A depository bank allows investors to hold and trade shares of companies located outside the U.S. that trade in American financial markets. Using depository banks makes investing in non-U.S. companies safer and easier to manage. These institutions also help to simplify the various tax issues involved in cross-border trading.
These types of banks hold American Depository Shares (ADSs) and issue American Depository Receipts (ADRs) to investors. ADSs are decided between the bank and the company selling its shares. The ADR is equivalent to an exact amount of ADSs held by the shareholder. ADSs and ADRs are, therefore, mechanisms for holding and trading non-U.S. shares of companies trading in America.
There are several types of ADR programs issued by a depository bank. These include unsponsored share and restricted share programs. The type of program used by a share issuing company is determined when it sets up an ADR program.
Unsponsored shares are issued by companies with no formal agreement with a depository bank; in fact, the shares may be issued by more than one bank. These shares are issued on a market demand basis, which is also known as over-the-counter (OTC) market trading. If shares have been issued by more than one bank, then each bank only deals with the shares it issued and is not responsible for those issued by other banks.
Unsponsored programs are sub-divided into Level I (OTC), Level II (Listed), and Level III (offering) programs. Level I ADRs are the most popular, involving one transfer agent or depository and requiring the minimum amount of reporting to the U.S. Securities and Exchange Commission (SEC). Level II involves more regulation from the SEC, but in exchange allows the company to list its stocks in the U.S. stock exchange. Level III ADR programs involve even more stringent rules, but allow foreign held shares to be deposited in a U.S. depository bank and to make share offerings to raise capital.
Restricted programs for U.S. depository banks are divided into 144-A and Regulation S. These restrictions limit who can buy shares in the company. SEC Rule 144-A makes share issuing a private matter; therefore, only Qualified Institutional Buyers, or QIBs, can purchase stocks. Regulation S, also under SEC, means the shares cannot be purchased by American citizens.
The depository bank will help its American investors receive dividends from their ADSs. A dividend is a percentage of a company’s earnings that is distributed amongst the company’s investors. The size of the dividend depends on two factors: the amount of the profits, and the number of shares owned by the shareholder.
A depository bank will also help an investor deal with capital gains and other taxes. This is crucial to the investor because taxes levied by the country in which the company is based may be unfamiliar. Capital gains tax is a tax levied on the profits made from selling non-inventory assets such as shares. Not all countries have a capital gains tax.