What are American Depositary Shares (ADS)?
An American depositary share (ADS) is an equity share of a non-U.S. company that is held by a U.S. depositary bank and is available for purchase by U.S. investors.
The entire issuance of shares by a foreign company is called an American Depositary Receipt (ADR), while the individual shares are referred to as ADSs. But the terms American Depositary Shares and American Depositary Receipts are often used interchangeably.
American Depositary Shares (ADS) refer to shares in foreign companies that are held by U.S. depositary banks and can be traded in the U.S., including on major exchanges.
The terms American Depositary Shares and American Depositary Receipts are often used interchangeably.
How Do American Depositary Shares Work?
ADS, American Depositary Shares, or American Depositary Receipts (ADRs), permit the foreign equity stock exchanges in the United States. Most of the foreign company stocks are traded in this way on the US stock exchange. Depositary banks release American depositary receipts in the United States, and all ADRs represent one or more foreign stocks or some stocks. If you are an ADR holder, you possess the rights and credentials of the underlying foreign stock.
American depositary stocks are different from American depositary receipts since the face value of American depositary stocks is usually just a fraction of the face value of the mortgage stock, while American depositary receipts normally use the number of units (such as 10 shares) to hold the stock as a unit.
American Depositary Shares (ADS) was funded by the stock-issuing company that aimed to acquire US investors without being listed on the US market. American Depositary Receipt (ADR) hold the rights of foreign stocks available for the US citizens to buy. Brokerage firms and banks initiate ADR.
The Downside of American Depositary Shares
There is some currency risk involved in holding ADSs. Fluctuations in the exchange rate between the U.S. dollar and the foreign currency will have some effect on the price of shares as well as on any income payments, which must be converted into U.S. dollars.
Tax treatment of dividends from ADSs is also different. Most countries apply a withholding amount on dividends issued for ADRs. This withholding amount can vary. For example, Chile and Switzerland withhold 35% while France can withhold as much as 75% of the tax on dividends, in the case of non-cooperative countries within the EU.
The withholding tax is in addition to the dividend tax already levied by U.S. authorities. The dividend tax can be avoided by ADR investors by filling out Form 1116 for foreign tax credit.
Risks of American Depositary Shares
For the Foreign Company
- Foreign exchange risk
Foreign exchange risk is essentially the same risk as to the one we mentioned for investors, but we wanted to acknowledge that the foreign company also faces the other side of the risk.
- Liquidity risk
Even though ADS expands a company’s shares into the US, there may be a liquidity risk depending on the appetite of investors for the company’s shares. If the appetite is low and there is a low volume of ADS bought, the foreign company may not be able to receive the capital raising it needed.
For American Investors
- Country climate risk
First and foremost, investing in ADS will involve the same risk as actually investing in a foreign company. Investors will still face the risk of the country and the company, such as economics, politics, wars, etc.
- Foreign exchange risk
In addition, you will face the risk of foreign exchange. Depending on how the US dollar compares to the foreign currency, the returns you earn from stock price changes and dividends may vary. For example, if the US dollar is up against the foreign currency, then the actual dollar amount of the dividend will go down. If the US dollar is down, the dividend dollar amount will increase.
- Tax treatment risk
There can also be tax treatment differences between countries that will affect the return. For example, some companies apply a withholding amount on cash flows issued for ADS. Since the withholding amount can change depending on the country, some investors may get taxed more for their returns.
- Small amount of choices
Although ADS is an easy way to transfer a foreign company’s shares into the U.S., not all companies do it. For example, Japan’s Toyota issues ADS, whereas Germany’s BMW does not. It results in a limited selection for investors, as some companies may be unavailable to invest in.
Examples of American Depositary Shares
A single ADS often represents more than one share of common stock. Further, ADSs can “gap” up or down outside of U.S. trading hours, when trading is happening in the company’s home country and U.S. markets are closed.
For example, South Korea’s Woori Bank, a subsidiary of Woori Financial Group, has ADSs that are traded in the U.S. The bank’s ADS gapped up by $0.03 on July 20, 2016. A technical analysis of the price action on this ADS shows that for the past decade, its price continued higher two-thirds of the time after a gap up.