
The depositary bank charges fees for creating and maintaining ADRs. These fees are typically $0.01 to $0.05 per share per year, deducted from dividend payments. The fee is disclosed in the ADR's SEC filings but is not always visible on a brokerage statement.
Three Levels of ADRs
The SEC categorizes ADRs into three levels based on the degree of regulatory compliance and listing status.
Level I (OTC-traded). These ADRs trade on the over-the-counter market, not on a major exchange. The foreign company files minimal paperwork with the SEC (Form F-6) and is exempt from full SEC reporting requirements. Level I ADRs cannot be used to raise capital in the United States. They are the simplest and cheapest form of ADR for the foreign company, but they are the least liquid for investors. Prices are displayed on the OTC Pink Sheets or the OTC Bulletin Board.
Many large international companies maintain Level I ADR programs. The shares are accessible to U.S. investors, but without the full transparency and liquidity that comes with an exchange listing.
Level II (Exchange-listed). These ADRs trade on the NYSE, Nasdaq, or NYSE American (formerly AMEX). The foreign company must register with the SEC (Form 20-F) and comply with U.S. reporting standards, including annual reports that reconcile the company's home-country accounting standards with U.S. GAAP or IFRS. Level II ADRs cannot be used to raise new capital; they represent existing shares only.
Level II ADRs offer the best combination of liquidity and transparency for investors. Companies like Toyota (TM), Sony (SONY), and Novartis (NVS) have Level II programs.
Level III (Exchange-listed with capital raising). These ADRs also trade on a major U.S. exchange and require full SEC registration, but they allow the foreign company to raise capital by issuing new shares in the U.S. market. The company files a registration statement (Form F-1 or F-3) in addition to ongoing reporting requirements. Level III ADRs are the most burdensome for the company but provide access to the world's deepest capital market.
Alibaba's NYSE listing in 2014, which raised $25 billion in the largest IPO in history at that time, was conducted through Level III ADRs.
Unsponsored ADRs
In addition to the three sponsored levels, unsponsored ADRs exist. These are created by depositary banks without the participation or approval of the foreign company. Multiple banks can create unsponsored ADRs for the same company, sometimes leading to multiple ADR programs for a single foreign firm.
Unsponsored ADRs trade on the OTC market and are not subject to the same information requirements as sponsored ADRs. The foreign company has no obligation to provide information to U.S. investors or to cooperate with the depositary bank. For investors, this means less reliable information flow and potentially higher costs.
The SEC has periodically tightened rules around unsponsored ADRs. In 2008, it allowed depositary banks to establish unsponsored ADR programs without SEC approval, which led to a surge in new programs. Some of these were later delisted or deregistered as the foreign companies objected to having their shares traded in the U.S. without their involvement.
Currency Risk
ADRs are priced and traded in U.S. dollars, but the underlying shares are denominated in the foreign company's home currency. This creates currency risk that many ADR investors underestimate.
If an investor buys ADRs of a German company and the euro weakens 10% against the dollar over the holding period, the ADR price will decline approximately 10% even if the stock price on the Frankfurt exchange is unchanged. The reverse also applies: a strengthening euro boosts ADR returns.
The math is straightforward. An ADR's U.S. dollar price equals the foreign share price multiplied by the exchange rate (adjusted for the ADR ratio). If the foreign share price rises 15% but the foreign currency falls 10%, the ADR return is approximately 3.5% (1.15 x 0.90 = 1.035).
Currency risk can be significant over long holding periods. The U.S. dollar appreciated roughly 25% against the Japanese yen from 2021 to early 2024. An investor holding Japanese ADRs during this period had returns reduced by roughly 25% compared to a Japanese investor holding the same shares in yen.
Some investors hedge currency risk using forward contracts or currency ETFs. Others accept the risk as part of the diversification benefit of owning foreign assets, since currency movements are not consistently correlated with equity returns.
Tax Implications
ADRs introduce tax considerations that do not apply to domestic stocks.
Foreign tax withholding. Many countries withhold taxes on dividends paid to foreign investors. When a German company pays a dividend, Germany withholds approximately 26.375% of the dividend before it reaches the ADR holder. The withheld amount varies by country: Japan withholds 15%, the United Kingdom withholds 0%, and France withholds 30% (though tax treaties may reduce these rates).
Foreign tax credit. U.S. taxpayers can claim a foreign tax credit on their U.S. tax return for the amount withheld by the foreign government, avoiding double taxation. The credit is claimed on IRS Form 1116. The calculation can be complex for investors holding ADRs from multiple countries, and the credit is subject to limitations based on the investor's overall foreign-source income.
Tax treaty benefits. The United States has tax treaties with many countries that reduce withholding rates below the statutory level. The depositary bank may automatically apply the reduced treaty rate, or the investor may need to file paperwork with the foreign tax authority to claim the lower rate. Treaty rates are typically 15% for dividends, compared to statutory rates that can be 30% or higher.
Holding in retirement accounts. When ADRs are held in IRAs or 401(k)s, foreign taxes are still withheld on dividends, but the investor cannot claim the foreign tax credit because U.S. taxes are not owed on the income within the account. This means the foreign withholding represents a permanent, unrecoverable tax reduction on dividends. For this reason, ADRs from high-withholding countries (Germany, France, Switzerland) may be less tax-efficient in retirement accounts than in taxable accounts.
ADRs and Chinese Companies: The VIE Structure
A substantial number of ADRs represent Chinese companies, including Alibaba, JD.com, Baidu, and NIO. These companies are structured as variable interest entities (VIEs), which adds a layer of risk not present in most other ADRs.
Chinese law restricts or prohibits foreign ownership in certain industries, including technology and media. To circumvent these restrictions, Chinese companies create a VIE structure. The company that investors actually own (through ADRs) is a shell corporation registered in the Cayman Islands or another offshore jurisdiction. This shell company holds contractual agreements with the operating company in China, which runs the actual business. The ADR holder does not own equity in the Chinese operating company; they own equity in a Cayman Islands entity that has contractual rights.
The risk is that the Chinese government could decide to invalidate these contractual arrangements, which would leave ADR holders with a claim on a shell company with no operating assets. This risk increased in visibility during 2021-2022 when China's regulatory crackdowns on technology companies caused Chinese ADRs to lose hundreds of billions in market value.
The SEC has also increased scrutiny of Chinese ADRs under the Holding Foreign Companies Accountable Act (HFCAA), which requires that foreign companies listed in the U.S. allow the Public Company Accounting Oversight Board (PCAOB) to inspect their audit workpapers. Chinese companies had resisted this requirement for years, but a 2022 agreement between U.S. and Chinese regulators allowed PCAOB inspections to proceed, reducing the immediate delisting risk.
ADRs as a Research Tool
Even investors who never buy ADRs can benefit from understanding them. ADR price movements provide a real-time, dollar-denominated signal about how the global market is valuing major international companies. When Asian markets close and the U.S. market opens, ADRs of Japanese, Korean, and Chinese companies begin trading and reflect the latest U.S. investor sentiment toward those companies.
Analyzing ADR premiums and discounts relative to the home-market share price also reveals information about capital flows, investor sentiment, and currency expectations. A persistent premium on a Chinese ADR relative to its Hong Kong-listed shares might indicate that U.S. investors value the stock more highly, or that barriers to arbitrage (capital controls, trading restrictions) prevent the prices from converging.
ADRs have been a feature of U.S. markets since 1927, when JPMorgan created the first ADR for the British retailer Selfridges. Nearly a century later, they remain the primary mechanism through which U.S. investors access foreign equities, with all the benefits of familiar infrastructure and all the additional risks of cross-border ownership.
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