ADRs & GDRs: How to Access a Foreign Market

In a prior article about mutual funds, the investment strategy in the prospectus defines the universe of securities for the fund manager i.e. small cap growth stocks in the US.  Some companies cross list their stocks on secondary markets to access investors from another country.  In the example above, a non-US company would create American Depository Receipts (ADRs) and the fund manager could invest in it.

ADRs are administered by a depository bank.  Most of them are handled by BNY Mellon, JP Morgan, Citi, Deutsche Bank and ComputerShare Trust Company.  According to their website, BNY Mellon holds a 64% market share in ADRs.  The foreign company would deposit X amount of shares into the bank who then issues a ADRs.  This new security can represent any number of shares.  The only guideline is that the ADRs should be at least $10.  This is because some investors do not buy stocks under that price.

There are three levels of programs for ADRs:  Level I - OTC, Level II - Listed and Level III - Offering.  Level I is the least restrictive.  All the company has to do is be listed on a foreign exchange and publish an annual report in English using its home country's accounting rules.  But it can only be traded over the counter.  Achieving Level II allows the company to be traded over an exchange (NYSE and NASDAQ).  The company has to register with the SEC, file an annual report using US accounting rules and meet the exhange's listing requirements.  Level III is the highest and allows the company to raise capital by issuing shares.  It has Level II responsibilities plus file concurrent documentation in the primary and secondary countries and file an Offering Prospectus when issuing shares.

If the depository receipt is in any other country, it is called a Global Depository Receipt.

For hedge fund managers, this could be a simple relative value arbitrage trade where they compare the values of the securities in the primary and secondary markets by buying the undervalued security and shorting the overvalued security.  They would exit the positions once the two securities' prices were in equilibrium.