What exactly is ADR? A comprehensive guide to the new investment option in U.S. stocks

Quick Overview of ADR

ADR stands for American Depositary Receipt, which is a simplified way to understand it as a stock proxy issued by foreign companies in the US market. Through the ADR mechanism, overseas investors can invest in foreign companies as easily as buying US stocks, without the need for complicated cross-border account opening procedures.

Core Features:

• Issued by US depositary banks and traded on NYSE, NASDAQ, or OTC markets
• Opens US financing doors for overseas companies and allows global investors to easily allocate international assets
• Attention should be paid to liquidity, exchange rate risks, and regulatory differences among different levels of ADRs

Why Are Foreign Companies Enthusiastic About Issuing ADRs?

For foreign companies, issuing ADRs is cheaper and simpler than directly listing in the US. Many companies are already listed in their home countries and do not want to go through the tedious process of secondary listing. At this point, ADRs become an ideal solution—allowing access to the world’s most active capital markets for financing without going through a full IPO process.

For investors, if they want to buy a foreign company’s stock but there is no ADR, they need to open foreign brokerage accounts, exchange currencies, convert to local currency, and then fund the account, which is costly and complex. With ADRs, investors only need to use USD, making it as simple as buying any US stock, greatly lowering the barrier to cross-border investment.

TSMC (TSM.US) is the best example—Taiwanese investors can trade directly on US stock platforms without opening a Taiwan stock account, and international investors can easily participate in Taiwan’s semiconductor industry.

Two Types and Three Levels of ADRs

Two Types

Sponsored ADRs: Foreign companies actively sign agreements with US depositary banks, controlling ADR issuance and paying bank fees. The banks handle transaction settlement. These ADRs must comply with SEC regulations, disclose financial reports and information regularly, and have a high level of compliance.

Unsponsored ADRs: Banks actively issue them, and foreign companies may be unaware. These ADRs can only be traded on OTC markets, with significantly higher risks. Tencent (TCEHY.US), BYD (BYDDY.US), Meituan (MPNGY.US) are all unsponsored ADRs.

Three Levels

From lenient to strict, ADRs are divided into Level 1, Level 2, and Level 3:

Level 1 ADRs have minimal disclosure, with the highest liquidity and compliance risks; Level 3 is the most regulated and suitable for institutional investors.

It’s Not 1:1 Conversion! The Secret of ADR Ratios

It’s important to note: ADR and foreign stocks are not converted 1:1. For example, Hon Hai’s ADR ratio is 1:5—5 shares of Taiwan Hon Hai (2317.TW) equal 1 ADR (HNHPF.US).

The company sets ratios based on two factors:

• Stock price and exchange rate: determined by foreign stock prices and USD exchange rates
• Liquidity considerations: if the stock price is too high for easy trading, the ratio is adjusted to make participation easier for investors

Check out the ADR ratios of major Taiwanese companies:

Taiwan Stock vs Taiwan ADR: Five Key Differences Investors Must Know

Although the same company, Taiwan stocks and ADRs offer very different investment experiences:

Nature Difference: Taiwan stocks are actual shares; ADRs are certificates representing shares.

Trading Venue: Taiwan stocks are traded on Taiwan’s exchange under Taiwanese regulation; ADRs are traded on US markets under SEC regulation.

Different Codes: Hon Hai is 2317 in Taiwan stocks, HNHAY in ADR.

Investor Base: Taiwan stocks mainly attract local Taiwanese investors; ADRs attract global US stock participants.

Conversion Rules: Buying one Taiwan stock equals one share; buying ADRs is based on the ratio (e.g., 1:5 means 1 ADR equals 5 Taiwan stocks).

Premium/Discount Phenomenon: Although their trends are generally aligned, daily fluctuations can differ. TSMC ADRs may trade at a premium (price higher after conversion than Taiwan stock) or at a discount (lower than Taiwan stock), creating arbitrage opportunities for savvy investors.

A-shares Also Have ADR Versions

A-shares also have ADRs, with the main differences as follows:

Three Key Factors to Read Before Investing in ADRs

1. Liquidity Issues Cannot Be Ignored

While foreign companies are well-known locally, few know about them in the US stock market, and trading ADRs involves relatively few investors. Plus, ADR issuance volume is generally lower than ordinary stocks, so you may face difficulties buying or selling.

Data comparison is clear: China Telecom (CHT.US) has an average monthly ADR trading volume of only 145,000 shares, while the same company’s Taiwan stock has an average monthly volume of 12.24 million shares—US market trading is far less active than the domestic market.

2. Company Fundamentals Determine Long-term Returns

Investing in ADRs is similar to investing in any stock—you must analyze the company’s operations, industry outlook, policy support, and other factors. These are the fundamental drivers of ADR price movements.

Note: Level 1 ADRs do not require financial disclosures in the US; investors need to actively obtain financial information from the company’s home country. For example, TSMC’s ADR surged 32% in early 2023, driven by factors like China’s pandemic easing, positive earnings reports, and industry upturns.

3. Arbitrage Opportunities from Premiums and Discounts

Key concept: The price trend of ADRs and local stocks is not perfectly synchronized, leading to premium and discount phenomena.

Premium = ADR price after conversion > local stock price (foreign investors favor ADRs)
Discount = ADR price after conversion < local stock price (domestic investors favor local stocks)

Taking TSMC as an example: on March 22, 2023, TSMC closed at $92.6. Using a 1:5 ratio and an exchange rate of 30 yuan, the conversion price is 553.3 yuan; the Taiwan stock closed at 533 yuan on the same day. This creates a premium—savvy investors can sell the premium ADRs and buy the discounted Taiwan stocks to profit from the difference.

Advantages and Risks of ADR Investment

Advantages

Lower tax and fee costs: Taiwanese investors trading ADRs profit under 1 million yuan are tax-exempt; US stock trading has no transaction tax; many overseas brokers offer zero or very low fees.

More diversified investment options: US stocks only include US companies; with ADRs, you can directly invest in leading companies from China, Taiwan, Japan, and other countries. Want to hold both Tesla (TSLA.US) and NIO (NIO.US)? It’s entirely possible.

Risks

Cross-border operational costs: Opening overseas brokerage accounts, exchanging USD, and funding accounts involve upfront costs. Using Taiwanese brokers for proxy purchases incurs 1-2% handling fees.

Exchange rate risks everywhere: Investing 30,000 TWD in ADRs, converted at 1:30 to $1,000. A 20% profit turns into $1,200, but if the exchange rate shifts to 1:25, converting back yields only 30,000 yuan—your gains are eroded by exchange rate fluctuations. When the local currency of foreign companies and USD fluctuate significantly, ADRs will also fluctuate accordingly.

Liquidity constraints: Some small-cap ADRs have low trading volume, making it hard to sell; unsponsored ADRs carry higher risks.

Summary

ADR is essentially a convenient tool for international investment, allowing global investors to participate in high-quality overseas companies without leaving home. However, it is not exactly the same as directly buying Taiwan stocks or A-shares—factors like exchange rates, liquidity, and premiums/discounts must be considered.

The core logic of investing in ADRs: analyzing company fundamentals is the top priority, followed by monitoring premium/discount arbitrage and exchange rate risks. Understanding the deeper meaning of ADRs enables you to navigate the global capital markets with ease.