How does a depository bank benefit from issuing an ADR for a foreign company for free?

A:

For domestic investors the benefits of increasing the portion of their portfolio that they invest in foreign companies is becoming clearer, and clearer. The easiest way for an investor to do this is by investing in American Depository Receipts (ADRs). An ADR is a financial product that is issued by a domestic depository bank and is traded on the domestic exchanges such as the New York Stock Exchange (NYSE) and the Nasdaq. ADRs represent shares in a foreign company, but they eliminate the need for investors to purchase those shares in the company's local market and in that market's currency.

There are many depository banks that issue ADRs in the United States. The biggest one being the Bank of New York. These depository banks help with the setup and operation of a company's depository receipt program. These banks often will offer to provide these issuing services to companies for free. This raises the question, what benefit is the bank receiving for providing such a service?

When a depository receipt is issued by a depository bank, the bank has actually purchased the equivalent amount of shares in the local market. Those shares are held by a local custodian bank for the depository bank. The depository receipts can then be traded normally in the American market as any other stock would trade. If for some reason a depository receipt is canceled, it is no longer traded in the American market. The ADRs are returned to the depository bank and the shares held by the local custodian are released back into the local market.

Although the depository banks must do a lot to issue a new ADR, they receive no real benefit from the foreign company. The benefit the depository bank receives occurs whe the ADR is ultimately sold into the market. The depository bank receives a commission on the trade, just like any other trade. Often times depository banks will also deduct their fees from dividends that investors are to receive. They may also pass on expenses related to currency conversion to investors. It is through these fees and expenses that they charge to investors that depository banks benefit from issuing ADRs.

To learn more, see What Are Depository Receipts, American Depository Receipt Basics, and Investing Beyond Your Borders.

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