What Is an ADS in Finance and How Does It Work?

American Depositary Shares (ADS) allow investors to access foreign stocks without navigating international exchanges. These securities represent shares in non-U.S. companies but trade on U.S. markets like the NYSE or Nasdaq, enabling investors to buy and sell foreign equities using familiar platforms and currency. ADS provide exposure to global companies while benefiting from U.S. market regulations and liquidity. However, they come with specific structures, fees, and tax considerations that investors should understand before investing.

Purpose in Cross-Border Transactions

ADS help foreign companies enter U.S. capital markets without the complexity of a direct listing. Many international firms seek investment from U.S. institutional and retail investors, who provide liquidity and demand for shares. By issuing ADS, these companies can raise capital and expand their investor base while avoiding the extensive regulatory requirements of a full U.S. listing.

For investors, ADS simplify foreign stock ownership by eliminating the need to trade on overseas exchanges, convert currencies, or open international brokerage accounts. Instead, they can buy and sell shares in U.S. dollars through familiar platforms. This accessibility makes it easier to diversify portfolios with international exposure while benefiting from U.S. securities laws.

Since ADS trade on U.S. exchanges, they are subject to market scrutiny, analyst coverage, and institutional investment, which can lead to more accurate valuations compared to the company’s home market. This increased visibility can enhance a company’s global reputation and attract more investors.

Issuance Mechanics

The creation of ADS involves several entities that ensure foreign shares can be bought and sold in the U.S. market. These include the underlying shares, depositary banks, and custodian banks, each playing a role in facilitating the process.

Underlying Shares

ADS are backed by shares of the foreign company, which are issued in the company’s home country and held by a custodian bank on behalf of the depositary bank. The ratio between ADS and the underlying shares varies; one ADS may represent a single foreign share or multiple shares, depending on the company’s preference and market conditions.

Foreign companies must approve ADS issuance, though in some cases, depositary banks create ADS independently through unsponsored programs by acquiring shares from the open market. Regardless of the structure, the underlying shares remain in the foreign market while ADS trade in the U.S., allowing investors to gain exposure to the company without directly holding foreign securities.

Depositary Banks

Depositary banks such as JPMorgan Chase, Citibank, and BNY Mellon issue and manage ADS in the U.S. market. They act as intermediaries between investors and the foreign company, converting foreign shares into ADS, maintaining ownership records, and handling corporate actions like dividend payments and voting rights.

When a company establishes an ADS program, the depositary bank enters into a deposit agreement outlining issuance terms, fees, and investor rights. The bank ensures compliance with U.S. securities regulations, including those set by the SEC and FINRA. In unsponsored ADS programs, the depositary bank operates independently but must still follow regulatory requirements and provide investor disclosures.

These banks help maintain liquidity and transparency by ensuring that the number of ADS in circulation matches the underlying shares held in custody. They also facilitate the conversion of ADS back into foreign shares if investors wish to trade directly in the company’s home market.

Custodian Arrangements

Custodian banks, typically located in the foreign company’s home country, hold the underlying shares backing ADS. They work under agreements with depositary banks to ensure the safekeeping and administration of these shares.

When investors purchase ADS, the depositary bank instructs the custodian to hold the corresponding number of foreign shares. When ADS are sold or converted back into local shares, the custodian releases the appropriate number of shares to the market.

Custodian banks also handle corporate actions such as dividend payments. When a foreign company declares a dividend, the custodian collects the payment in local currency, converts it into U.S. dollars, and transfers it to the depositary bank, which then distributes it to ADS holders. This process ensures investors receive their entitlements without dealing with foreign tax laws or currency exchange complexities.

Trading and Regulatory Oversight

Once issued, ADS trade on major U.S. exchanges like the NYSE and Nasdaq or, in some cases, over-the-counter (OTC) markets. Their trading follows the same market dynamics as domestic stocks, including bid-ask spreads, market orders, and trading volume, which influence liquidity and price stability. Institutional investors, hedge funds, and retail traders all participate in ADS transactions, contributing to their visibility.

Since ADS represent foreign companies, their prices can be affected by exchange rate fluctuations between the U.S. dollar and the foreign company’s home currency. Even if the underlying stock remains unchanged in its local market, currency movements can impact ADS prices. Additionally, geopolitical events, foreign regulations, and differences in trading hours between the U.S. and the company’s home exchange can create pricing discrepancies, sometimes leading to arbitrage opportunities.

Regulatory oversight ensures ADS comply with U.S. securities laws. The SEC enforces disclosure requirements, mandating that foreign issuers provide financial statements and material company information. Sponsored ADS, particularly those registered under Form F-6, must comply with periodic reporting requirements similar to domestic public companies, including filings such as Form 20-F, which aligns with SEC annual reporting standards.

FINRA monitors broker-dealer activities related to ADS trading, ensuring fair practices and transparency. The PCAOB sets auditing standards for foreign firms with U.S.-listed ADS, reinforcing financial reporting reliability. Foreign issuers must also comply with the Foreign Corrupt Practices Act (FCPA), as violations related to bribery or improper financial practices can lead to penalties and delisting risks.

Dividends, Taxes, and Voting Rights

ADS holders receive dividends if the foreign company distributes earnings, but these payments are subject to taxation and currency conversion. When a foreign company declares a dividend, the payment is issued in local currency, converted into U.S. dollars by the depositary bank, and then distributed to ADS holders. Foreign withholding taxes, typically ranging from 10% to 30%, are applied before the net amount reaches investors.

U.S. tax law allows ADS holders to claim a Foreign Tax Credit (FTC) to offset these withholdings, but limitations exist, particularly for those subject to the alternative minimum tax (AMT) or exceeding allowable credit caps under IRS Section 901.

ADS dividends may qualify as “qualified dividends” under IRS regulations if the foreign company resides in a country with a U.S. tax treaty and the investor meets holding period requirements. If eligible, dividends are taxed at long-term capital gains rates—15% or 20% for most taxpayers instead of ordinary income tax rates, which can reach 37%. However, dividends from companies in jurisdictions without U.S. tax treaties or those classified as passive foreign investment companies (PFICs) under IRS Section 1297 are taxed at higher ordinary rates.

Voting rights for ADS holders vary. While many sponsored ADS programs allow investors to vote on corporate matters, the process is not automatic. The depositary bank receives voting instructions from the foreign company and may pass them to ADS holders, but it is not required to do so. Voting deadlines for ADS holders are often earlier than those for domestic shareholders due to processing times. Some companies, particularly those with unsponsored ADS programs, do not extend voting rights at all.

Potential Fees

Investing in ADS comes with fees that can impact returns. The depositary bank, brokerages, and tax authorities impose various charges.

A common fee is the annual depositary service fee, typically ranging from $0.01 to $0.05 per ADS. This charge covers administrative expenses such as record-keeping, dividend processing, and regulatory compliance. It is usually deducted from dividend payments, but if the company does not issue dividends, the fee may be collected directly from the investor’s brokerage account. Some brokerages absorb this cost, while others pass it on to clients.

Additional fees apply when converting ADS into underlying foreign shares or vice versa. These conversion fees, often around $5 to $10 per transaction, are charged by the depositary bank and can add up for investors frequently moving between ADS and local shares. Foreign exchange fees may also be incurred when dividends or proceeds from share sales are converted from the foreign company’s currency into U.S. dollars. These costs vary depending on exchange rate spreads and the financial institution handling the transaction.