Complete Guide to US Stock ADRs: From Basic Concepts to Investment Decisions

What Are US Stock ADRs? Quick Core Concepts

American Depositary Receipts (ADRs) are essentially financial certificates issued by U.S. depositary banks representing shares of foreign companies traded in the U.S. market. In simple terms, if you want to invest in a Taiwanese or Chinese listed company but prefer to trade on U.S. stock exchanges, ADRs serve as a bridge connecting these two markets.

The operation mechanism of ADRs is relatively straightforward: foreign companies deposit their shares with a U.S. depositary bank, which then issues corresponding U.S. stock ADR certificates. Investors purchase these certificates. This arrangement allows overseas investors to participate in trading on Nasdaq, NYSE, or OTC markets without opening local securities accounts or converting to local currency.

Why Do Companies Choose to Issue ADRs in the U.S.?

For foreign listed companies, issuing U.S. ADRs offers advantages in streamlined processes and financing efficiency. Compared to the complex approval process of secondary listing in the U.S., issuing ADRs has lower thresholds and costs. Many companies already successfully listed in their home countries (like TSMC, BYD) are reluctant to undergo full re-listing procedures, but given the U.S. market’s status as the world’s most active capital market, its financing potential and international recognition are hard to give up. Therefore, issuing U.S. ADRs becomes an optimal compromise.

From an investor’s perspective, the existence of ADRs significantly reduces the difficulty of investing in foreign companies. No need to handle complicated currency exchanges, multiple account openings, or unfamiliar trading rules—just use USD to trade on familiar U.S. platforms.

Classification of U.S. Stock ADRs: Sponsored vs. Unsponsored

Based on the issuer and regulatory level, U.S. ADRs are divided into two main categories:

Sponsored ADRs are issued by the company’s official appointed bank under a formal agreement. The foreign company maintains control over the ADRs and pays related fees. These ADRs must comply with strict SEC regulations, including regular financial disclosures and operational information. Sponsored ADRs generally have better liquidity and are listed on formal exchanges.

Unsponsored ADRs are issued proactively by depositary banks, sometimes without the involvement of the original company. These ADRs can only be traded OTC, with looser regulation and incomplete information disclosure, making them relatively higher risk. Tencent (TCEHY.US), BYD (BYDDY.US), and Meituan (MPNGY.US) are typical examples of unsponsored ADRs.

The Three Levels of U.S. Stock ADRs and Their Differences

According to the depth of market access and regulatory requirements, ADRs are classified into Level 1, Level 2, and Level 3, with increasing regulatory standards:

Level 1 ADRs are traded only OTC, with minimal disclosure requirements, the loosest regulation, and the weakest liquidity, thus carrying the highest risk.

Level 2 ADRs can be listed on Nasdaq or NYSE, requiring submission of F-6 and 20-F reports. Regulatory oversight is significantly increased, and trading liquidity improves substantially.

Level 3 ADRs possess all features of Level 2 but also have financing capabilities. Companies can raise funds directly through issuing Level 3 ADRs, requiring the most rigorous disclosures (F-6, 20-F, F-1, F-3, or F-4). This is the most regulated form.

Conversion Ratios of U.S. Stock ADRs: Key Price Mechanism

Investors must understand a crucial concept when trading ADRs: U.S. ADRs are not 1:1 equivalents of the underlying foreign shares. For example, TSMC’s ADR ratio is 1:5, meaning 5 shares of Taiwan TSMC (ticker 2330.TW) equal 1 ADR (TSM.US). This ratio considers the share price levels and exchange rates to keep ADR trading within a reasonable price range.

Here are common Taiwan companies’ ADR ratios for reference:

• TSMC (TSM.US / 2330.TW): 1:5 ratio
• Hon Hai (HNHAY / 2317.TW): 1:5 ratio
• Chunghwa Telecom (CHT.US / 2412.TW): 1:10 ratio
• ASE Technology (ASX.US / 3711.TW): 1:5 ratio

The Fundamental Difference Between TWD and TWD U.S. ADRs

Although the same company is traded in both markets, TWD and TWD ADRs differ significantly in multiple aspects:

Nature: TWD is the actual issued stock of the company, while ADRs are certificates issued by depositary banks, legally distinct.

Trading Venue and Regulation: TSMC trades on the Taiwan Stock Exchange under Taiwanese regulation, whereas its ADR trades on NYSE under U.S. SEC oversight.

Ticker Symbols: Reflecting different markets, e.g., Hon Hai’s TWD code is 2317, while its ADR is HNHAY.

Investor Demographics: TWD primarily targets Taiwanese investors; ADRs attract a global investor base.

Premiums and Discounts: Investors must pay attention to premiums or discounts. Although long-term trends are similar, short-term fluctuations can occur due to market sentiment, liquidity, and exchange rate movements. For example, at times, TSMC’s ADR may trade at a premium relative to its TWD price, or at a discount. Savvy investors sometimes exploit these discrepancies for arbitrage.

Key Factors to Consider When Investing in U.S. Stock ADRs

Liquidity Risk

The trading volume of ADRs is often much lower than that of the company’s home market shares. For example, Taiwan’s Chunghwa Telecom’s average monthly ADR trading volume is about 145,000 shares, compared to 12.24 million shares in Taiwan. Low liquidity means investors may face difficulties exiting positions quickly, especially when needing to liquidate, possibly forcing sales at unfavorable prices.

Company Fundamentals Assessment

Like any stock investment, investing in ADRs requires thorough research into the company’s operational status, industry outlook, and policy environment. However, note that some Level 1 ADR companies are not required to disclose full financial reports in the U.S. Investors must actively review the company’s financial info in its home country, e.g., Taiwanese companies’ financials are accessed via the Taiwan Stock Exchange.

Exchange Rate Risk

Since ADRs are priced in USD, exchange rate fluctuations introduce risk. Investors’ actual returns depend not only on stock price movements but also on USD to local currency exchange rates. If the foreign company’s local currency experiences volatility against USD, ADR prices will also fluctuate accordingly.

Arbitrage Opportunities from Premiums and Discounts

When ADRs are priced significantly higher than the local stock, there is a premium opportunity; conversely, discounts present arbitrage chances. Some professional investors sell ADRs at a premium and buy local stocks, or vice versa, to profit from these discrepancies.

Advantages of Investing in U.S. Stock ADRs

Significant Tax Benefits. If Taiwanese investors profit from U.S. stock trading under 1 million TWD, they are not subject to income tax; additionally, U.S. stock trading does not impose transaction taxes like Taiwan’s stock market, greatly reducing tax burdens. For high-frequency traders, overseas brokers often offer zero or very low commissions, much cheaper than Taiwan’s 1%-2% brokerage fees.

Diversification Opportunities. While the U.S. market mainly focuses on U.S. companies, ADRs enable investors to access high-quality global enterprises. Want to invest in electric vehicle industry? Not only can you buy Tesla (TSLA.US), but also Chinese NIO (NIO.US), forming a truly international portfolio.

Disadvantages of Investing in U.S. Stock ADRs

Operational Complexity for Non-U.S. Investors. Taiwanese investors must open overseas brokerage accounts, convert TWD to USD, transfer USD into the account, and then place orders. This process is time-consuming and involves currency exchange costs and transfer fees. Even through Taiwanese brokers’ proxy services, high fees of 1%-2% are common.

Double Exchange Rate Risk. Investors face USD to TWD exchange risk, and if the local currency of the foreign company fluctuates sharply against USD, ADR prices will also move accordingly. In short, investors need to analyze both stock trends and exchange rates, increasing difficulty.

Overall, U.S. ADRs open the door for international investors to access global high-quality companies but also require sufficient awareness and assessment of risks.