DEFINITION of Sponsored ADR
A sponsored ADR is an American depositary receipt (ADR) that a bank issues on behalf of a foreign company whose equity serves as the underlying asset. A sponsored ADR creates a legal relationship between the ADR and the foreign company, which absorbs the cost of issuing the security. Unsponsored ADRs can only trade on the over-the-counter market (OTC), while sponsored ADRs can be listed on major exchanges.
BREAKING DOWN Sponsored ADR
Foreign companies use ADRs in order to tap into capital markets abroad. Investors who may typically focus on domestically listed companies are given the opportunity to obtain returns from higher growth emerging markets, such as those in China or India. Despite being listed in America, a company using a sponsored ADR will still have its revenue and profit denominated in its home currency.
There are three levels of sponsored depository receipts. A Level I sponsored ADR can only be traded over-the-counter (OTC) and cannot be listed on a U.S. exchange, but is easier to set up for foreign companies, does not require the same disclosures, and does not require the company to abide by the generally accepted accounting principles GAAP. Level II sponsored ADRs can be listed on an exchange and are thus visible to a wider market, but require the company to comply with the SEC. Level III sponsored ADRs permit the company to issue shares to raise capital, but require the highest level of compliance and disclosure.
Sponsored ADR and Additional Means of Foreign Investing
Foreign investing can bring significant rewards but often at a higher risk. Distinct from portfolio investments in which an investor purchases equities of foreign-based companies, another form of foreign investing is foreign direct investing. This occurs when a company expands its operations into new and emerging economies. Foreign direct investing can take the form of opening new franchises or regional headquarters in a developing country, relying on a mix of local and expatriate employees. Companies may also open a subsidiary or associate company. This can involve acquiring a controlling interest in an existing foreign company, or merging or creating a joint venture with a foreign company.
In general, companies make foreign direct investments in more open economies that offer a skilled workforce and strong prospects for growth, without hindrances of intense regulations or political instability. In 2018, the Brookings Institute published “Competing in Afria: China, the European Union, and the United States,” which stated that the United States is the largest investor in the African continent with total FDI of $54 billion.