American depositary receipts are certificates of stock representing foreign companies, and are listed and traded on a U.S. exchange per Financial Web. ADRs give the U. S investor exposure to foreign markets. An ADR can represent one or more shares, or a block of shares of a non-U.S. company. ADRs tend to trade in tandem to the price of the foreign stock in its home market.
Trading in American depositary receipts is trading in foreign market, with associated risks typical of trading in these markets.
Foreign currency risk
The holder of an ADR is exposed to currency risk Lets assume a US investor or trader holds a South African mining stock ADR. The price on ADR goes up 25 percent in tandem with the stock, but the South African rand weakens by 25 percent or more, leaving you with no gain, or a loss.
Counterparty or default risk
A depositary bank issues American depositary receipts on the stocks of foreign companies. The depositary bank could fail to honor its obligations as counterparty. It could be experiencing financial problems or be declared insolvent. The investor may not receive the ADRs they paid for and they could lose their entire investment. Conversely the investor may not receive funds from ADRs sold.
The underlying foreign company could be in financial difficulty. It could be liquidated or be placed under receivership, leaving ADR holders with little hope recouping losses.
Transparency and information risk
Some foreign companies do not provide the high level of financial reporting available to U.S. investors. Many foreign jurisdictions have different financial disclosure regimes compared to the US. Company financial reports could also be in a different language and provide little useful information without translation into English. The lack of the relevant information can make it difficult for the investor make informed decisions.
Political and economic risk
The home or domicile country of the foreign company could be politically and economical unstable. The holder of an ADR could risk loosing their entire investment. Investor returns could be under threat from government instability, a coup, civil strife and negative foreign policy decisions. A government could mismanage the economy, through very high levels of corruption and poor governance.
Political risk and economic risks could reduce investment returns or totally prevent the quick withdraw of capital from an investment.
The stock of foreign owned company could become illiquid, leaving the investor unable to exit the investment, and thereby incur a loss. The liquidity in a stock could drop for a many reasons. A majority shareholder could have bought up stock, or the stock may have been illiquid for a very long time. Trading in the stock could also be halted due to financial irregularities or criminal investigations.