ADRs has been around since 1927 and it was introduced to the US markets at that time. It was created as a investment vehicle to make it easier for investor to buy shares of a foreign listed company. The conventional way of buying shares of a foreign listed company is that the investor will have to open an brokerage account that has access to the stock exchange which the company is listed on and buy the shares of the company through it. However, there are many problems associated with this way of buying shares and such as the difference in the currencies between the investor's own currency and the currency in which the company is listed in, high expenses associated such as brokerage and handling fees along with custodian fees and financial regulations associated with foreign ownership of shares of the listed company in that country. As such, ADRs can overcome the problems as mentioned above.
The process of creating ADRs can be roughly explained as follows. Banks will buy a bulk purchase of the shares of the foreign listed companies through their counterparts in the country which the country is listed in. Subsequently, this bulk purchase of shares will be divided into smaller bundles and this will be released for sale on the US stock exchanges to investors. Thus the purchase of ADRs represents a claim on the associated portion of the bulk purchase of the shares of the foreign listed companies by the bank.
Level 1 - This is the most basic type of ADR where foreign companies either don't qualify or don't wish to have their ADR listed on an exchange. Level 1 ADRs are found on the over-the-counter market and are an easy and inexpensive way to gauge interest for its securities in North America. Level 1 ADRs also have the loosest requirements from the Securities and Exchange Commission (SEC).There are three types of ADRs and as taken from investopedia.com, the three type of ADRs are as follows.
Level 2 - This type of ADR is listed on an exchange or quoted on Nasdaq. Level 2 ADRs have slightly more requirements from the SEC, but they also get higher visibility trading volume.
Level 3 - The most prestigious of the three, this is when an issuer floats a public offering of ADRs on a U.S. exchange. Level 3 ADRs are able to raise capital and gain substantial visibility in the U.S. financial markets.
The ADRs listed on SGX belongs to either level 2 or level 3.
The ADRs are also divided into two categories and they are single-listed ADRs and dual listed ADRs. Single-listed ADRs are listed only have ADRs listed in the US and the companies of these ADRs do not have any shares listed on any stock exchanges. In comparison, the companies of these dual-listed ADRs have shares listed on a stock exchange and also have ADRs listed in the US. As such, the risk implications for these ADRs can be different and it is further explained in this post.
So what are the risks of investing in these ADRs ? Besides the usual risk of fluctuating prices and currency difference which are also common if you invest in equities listed overseas, the following are risk factors which are unique to ADRs.
Termination of ADRs
As stated on the SGX website, for single-listed ADRs, the ADRs holders will get back the equivalent of the shares as proportional to the amount of ADRs that they owned. However, the shares of the company for the single-listed ADRs are not publicly traded on any stock exchange, it will be difficult to sell these shares for cash although CDP will try to sell them. For dual-listed ADRs, this is less of a problem since the shares of the company are publicly traded on an overseas stock exchange so it will still be relatively easier to sell it.
Counterparty risks
ADRs holders do not actually hold the shares of the underlying company and these shares are held with a custodian or with the depository bank. In the event that that the custodian or the depository bank goes into financial difficulties, there is a risk that ADRs holders may not be able to retrieve back the shares though these shares are not supposed to be part of the assets of the custodian or the depository bank.
Trading Halt
In the event where trading is halted either in the US or locally on SGX, ADR investors may suffer losses due to the inability to trade or due to changes in the market from time delay.
There are also other things that you should take note. Firstly, ADRs holders have no voting rights since essentially they are holding ADRs and not the shares of the underlying company. Secondly, ADRs holders will not be able to receive any non-cash entitlement such as rights issue or bonus shares although CDP or the depository banks will try to sell these non-cash entitlement and distribute the cash proceeds to the ADR holders. Thirdly, transaction charges and tax if any, will be deducted from the dividends before it is distributed to the ADRs holders.
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