In-Depth Understanding of US Stock ADRs: The Complete Guide Every Investor Must Know

What is ADR? Starting from the Basic Concept

ADR (American Depositary Receipt) is a certificate issued by a U.S. depositary bank representing shares of a foreign listed company. In simple terms, when overseas companies want to trade on the U.S. stock market but do not want to go through the complex process of listing, they choose to issue ADRs.

Taking TSMC (TSM) as an example, this Taiwanese semiconductor giant is listed in Taiwan and also traded in the U.S. on NASDAQ in the form of ADRs. Investors do not need to open a Taiwan stock account or exchange currency into New Taiwan Dollars; they can trade TSMC just like any U.S. stock. This is the core value of ADRs: providing a convenient channel for global investors to invest in foreign companies.

Foreign companies deposit their local stocks with a U.S. depositary bank, which then issues ADR certificates that circulate in the U.S. stock market. This process makes cross-border investment much more convenient.

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

For overseas listed companies, issuing ADRs is much more economical and convenient than secondary listing in the U.S. The U.S. stock market is the largest and most active capital market globally. Many mature companies are already listed domestically but want to access U.S. financing. Issuing ADRs becomes the best solution.

Compared to the cumbersome and costly full listing process, ADRs only require a bank as an intermediary, allowing companies to access U.S. capital markets for funding.

For investors, if they want to buy shares of a foreign company but cannot obtain them through ADRs, they would need to open a local securities account, exchange currency, and understand local trading rules—these additional costs and complexities are eliminated. Therefore, the emergence of ADRs lowers the entry barrier for companies into the U.S. market and significantly simplifies international investment processes.

ADRs Are Divided into Two Main Types, with Different Risk Levels

According to issuance methods, ADRs are classified as Sponsored ADRs and Unsponsored ADRs.

Sponsored ADRs are issued through a formal agreement between the foreign company and the U.S. depositary bank. The company maintains control over the ADRs and pays related fees, while the bank assists with transaction handling. These ADRs must comply with U.S. Securities and Exchange Commission (SEC) regulations, regularly disclose financial reports and relevant information, and have the highest compliance level, thus carrying relatively lower risk.

Unsponsored ADRs are not issued proactively by the company, and in some cases, the company may not even participate. They are entirely implemented by the depositary bank alone. These ADRs can only be traded over-the-counter (OTC), and their risk is significantly higher. Tencent (TCEHY), BYD (BYDDY), and Meituan (MPNGY) are examples of unsponsored ADRs.

ADRs are also divided into three levels, with increasing regulatory requirements

Level 1 ADRs have the loosest regulatory requirements, can only be traded OTC, have minimal information disclosure, and the lowest liquidity and safety.

Level 2 ADRs can be traded on NASDAQ or NYSE, with stricter regulations and more compliance filings.

Level 3 ADRs have the most stringent requirements, are traded on major exchanges, and allow companies to raise capital through ADRs, requiring full U.S. financial statements and regulatory filings.

ADR Ratios: 1:1 Is Not the Default

When investing in ADRs, it’s important to understand that the exchange ratio between ADRs and foreign stocks is not necessarily 1:1.

For example, Hon Hai (Foxconn) has an ADR ratio of 1:5, meaning 5 shares of Taiwan Hon Hai (2317) equal 1 U.S. ADR (HNHAY). The company sets the ratio considering two factors: stock price and exchange rate fluctuations. If the local stock price is too high, it may be adjusted to make the ADR more attractive to investors.

Common Taiwan company ADR ratios:

Taiwan Stock vs Taiwan Stock ADR: Looks Similar but Significantly Different

Although companies like TSMC are traded both in Taiwan and the U.S., there are notable differences:

Nature: Taiwan stocks are directly issued by the company, while ADRs are certificates representing those stocks.

Trading Venue: Taiwan stocks are traded on the Taiwan Stock Exchange under Taiwanese regulation; ADRs are traded on U.S. exchanges (like NYSE) under U.S. regulation.

Ticker Symbols: TSMC’s Taiwan stock code is 2330, while its ADR code is TSM.

Investor Base: Taiwan stocks mainly attract local Taiwanese investors; ADRs are open to global investors.

Price Movements: Although generally correlated, due to exchange rates, time zone differences, and trading volume disparities, daily price fluctuations and final returns can differ—this is known as the premium or discount phenomenon. For example, if the ADR price converted to TWD is higher than the Taiwan stock price, it’s a premium; if lower, it’s a discount.

The Difference Between A-shares and A-shares ADRs

The same logic applies to Chinese stocks. Companies like BYD and Great Wall Motors are traded on the Shanghai and Shenzhen exchanges and also have ADRs traded in the U.S. (BYDDY, GWLLY).

The fundamental difference is: A-shares are regulated by China’s CSRC and mainly targeted at domestic investors; A-shares ADRs are regulated by the U.S. SEC and accessible to global investors. Their nature, exchanges, regulatory frameworks, and investor composition are entirely different.

Three Key Factors to Evaluate Before Investing in ADRs

Can liquidity meet your trading needs?

ADR trading volume is often much lower than the company’s domestic trading volume. For example, China Telecom (CHT) has an average monthly ADR trading volume of about 145,000 shares, while its Taiwan stock’s daily trading volume reaches 12.24 million shares. Poor liquidity can lead to large bid-ask spreads and difficulty executing trades, especially for frequent traders.

Is the company’s fundamentals sound?

Similar to investing in stocks, ADR investment requires assessing the company’s operational health, industry outlook, and policy support. Especially for Level 1 ADRs, companies are not required to disclose financial reports in the U.S., so investors must actively review the financial statements published in the local market. For example, TSMC’s ADR surged over 32% in early 2023, driven by pandemic reopening, strong financials, and optimistic industry prospects.

How will premium or discount phenomena affect your returns?

Due to time zone, exchange rate, and trading volume factors, ADR prices can differ from local stock prices. When the ADR price exceeds the local stock price, it’s a premium; when lower, it’s a discount. Savvy investors can exploit this difference for arbitrage—selling ADRs when they are at a premium and buying the local stock to profit.

Advantages and Disadvantages of Investing in ADRs

Advantages: Tax and Cost Optimization

For Taiwanese investors, profits from ADRs under NT$1 million are not subject to income tax, which is a significant advantage. Additionally, unlike Taiwan stock trading, which involves transaction taxes, ADR trading has a more favorable cost structure.

For frequent traders, overseas brokers often offer zero commissions or very low fees, saving a lot compared to Taiwan’s 1-2% transaction fee. This makes ADRs more attractive for active traders.

Furthermore, ADRs allow investment in companies listed worldwide—if you want to invest in electric vehicle companies, you can choose U.S. Tesla (TSLA) or Chinese NIO (NIO), greatly diversifying your portfolio.

Disadvantages: Complex Processes and Exchange Rate Risks

Non-U.S. investors face additional steps: opening overseas brokerage accounts, converting currency to USD, and depositing funds—all incurring costs. Using Taiwanese brokers for proxy purchases can involve fees as high as 1-2%.

Exchange rate risk is a critical cost. Investors convert TWD to USD to buy ADRs, and when selling, convert back to TWD. During this period, exchange rate fluctuations can erode gains—if the stock rises 20%, but USD/NTD depreciates more than 20%, the final return could be negative. Additionally, foreign companies’ local currency and USD exchange rate fluctuations can also influence ADR prices.

Summary: ADR Is Not a Deep Mystery

Understanding ADRs mainly involves recognizing that they are a bridge—connecting overseas investors with global companies. They simplify cross-border investment but also introduce new risks (liquidity, exchange rate, ratio conversion). Properly evaluating these factors before investing enables you to navigate the global stock markets with confidence.