Table of Contents
- What Are American Depositary Shares?
- ADS vs. ADR: Clearing Up the Terms
- Understanding How ADS Work
- What Is an American Depositary Receipt?
- Benefits of ADSs
- Downsides of ADSs
- Examples of ADSs
- Differences Between ADS and ADR
- What Are F Shares?
- Is Arbitrage Trading Possible With ADSs?
- What Are Depositary Banks?
- The Bottom Line
What Are American Depositary Shares?
Let me explain what an American Depositary Share is: it's an equity stake in a non-U.S. company that's held by a U.S. bank, and you as a U.S. investor can buy it directly.
If you're looking to invest in foreign companies without dealing with the hassle of international exchanges, American Depositary Shares (ADS) are your go-to option. These are securities issued by U.S. banks, each representing a specific number of shares in a foreign company, and they trade on U.S. stock exchanges just like any domestic stock.
ADS vs. ADR: Clearing Up the Terms
You might hear ADS and ADR used interchangeably, but technically, ADS refers to the individual shares of the foreign company held by the depositary bank, while ADR is the physical certificate issued by that bank.
An ADR is a negotiable certificate from a U.S. bank under agreement with a foreign company—it's proof of ownership of ADSs, much like a stock certificate shows you own equity shares.
Key Takeaways on ADS
- ADS are shares in foreign companies held by U.S. depositary banks and traded on major U.S. exchanges.
- The terms ADS and ADR are often swapped in conversation.
- ADSs give foreign companies access to a wider investor base and U.S. financial markets.
- The primary downside is currency risk, even though they're denominated in U.S. dollars.
Understanding How ADS Work
ADSs are designed to make share trading straightforward for you. Depending on the foreign company's compliance with U.S. regulations, they can trade over-the-counter (OTC) or on major exchanges like the NYSE or Nasdaq. If listed on a major exchange, the company usually has to report at the level of domestic firms and follow GAAP.
What Is an American Depositary Receipt?
An American Depositary Receipt (ADR) is a tool non-U.S. companies use to offer their shares to American investors and raise capital here. It lets you invest in foreign companies without navigating foreign exchanges, currencies, or trading rules.
These are issued by U.S. depositary banks and represent a set number of shares in the foreign company's stock. Dividends start in the local currency but get converted to U.S. dollars by the bank, making things easier for you.
There are two types: sponsored ADRs, which have the foreign company's backing and a formal agreement with the bank, usually listed on major U.S. exchanges; and unsponsored ADRs, set up without the company's involvement, typically trading OTC. Sponsored ones are SEC-regulated, often requiring U.S. GAAP financial statements or reconciliations.
Benefits of ADSs
For foreign companies, offering shares via ADSs means reaching a broader investor pool, which can cut capital-raising costs. As a U.S. investor, you get to buy into foreign firms without handling currency conversions or cross-border paperwork.
Downsides of ADSs
You still face currency risk with ADSs—exchange rate changes between the U.S. dollar and the foreign currency can impact share prices and dividend payouts, which need conversion to dollars.
Dividend taxes are another issue. Most countries withhold taxes on ADR dividends; for instance, Chile and Switzerland take 35%, and France might withhold up to 75% for certain cases. This is on top of U.S. dividend taxes, but you can claim a foreign tax credit using Form 1116 to offset it.
Examples of ADSs
Often, a single ADS stands for more than one share of the foreign company's common stock. ADSs can also gap up or down outside U.S. trading hours when the home market is active and U.S. ones are closed.
Take Taiwan Semiconductor Manufacturing Company Limited (TSM)—it has ADSs in the U.S., and in 2024, its chart showed gaps, with green boxes for upward gaps and red for downward ones.
Differences Between ADS and ADR
ADSs and ADRs are linked instruments that simplify trading foreign shares on U.S. exchanges. Here's how they differ: An ADS is the actual share of the foreign company held by the depositary bank, while an ADR is the negotiable certificate representing a number of those shares. You trade ADRs on U.S. exchanges, which represent ownership of ADSs, and ultimately the foreign shares. The ADS enables the foreign stock to trade in the U.S., forming the basis for ADRs.
What Are F Shares?
F shares are foreign company shares traded directly on U.S. exchanges without ADRs, marked with an 'F' in their ticker symbol to show they're foreign.
Is Arbitrage Trading Possible With ADSs?
Arbitrage with ADSs happens due to market inefficiencies, exchange rates, and liquidity differences, but it's tough because of transaction costs, market risks, and complexities in cross-market trading.
What Are Depositary Banks?
Depositary banks handle the issuance and management of ADSs and ADRs, connecting U.S. investors to foreign companies. Key players include JPMorgan Chase & Co. (JPM), Citigroup (C), Bank of New York Mellon (BK), and Deutsche Bank (DB).
The Bottom Line
In summary, ADSs are U.S. dollar-denominated equity shares of foreign companies available on American exchanges. A U.S. depositary bank issues them, representing a set number of the foreign shares, with the bank setting the ratio. This setup lets you access foreign stocks without trading overseas. An ADR, meanwhile, is the certificate from the bank representing those ADSs.
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