American Depositary Receipt

First created in 1927 by J.P. Morgan for the British retailer Selfridges, which was listed on the New York Curb Exchange — the precursor to the American Stock Exchange — American Depositary Receipts have grown into the primary mechanism through which tens of millions of American investors access the equity of companies as geographically and structurally diverse as Taiwan Semiconductor Manufacturing Company, Nestlé, Alibaba, BP, Toyota, and Samsung. 

The regulatory framework governing American Depositary Receipts spans the Securities Act of 1933, the Securities Exchange Act of 1934, SEC Form F-6, Form 20-F, SEC Rule 12g3-2(b), and a comprehensive body of disclosure and investor protection obligations that vary significantly across the three levels of sponsored program. 

This entry examines the precise mechanics of how American Depositary Receipts are created, the distinction between sponsored and unsponsored programs, the three levels of sponsored programs and their regulatory requirements, the ADR ratio and its relationship to pricing, currency risk and dividend withholding tax, the role of the depositary bank, the specific risks that distinguish American Depositary Receipts from domestic equity investments, and the examination-critical distinctions that appear throughout the SIE, Series 7, and Series 65 curricula.

Definition and Overview

An American Depositary Receipt is a certificate issued by a United States depositary bank that represents ownership of foreign ordinary shares held in custody by that bank or its appointed agent in the company's home country. 

The depositary receipt itself trades on United States markets as if it were a domestic stock — quoted in dollars, settled in the standard United States T-plus-one settlement cycle, and accessible through any domestic brokerage account — while the underlying foreign shares are held abroad by the custodian on behalf of the depositary.

The fundamental purpose of the American Depositary Receipt is to remove the practical barriers that historically prevented American investors from accessing foreign equity markets. Before their introduction, an investor wishing to purchase shares of a foreign company would need to open a foreign brokerage account, transact in a foreign currency, navigate foreign settlement systems and local securities laws, arrange for currency conversion of any dividends received, and in many cases obtain and read financial statements prepared under foreign accounting standards in a foreign language. 

The American Depositary Receipt structure eliminates all of these friction points by interposing a United States depositary bank that handles all of the cross-border mechanics while the investor interacts only with the familiar domestic market infrastructure.

The Mechanics of Creation

American Depositary Receipts are created through a defined process involving a broker, a foreign custodian, and a United States depositary bank. 

A broker purchases the underlying ordinary shares of the foreign company on its home stock exchange — paying in the local currency and completing settlement under local market rules. 

The broker then delivers those shares to the depositary bank's appointed custodian in the foreign country. 

The foreign custodian holds the ordinary shares on behalf of the depositary and notifies the depositary that the shares have been received. 

The United States depositary bank then issues American Depositary Receipts representing those underlying shares to the broker, which are delivered to the original investor or sold in the United States market.

The three major United States depositary banks that dominate the American Depositary Receipt market are Bank of New York Mellon, JPMorgan Chase, and Citibank. 

Each maintains an extensive global network of custodians and correspondent relationships that enable them to hold foreign shares in local markets, receive local dividends, exercise or collect on corporate actions, and perform the currency conversion and communication functions that American Depositary Receipt holders depend upon.

The cancellation process operates in reverse. An investor wishing to exchange American Depositary Receipts for the underlying ordinary shares notifies the depositary, which instructs the foreign custodian to release the corresponding ordinary shares for delivery to the investor's foreign account. The American Depositary Receipts are then cancelled.

The ADR Ratio

The ADR ratio is the fixed relationship between the number of American Depositary Receipts and the number of underlying foreign ordinary shares they represent. The ratio may be expressed as one-to-one, where one American Depositary Receipt represents exactly one ordinary share, as many-to-one, where one American Depositary Receipt represents multiple ordinary shares, or as a fraction, where one American Depositary Receipt represents a fraction of an ordinary share.

The ratio is deliberately set to produce a convenient trading price in United States dollars — typically in the range of ten to one hundred dollars per American Depositary Receipt — regardless of the price of the underlying share in the foreign market. A Japanese company whose ordinary shares trade at approximately ten thousand yen each might establish an American Depositary Receipt ratio of one-to-one hundred, meaning each American Depositary Receipt represents one hundred underlying shares, producing an American Depositary Receipt price of roughly sixty-five to seventy dollars at a typical dollar-yen exchange rate. A Swiss company whose shares trade at several hundred Swiss francs each might use a one-to-five ratio, issuing one American Depositary Receipt for every five underlying shares, to produce a dollar price that falls within the conventional trading range.

The price of an American Depositary Receipt tracks the price of the underlying foreign share adjusted for the ratio and the prevailing exchange rate. If the underlying share in the home market rises in local currency terms, the American Depositary Receipt price in dollars will rise by the same proportion, all else equal. If the home currency appreciates against the dollar, the American Depositary Receipt price rises even without movement in the local share price, because the underlying asset is worth more dollars when the foreign currency is stronger. The interaction between the local share price and the exchange rate means that American Depositary Receipt holders are exposed to both the equity performance of the foreign company and the currency performance of the foreign country.

Sponsored Versus Unsponsored American Depositary Receipts

The most fundamental structural distinction in the American Depositary Receipt universe is between sponsored programs, which involve a formal agreement between the foreign company and the depositary bank, and unsponsored programs, which are created by depositary banks without the cooperation or formal involvement of the foreign company whose shares they represent.

Unsponsored American Depositary Receipts

Unsponsored American Depositary Receipts are created by a depositary bank — or multiple depositary banks, since there is no exclusivity requirement — typically in response to market demand from American investors for exposure to a particular foreign company, without any formal agreement with or participation by the foreign company itself. The foreign company plays no role in establishing the facility, bears no costs associated with it, and is under no obligation to communicate with American Depositary Receipt holders or facilitate their exercise of shareholder rights.

An unsponsored American Depositary Receipt facility may be established only if the foreign company is either subject to the reporting requirements of the Securities Exchange Act of 1934 or is exempt from those requirements under SEC Rule 12g3-2(b). Rule 12g3-2(b) provides an exemption from Exchange Act registration for foreign private issuers that furnish to the SEC in English the information that they disclose in their home country — effectively making publicly available in the United States the same disclosure that home country investors receive, without requiring full SEC registration and reporting compliance.

Unsponsored American Depositary Receipts are quoted and traded only on the over-the-counter markets — they cannot be listed on national securities exchanges including the New York Stock Exchange or Nasdaq. They typically carry less investor protection than sponsored programs because the foreign company is not formally party to the depositary arrangement and may not forward shareholder communications, exercise notices, voting materials, or corporate action notices to the depositary for transmission to holders. Unsponsored American Depositary Receipt holders generally bear all costs of the facility and may not receive the voting rights and corporate communication benefits available under sponsored programs.

Sponsored Level One American Depositary Receipts

Level One is the lowest level of sponsored American Depositary Receipt program and requires the least regulatory compliance from the foreign company. The foreign company enters into a deposit agreement with a single designated depositary bank, which is then exclusively responsible for the American Depositary Receipt facility. The depositary registers the American Depositary Receipts with the SEC by filing Form F-6 — the simplified registration statement specific to American Depositary Receipts that covers the terms of the deposit agreement and the form of the American Depositary Receipt certificate but does not require substantive disclosure about the foreign company's business, financial condition, or management.

Form F-6 contains no information about the issuer itself beyond the contractual terms of the deposit arrangement. The foreign company need not comply with United States GAAP reporting requirements or file annual reports with the SEC — it relies on the Rule 12g3-2(b) exemption to satisfy the underlying reporting requirement for the depositary receipt facility.

Level One American Depositary Receipts are traded over-the-counter and cannot be listed on national securities exchanges. They are used to establish a market presence in the United States without the compliance costs and reporting obligations required for exchange listing, making them attractive to foreign companies that wish to build investor awareness among American institutional and retail investors without committing to full SEC reporting.

Sponsored Level Two American Depositary Receipts

Level Two sponsored American Depositary Receipt programs allow exchange listing — the American Depositary Receipts may trade on the New York Stock Exchange, Nasdaq, or other national securities exchanges — but do not permit the foreign company to raise new capital through a public offering in the United States.

In addition to the Form F-6 filing required for all American Depositary Receipt programs, Level Two programs require the foreign company to file a full registration statement on Form 20-F under the Securities Exchange Act of 1934. Form 20-F is the comprehensive annual disclosure document required of foreign private issuers registered under the Exchange Act and is the foreign company equivalent of the United States Form 10-K annual report — covering the company's business, financial condition, results of operations, risk factors, corporate governance, and significant corporate relationships in detail. The financial statements included in Form 20-F must be prepared in accordance with United States GAAP or with International Financial Reporting Standards as published by the International Accounting Standards Board, or alternatively in accordance with home country accounting standards with a quantified reconciliation to United States GAAP.

Once registered under the Exchange Act through Form 20-F, the foreign company becomes subject to ongoing periodic reporting obligations including annual Form 20-F filings, interim report filings on Form 6-K for material developments, and compliance with SEC disclosure rules applicable to registered issuers.

Sponsored Level Three American Depositary Receipts

Level Three represents the highest level of sponsored American Depositary Receipt program and is the only type that permits the foreign company to raise new capital through a public offering of American Depositary Receipts in the United States. A Level Three program involves a public offering of securities and therefore requires registration under the Securities Act of 1933 — the statute governing the initial public offering of securities to the investing public — in addition to the Securities Exchange Act of 1934 registration required for Level Two programs.

The Securities Act registration for a Level Three offering uses Form F-1 for initial public offerings or Form F-3 for shelf registration statements, which require substantially the same disclosure as Form 20-F regarding the company's business, financials, and risk factors, but with the additional prospectus requirements applicable to a public offering. The depositary simultaneously registers the American Depositary Receipts themselves on Form F-6. The foreign company must comply with the same ongoing periodic reporting obligations as a Level Two program and is subject to the liability provisions of the Securities Act for material misstatements and omissions in the offering documents.

Level Three programs are used by foreign companies seeking to tap the deep United States equity capital markets for growth financing, acquisitions, or general corporate purposes, accessing the world's largest pool of institutional and retail investor capital in exchange for full compliance with the SEC's comprehensive disclosure framework.

The Role of the Depositary Bank

The depositary bank occupies the central operational position in the American Depositary Receipt structure, serving simultaneously as issuer of the receipt certificates, custodian of the underlying shareholder relationship, currency converter, dividend distributor, and communications intermediary between the foreign company and American investors.

When the foreign company pays a dividend in its home currency, the depositary bank's foreign custodian receives the dividend in local currency, deducts any applicable foreign withholding tax required by the issuer's home country, and converts the remaining amount into United States dollars at the prevailing exchange rate. The depositary bank then distributes the dollar-denominated dividend to American Depositary Receipt holders, deducting its depositary service fee — typically one to three cents per American Depositary Receipt, which is usually subtracted directly from the dividend payment rather than charged separately.

In addition to dividend processing, the depositary bank receives and forwards corporate communications including annual reports, proxy materials, and notices of extraordinary corporate actions such as rights offerings, stock splits, and mergers. For sponsored programs, the depositary is contractually obligated to make reasonable efforts to forward these communications. For unsponsored programs, no such obligation exists.

Currency Risk — A Critical Concept

While American Depositary Receipts trade in dollars, settle in dollars, and pay dividends in dollars, they remain fundamentally exposed to foreign currency risk — a distinction that is frequently tested on securities licensing examinations and is among the most important concepts for investor communication.

The value of an American Depositary Receipt in dollars is at all times a function of both the value of the underlying shares in the home currency and the exchange rate between the home currency and the United States dollar. When the home currency weakens against the dollar, American Depositary Receipt prices fall in dollar terms even if the underlying share price in local currency is unchanged, because the underlying asset is worth fewer dollars when converted at the weaker exchange rate. When the home currency strengthens, American Depositary Receipt prices rise in dollar terms even without any change in the local share price.

The currency risk applies to dividends as well as price appreciation. A Japanese company that declares a dividend of one hundred yen per share will produce a smaller dollar dividend for American Depositary Receipt holders when the yen is weak against the dollar and a larger dollar dividend when the yen is strong, regardless of any change in the company's dividend policy. A registered representative explaining American Depositary Receipts to a client must make clear that the dollar-denominated presentation does not eliminate the currency exposure — it merely converts it into an implicit risk rather than a visible one.

Foreign Dividend Withholding Tax

Foreign governments typically impose withholding taxes on dividends paid to non-resident shareholders, deducting a specified percentage of the gross dividend before distribution. Withholding rates vary by country and are often reduced by tax treaties between the United States and the issuer's home country. Typical withholding rates range from fifteen percent for countries with favourable tax treaties with the United States — including Germany, the United Kingdom, and Japan — to thirty percent for countries without comprehensive tax treaty arrangements.

American investors who receive dividends from American Depositary Receipts and have had foreign taxes withheld may claim a foreign tax credit on their United States tax return, reducing their United States tax liability by the amount of foreign tax paid, subject to certain limitations. The depositary bank typically reports the gross dividend, the amount of foreign tax withheld, and the net dollar amount distributed to each holder on Form 1099-DIV, providing the information needed to claim the foreign tax credit. The interaction between foreign withholding tax and the foreign tax credit means that the effective after-tax cost of the withholding is reduced for most American investors, though not entirely eliminated.

Additional Risks of American Depositary Receipt Investment

Beyond currency risk and foreign dividend withholding tax, American Depositary Receipts carry several additional risk categories that distinguish them from equivalent domestic equity investments and require disclosure and explanation to clients.

Political and country risk encompasses the possibility that political instability, changes in government, shifts in regulatory policy, nationalisation of industry, or restrictions on capital flows in the issuer's home country could adversely affect the value of the underlying foreign shares or the ability of the depositary to convert dividends and repatriate capital to American investors. Countries with less established rule of law, higher corruption indices, or histories of expropriation carry higher political risk premiums that should be reflected in the price of American Depositary Receipts from those jurisdictions.

Information risk arises from the possibility that disclosure standards in the issuer's home country may be less comprehensive, less reliable, or less timely than the standards applicable to United States domestic issuers under the Securities Exchange Act and GAAP. Level One and unsponsored American Depositary Receipt holders in particular may receive less information about the underlying company than holders of Level Two and Level Three programs, where full Form 20-F disclosure applies.

Liquidity risk may be greater for American Depositary Receipts — particularly Level One and unsponsored programs traded over-the-counter — than for comparable domestic equities with similar market capitalisation, because the American Depositary Receipt market is typically smaller than the home market and the over-the-counter trading mechanism provides less price transparency and potentially wider bid-ask spreads than exchange-listed markets.

Depositary fees, while individually small, represent an ongoing cost of holding American Depositary Receipts that does not apply to domestic equity investments. These fees — typically one to three cents per American Depositary Receipt per year, usually deducted from dividend payments — reduce the effective dividend yield and over long holding periods represent a meaningful drag on total return.

Program termination risk is a feature specific to American Depositary Receipts — the foreign company or the depositary bank may terminate the American Depositary Receipt program under the terms of the deposit agreement, requiring holders to either convert their American Depositary Receipts into the underlying foreign ordinary shares or sell their receipts in the market before termination. Termination of a sponsored program often requires advance notice — typically at least thirty days — to allow holders to make alternative arrangements, but may be disruptive and could require holders to establish foreign accounts to receive and hold the underlying ordinary shares.

American Depositary Receipts Versus Global Depositary Receipts

American Depositary Receipts are the United States-specific form of a broader category of instruments called depositary receipts, through which foreign equity is made accessible in non-home markets. Global Depositary Receipts operate on the same structural principles but are typically listed on non-United States markets — most commonly the London Stock Exchange or Luxembourg Stock Exchange — and are denominated in dollars or euros rather than the home currency. Global Depositary Receipts allow foreign companies to raise capital from European and international institutional investors using a similar mechanism. The two instruments are economically equivalent in structure but differ in their listing venue, applicable regulatory framework, investor base, and currency of denomination.

Examination Relevance and Key Takeaways

American Depositary Receipts are tested on the SIE, Series 7, and Series 65 examinations in the context of foreign equity investment, international diversification, currency risk, SEC registration requirements, and the distinction between different levels of sponsored programs. Candidates must understand the mechanics of American Depositary Receipt creation and cancellation, the difference between sponsored and unsponsored programs, the three levels of sponsored programs and their respective regulatory requirements including Form F-6 for all programs, Form 20-F for Level Two and Three, and capital raising capability exclusively at Level Three, currency risk as a persistent characteristic of all American Depositary Receipts regardless of dollar denomination, and foreign dividend withholding tax as a cost that can partially be offset through the foreign tax credit.

The core points to retain are these: an American Depositary Receipt is a certificate issued by a United States depositary bank representing a fixed number of foreign ordinary shares held by a custodian in the issuer's home country, first created by J.P. Morgan in 1927 for British retailer Selfridges, and today administered primarily by Bank of New York Mellon, JPMorgan, and Citibank; the ADR ratio — which may be one-to-one, many-to-one, or fractional — is set to produce a convenient dollar trading price and defines the relationship between the receipt price and the underlying share price converted at the prevailing exchange rate; unsponsored programs involve no formal agreement with the foreign company and trade only over-the-counter, while sponsored programs involve a deposit agreement and are available in three levels — Level One programs trade over-the-counter and require only Form F-6, Level Two programs list on national exchanges requiring Form F-6 and Form 20-F under the Exchange Act but raise no capital, and Level Three programs list on national exchanges, require Form F-6 and Form F-1 or F-3 under the Securities Act, and permit capital raising through public offerings; American Depositary Receipts trade and settle in dollars and pay dividends in dollars but remain subject to currency risk because their dollar value fluctuates with the exchange rate between the home currency and the dollar; foreign dividend withholding taxes reduce gross dividends received through American Depositary Receipts but can be partially offset through the foreign tax credit claimed on the United States tax return; and additional risks include political and country risk, information risk, liquidity risk especially for Level One and unsponsored programs, depositary service fees typically one to three cents per receipt per year deducted from dividends, and program termination risk.