What Is a 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. ADRs are a simple way for American investors to add international companies' stock to their portfolio.

Key Takeaways:

  • Banks issue sponsored ADRs on behalf of a foreign company whose equity serves as the underlying asset.
  • A sponsored ADR is a legal relationship between the ADR and the foreign company whereby the foreign company is responsible for the cost of issuing the security.
  • Sponsored ADRs are listed on major exchanges while unsponsored ADRs can only trade on the over-the-counter (OTC) market.

Understanding Sponsored ADRs

Foreign companies use ADRs to tap into foreign capital markets. 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 depositary receipts. A Level I sponsored ADR can only be traded over-the-counter (OTC) and cannot be listed on a U.S. exchange. However, this type of ADR is easier to set up for foreign companies, does not require the same disclosures, and does not require the company to abide by GAAP's generally accepted accounting principles. Thus, there is less information available for these securities.

Level II sponsored ADRs can be listed on an exchange and are thus visible to a wider market. Level II ADRs, however, 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 ADRs 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 foreign-based equities, another form of foreign investing is foreign direct investing (FDI). This occurs when a company expands its operations into new and emerging economies. FDI can take the form of opening new franchises or regional headquarters in a developing country and 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 engage in FDI in more open economies that offer a skilled workforce and strong prospects for growth, fewer regulations, and less political instability. In 2018, the Brookings Institute published “Competing in Africa: China, the European Union, and the United States,” which stated that the United States is the largest investor in the African continent with a total FDI of $54 billion.