Full Analysis of ADR: A New Path for Cross-Border Stock Investment

What is ADR? Understanding the Identity of Foreign Stocks in the US Stock Market

American Depositary Receipt (ADR) is essentially a financial certificate issued by a US depositary bank on behalf of a foreign company. In simple terms, when overseas companies want to enter the US stock market but do not want to go through the full listing process, they deposit their shares with a US bank, which then issues ADR certificates for investors to trade.

Taking TSMC as an example, this Taiwanese semiconductor giant is listed in Taiwan and also issues shares in the form of ADR on the NYSE (ticker: TSM). US investors do not need to open a Taiwan securities account; they can directly buy TSMC ADRs on the NYSE with US dollars, indirectly holding ownership of Taiwan stocks.

In short, ADRs are the “avatars” of foreign companies in the US stock market, allowing global investors to trade foreign enterprises directly in US dollars.

Why Do Overseas Companies Issue ADRs? The Core Logic of ADR Issuance

For foreign companies, listing in the US requires meeting strict regulatory and accounting standards, which is a complex and costly process. In contrast, issuing ADRs is a “fast track”—it allows companies to bypass complicated listing procedures and directly access the world’s largest capital market.

The US stock market has enormous daily trading volume, ample liquidity, and a large investor base, which is highly attractive to overseas companies seeking financing and expansion. Issuing ADRs enables these companies to retain their domestic listing status while gaining access to US market financing channels.

For investors, the convenience of ADRs is equally significant. Imagine if you want to buy shares of a foreign company but it has no ADRs—you would need to:

• Open a securities account in the relevant country
• Convert your local currency into the local currency
• Bear exchange rate risks
• Familiarize yourself with unfamiliar trading rules and tax systems

With ADRs, everything simplifies to “buying it like a US stock,” with transparent processes and relatively lower costs.

The ADR Grading System: Risk Differences Behind Different Levels

ADRs are divided into two types based on issuance method, and further classified into three levels based on market tier. This grading system directly impacts liquidity, regulatory oversight, and investment risk.

Differences in Issuance Methods:

Sponsored ADRs are officially issued through a formal agreement between the foreign company and a US bank. The company retains control over the ADRs and pays issuance fees; the bank handles trading settlement. These ADRs must comply with SEC regulations, including regular financial disclosures, offering the highest transparency.

Unsponsored ADRs are issued by banks independently based on market demand, sometimes without direct involvement from the foreign company. Tencent (TCEHY), BYD (BYDDY), and Meituan (MPNGY) are typical examples of unsponsored ADRs. These can only be traded over-the-counter (OTC), with looser regulation and higher risk.

Market Tier Classification:

Level 1 ADRs have the lowest threshold, traded only OTC, with no requirement to submit detailed reports to the SEC. This means minimal information for investors, lowest liquidity, and highest risk.

Level 2 ADRs can be traded on NASDAQ or NYSE, requiring submission of standard forms like F6 and 20F, with increased regulatory oversight. Many well-known companies’ ADRs are Level 2.

Level 3 ADRs have the strictest requirements, combining trading and fundraising functions, requiring full disclosure filings, and are under the tightest regulation. Only large, well-established foreign companies can issue Level 3 ADRs.

Simplified comparison: Level 1 is the loosest, Level 2 is moderate, Level 3 is the most stringent. Investors should prioritize Level 2 or Level 3 ADRs to reduce risk.

Demystifying the Conversion Between ADRs and Underlying Stocks: Ratios, Premiums/Discounts, and Exchange Rates

ADR Ratio: 1:1 is not the standard

Many investors mistakenly believe that ADRs and the underlying stocks are 1:1 convertible, but this is not true. For example, TSMC’s ratio is 1:5 (5 Taiwan shares equal 1 ADR), and Hon Hai (Foxconn) is also 1:5, but Chunghwa Telecom is 1:10.

Why do companies set different ratios? The core consideration is price compatibility. If TSMC’s Taiwan stock price is very high, converting to ADRs would result in a high US dollar price, potentially deterring US retail investors. By adjusting the ratio, companies ensure ADR prices stay within a reasonable range, facilitating trading and maintaining liquidity.

Six Key Differences Between Taiwan Stocks and Taiwan ADRs

Although Taiwan stocks and ADRs of the same company seem similar, they are actually quite different:

Nature: Taiwan stocks represent actual ownership of shares; ADRs are certificates representing those shares—what you hold is a receipt issued by the depositary bank, not the real stock.

Trading Venue and Regulation: Taiwan stocks are traded on the Taiwan Stock Exchange under Taiwanese regulation; Taiwan ADRs are traded on NYSE or NASDAQ under US regulation. The rules, tax systems, and disclosure requirements differ completely.

Ticker Symbols and Investor Base: Hon Hai Taiwan stock is 2317, ADR is HNHAY. The former targets local Taiwanese investors; the latter targets global US investors.

Price Movement and Hidden Differences: Although Taiwan stocks and ADRs are generally correlated, due to exchange rate fluctuations, trading time differences, and capital flows, their daily movements and periodic returns can diverge. For example, in early 2023, TSMC’s stock price rose in Taiwan while its ADR declined, illustrating the effect of premiums and discounts.

A-shares and A-shares ADRs: Cross-strait Investment Perspectives

The same logic applies to A-shares and A-shares ADRs. For example, BYD on the Shanghai Stock Exchange is 00285; its ADR is BYDDY. Great Wall Motors on the Shenzhen Stock Exchange is 601633; its ADR is GWLLY.

A-shares are regulated by China Securities Regulatory Commission (CSRC), while ADRs are regulated by SEC. The investor groups are entirely different. Global investors wanting to trade Chinese stocks in US markets can only do so via ADRs.

Key Factors to Consider Before Investing in ADRs

Liquidity: The Invisible Cost

China Telecom ADR’s average daily trading volume in March was only 145,000 shares, while the same period’s Taiwan stock average daily volume exceeded 12 million shares. What does an over 80-fold difference in liquidity imply?

When you want to quickly sell a large ADR position in US markets, you may face the awkward situation of “no takers” for your orders. Low liquidity widens bid-ask spreads, forcing you to accept lower prices when selling or pay higher costs when buying. For short-term traders, this is an invisible large cost.

Fundamental Analysis Is Essential

Investing in ADRs is similar to investing in regular stocks—you must evaluate the company’s operational status, industry outlook, policy environment, and other fundamental factors. But there’s a pitfall: Level 1 ADRs in the US do not require financial disclosures, so investors must seek financial reports from the company’s home market.

For unsponsored ADRs, the company may not disclose any information in the US; you need to obtain annual and quarterly reports from Taiwan, China, or other issuing countries and perform your own fundamental analysis. This is unfamiliar and time-consuming for many US investors.

Arbitrage Opportunities and Risks from Premiums/Discounts

ADR prices are not solely determined by the underlying stock prices. Suppose TSMC’s ADR ratio is 1:5, and on March 22, 2023, the ADR’s closing price was $92.6. Converting back to TWD: 92.6 ÷ 5 × 30 (exchange rate) = 553.8 TWD. On the same day, Taiwan stock closed at 533 TWD. This indicates an ADR premium (overvaluation).

Smart investors might choose to “arbitrage”—long the Taiwan stock and short the ADR to profit from the price difference. However, arbitrage involves cross-market operations, currency hedging, transaction costs, and other complexities, making it unsuitable for all investors.

The True Costs and Returns of Investing in ADRs

Tax Advantages to Expect

Taiwan investors can profit from ADR trading without paying income tax if gains are under NT$1 million. This is a significant advantage over Taiwan stock trading, which involves a 0.1% transaction tax and dividend taxation. Many overseas brokers offer zero or very low commissions, making frequent trading costs much lower than Taiwan brokers’ 1-2% handling fees.

But this is only the surface advantage. Investors also face hidden costs such as currency exchange costs, exchange rate risks, and the complexity of US tax reporting (some cases require tax filings).

Exchange Rate Risk: A Double-Edged Sword

Suppose you invest NT$30,000 to buy ADRs at a 1:30 exchange rate, converting to $1,000. If the ADR rises by 20%, your assets become $1,200. But when you convert back to NT$, if the exchange rate has changed to 1:25, you can only get NT$30,000—meaning a loss.

A 20% profit can be wiped out or turned into a loss due to exchange rate depreciation. Conversely, if the exchange rate appreciates, your gains are amplified. This exchange rate leverage adds volatility to ADR investments.

A New Window for Diversified Investment

ADRs enable US investors to gain exposure to Tesla (a US electric vehicle leader) and NIO (a Chinese EV startup) simultaneously, providing diversified insights into the EV industry. Without ADRs, US investors can only buy Tesla and cannot directly participate in the growth of Chinese or Taiwanese high-quality companies.

Final Considerations for Investing in ADRs

ADR is neither a paradise nor a trap; it is a convenient window to overseas investment. Investors should make decisions based on the following criteria:

Prioritize Level 2 or Level 3 ADRs over Level 1, and favor sponsored ADRs over unsponsored. Pay attention to liquidity—be cautious with ADRs with average daily volume below 500,000 shares. Learn to analyze financial information from the company’s home market; do not rely solely on US disclosures. Watch for premiums/discounts but avoid overtrading because of them. Most importantly, ADR returns come from the company’s growth, not trading tactics.

The reason to choose ADRs should be “long-term confidence in the company’s prospects,” not “arbitrage opportunities from price differences.”