Everything You Need to Know About Trading ADRs

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The globalization of financial markets has made it possible for investors to be a part of nearly any type of publicly-traded company in the world. If you have a brokerage account where you can buy or sell stocks, you may already be trading American Depositary Receipts (ADRs) without even realizing it. While similar to stocks, there are some differences you’ll want to keep in mind to be a successful investor.

ADRs are a financial instrument that allow foreign companies’ stock to be traded in American markets. They can be traded like stocks through buying and selling and some even have options contracts available.

One key difference is the fact that an ADR is a certificate that represents a specified number of shares in the foreign company. This was done as a way of circumventing the complexities of dealing with foreign exchange costs that can fluctuate independently of stock prices. Because ADRs can represent differing amounts of stock depending on the underlying issuer, investors should look up what the value of an ADR is before buying it. Some ADRs are a simple 1-to-1 exchange, while other ADRs can represent a handful of shares.

Diving Into the World of ADRs

Investors typically won’t trade stocks with questionable practices or confusing financials, which is why ADRs are sponsored by U.S.-owned banks. These issuing organizations agree to offer ADRs on a foreign companies stock in exchange for the proper financial documentation. They also decide how to value the ADR relative to the company’s local currency. Because of the exchange rate, some foreign stocks may only be worth a few pennies in U.S. currency. The sponsoring bank will take this fact into consideration and price the ADR at an appropriate price to reflect its actual value.

ADR’s are issued in one of three ways: Level 1, Level 2 and Level 3. Level 1-issued ADR stocks aren’t required to disclose as much financial information as stocks on the other two levels and are generally issued to gauge U.S. interest in the company. Level 1 ADRs are very similar to stocks that trade on pink sheets and you should exercise extreme caution before investing.

Level 2 and Level 3 ADRs trade on recognized U.S. exchanges like the NYSE and the NASDAQ. These issues get more visibility and gain benefits, including being able to raise additional capital in exchange for more detailed financial disclosures to the sponsoring bank and stock exchange.

Investors interested in trading ADRs can find out more about them from BNY Mellon or JP Morgan. These two sites will give you detailed information, like how many shares of stock an ADR represents on a foreign stock.

If an ADR offers a dividend, there may be additional tax concerns investors should be aware of as well. Each country has different rules regarding dividend taxation that can completely eliminate any benefit you would otherwise receive.

Finally, remember: ADRs can be more complicated than U.S. stocks, making them fit only for investors who are able to put in the extra work before investing. Make sure you do your due diligence before incorporating ADRs into your investment portfolio.