Deep Dive into ADR from Scratch: A Must-Read Guide for U.S. Stock Investors

ADR Quick Scan

Want to invest in TSMC, NIO, or BYD on the US stock market? In most cases, you’re not trading the actual stocks directly, but a special certificate—American Depositary Receipt (ADR). This is a certificate issued by a US depositary bank representing shares of a foreign company, and it can be traded on NASDAQ, NYSE, and OTC markets.

The emergence of ADRs solves a key problem: allowing foreign companies to raise capital in the US capital markets, while also making it more convenient for US investors to invest in global companies. But this tool is not without risks—liquidity, exchange rate fluctuations, and additional costs are all worth paying attention to.

How ADRs Work

When a foreign company wants to enter the US market, it usually doesn’t choose a complex and expensive direct listing. Instead, a more flexible approach is taken: delivering the company’s shares to a US depositary bank, which then issues certificates representing those shares—this is the ADR.

For example, with Taiwan’s leading semiconductor company, when you buy its ADR on NASDAQ, you’re actually purchasing a certificate representing its real shares. For most investors, this difference is hardly noticeable in actual trading. In short, ADR can be understood as a stock substitute launched by foreign companies in the US.

Why do companies bother issuing ADRs? The reason is practical: compared to a full listing in the US, issuing ADRs is simpler and cheaper. Many companies are already listed in their home country and do not need to relist, but the liquidity and financing capacity of the US market are irresistible.

For investors, there’s another advantage—if you want to buy foreign stocks without ADRs, you need to open a local broker account, exchange currencies, learn local trading rules, which is cumbersome and costly. With ADRs, the process is as simple as buying other US stocks.

Types of ADRs

Not all ADRs are the same. Certificates issued by depositary banks are divided into two main categories:

Sponsored ADRs—issued by the bank on behalf of the foreign company, with a signed agreement. The company retains control and pays related fees, while the bank handles trading. These ADRs must comply with SEC regulations and periodically disclose financial information.

Unsponsored ADRs—may not involve active participation from the foreign company, mainly implemented by the depositary bank. These ADRs can only be traded OTC and carry higher risks. Tencent, BYD, and Meituan are examples of this type in US stocks.

Besides the issuance method, ADRs are also classified into three levels based on market access:

Level 1 ADRs carry the highest risk—least disclosure and poorest liquidity. Levels 2 and 3 can be traded on mainstream exchanges and have stricter regulatory requirements.

ADR Ratios: The Hidden Conversion Code

This is a detail many beginners tend to overlook: ADRs do not correspond 1:1 with foreign stocks.

For example, Foxconn’s ADR ratio is 1:5, meaning 5 shares of Taiwan Foxconn stock equal 1 ADR certificate. TSMC’s ratio is 1:5, Chunghwa Telecom is 1:10. These ratios are set by the companies based on stock price, exchange rate, and liquidity needs.

It may seem complicated, but in practice, it’s straightforward. Here are the main Taiwan companies’ conversion references:

Taiwan Stock vs. Taiwan Stock ADR: Similar on the Surface, Different in Reality

Why does the same company list both on Taiwan stock market and US stock market? It may seem redundant, but there are key differences:

Nature—Taiwan stocks are issued by the company itself, while Taiwan ADRs are certificates representing those stocks.

Trading Locations—For example, Foxconn can be bought in Taiwan through the Taiwan Depository & Clearing Corporation (regulated by Taiwan authorities), and in the US via OTC (regulated by SEC).

Ticker Symbols and Ratios—The same company has completely different tickers in both markets, and conversion ratios vary.

Investor Composition—Taiwan stocks mainly target domestic investors, while Taiwan ADRs attract global capital.

Price Differences—This is the most interesting part. Although the stock trends are roughly the same in both markets, due to exchange rates, trading volume, time zone differences, daily volatility, and long-term returns often differ. This leads to premium and discount phenomena—when ADR prices are higher than Taiwan stocks, it’s called a premium; otherwise, a discount. Savvy arbitrageurs exploit these differences for profit.

The Unique Status of A-Share ADRs

Chinese concept stocks are also common in US markets. BYD, Great Wall Motors, and other A-share companies have issued ADRs. The logic of A-shares and A-share ADRs is similar to Taiwan stocks, but the regulatory framework differs greatly—A-shares are under CSRC jurisdiction, while A-share ADRs are regulated by SEC, leading to obvious differences in trading rules and financial disclosure requirements.

Practical Considerations for Investing in ADRs

Liquidity issues cannot be ignored

Foreign companies tend to be much less known in overseas markets than domestically. For example, Chunghwa Telecom’s average monthly trading volume in Taiwan is over 12 million shares, but its ADRs only trade about 145,000 shares per month. Poor liquidity means large orders may face delays or slippage.

Fundamental analysis remains crucial

Investing in ADRs does not change the stock selection logic. Company performance, industry outlook, policy environment—all these factors still determine long-term trends. A special note: Level 1 ADRs in the US do not require financial disclosures; investors must actively check the parent company’s financials in its home country.

Arbitrage opportunities from premiums and discounts

This is unique to ADRs. In March 2023, TSMC ADR closed at $92.6, which, at a 1:5 ratio and current exchange rate, was about NT$553, while the Taiwan stock closed at NT$533, creating a clear premium. Sharp investors might sell ADRs when there’s a premium and buy Taiwan stocks to arbitrage.

Pros and Cons of Investing in ADRs

Clear advantages

Tax and fee benefits—Taiwan investors can enjoy tax exemption on ADR gains up to NT$1 million. Overseas brokers often charge lower or zero transaction fees, especially for frequent traders.

Portfolio diversification—With the same strategy, you can buy US electric vehicle companies like Tesla and also hold Chinese NIO ADRs, creating a more comprehensive industry coverage.

Notable disadvantages

Operation costs for non-US investors—Opening overseas broker accounts, currency exchange, wire transfers all involve fees. Buying through Taiwanese brokers incurs an additional 1%-2% handling fee.

Exchange rate risk everywhere—ADRs are dollar-denominated, and their returns are affected by USD appreciation or depreciation. You might earn 20% stock gains but lose due to USD depreciation. Also, if the foreign company’s main business involves other currencies, exchange rate fluctuations with those currencies can also impact ADR prices.

Final Tips

ADRs serve as a bridge connecting global capital, but they are not risk-free tools. Before investing, carefully assess your risk tolerance, especially regarding exchange rate fluctuations. Also, choosing ADRs with sufficient liquidity and complete information disclosure will make your investment journey smoother.