For domestic investors, the benefits of increasing their investment exposure to foreign companies is becoming increasingly evident. The easiest way for an investor to do this is by buying shares in American Depositary Receipts (ADRs).
What Is an ADR?
An ADR is a financial product that is issued by a domestic depository bank and is traded on a domestic exchange, 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 sponsor ADRs in the United States. The biggest one being the Bank of New York Mellon (BNY) with State Street (STT) and JPMorgan Chase (JPM) not far behind. These depository banks help with the setup and operation of a company's depositary receipt program. Often, these banks will offer to provide issuing services to companies for free. This raises the question, what benefit is the bank receiving for providing such a service?
The Benefits of Issuing ADRs
When a depositary 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 ADRs can then be traded normally in the market as any other stock would trade.
If for some reason a depositary 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 that the depository bank receives occurs when 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 also may 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.