Must-read for US stock investors: Comprehensive analysis of ADRs and risk warnings

What is ADR? Quick Reference to Core Concepts

ADR (American Depositary Receipt) is a certificate issued by a U.S. depositary bank representing shares of a foreign company. In simple terms, when an overseas-listed company wants to access the U.S. capital market, it can do so without the hassle of a secondary listing by entrusting its shares to a U.S. depositary bank, which then issues ADRs that circulate and trade on NASDAQ, NYSE, or OTC markets.

The mechanism works straightforwardly: Foreign company → delivers local shares to depositary bank → depositary bank issues ADR → U.S. investors can trade directly on the U.S. stock market. For example, Taiwan’s semiconductor leader TSMC is listed as 2330 on the Taiwan Stock Exchange; in the U.S. market, it becomes TSM ADR, both representing the same company in essence, but with completely different trading venues, regulatory frameworks, and trading methods.

Why Does ADR Exist? Dual Benefits for Companies and Investors

Value for issuing companies: Compared to direct listing in the U.S., issuing ADRs simplifies the process and reduces costs. Many companies are already listed domestically and have no interest in secondary listings. Issuing ADRs opens a U.S. financing channel and connects with global investors, providing an efficient internationalization pathway.

Convenience for investors: If investors want to buy shares of a foreign company that does not issue ADRs, they must open a local securities account, go through complex currency exchange procedures, and bear exchange rate risks. With ADRs, everything is simplified to “trading like regular U.S. stocks,” greatly lowering the entry barrier. U.S. investors can easily participate in the growth opportunities of high-quality global companies.

ADR Classification: Fundamental Differences with or without Sponsorship

Based on the level of involvement of the issuing entity, ADRs are divided into two types, with significant differences in risk and compliance:

Sponsored ADRs: Signed through formal agreements between the depositary bank and the foreign company, with the company retaining control and paying fees. These ADRs must comply with SEC regulations, regularly disclose financial statements and key information. Traded on NASDAQ or NYSE, offering better liquidity and compliance, with relatively manageable risk.

Unsponsored ADRs: Issued unilaterally by the depositary bank, possibly without direct involvement from the company, with looser disclosure requirements. These are traded only in OTC markets, with poorer liquidity and higher risk. Examples include Tencent(TCEHY), BYD(BYDDY), Meituan(MPNGY).

ADR Levels: Three Tiers of Regulatory Oversight

Besides the sponsored vs. unsponsored distinction, ADRs are categorized into three levels based on their access to the U.S. market, with increasing regulatory and trading requirements:

Practical insight: Level 1 ADRs have minimal disclosure, weakest liquidity, and highest risk. Many small or obscure foreign companies fall into this category. Investors choosing Level 1 ADRs should review the company’s financial reports published on its home exchange to compensate for limited U.S. market information.

ADR Ratios: The Logic Behind Conversion

ADR does not correspond one-to-one with the parent company’s shares. For example, for TSMC, 5 shares of Taiwan TSMC (2330.TW) equal 1 ADR (TSM.US). The core consideration in setting the ratio is balancing stock price and liquidity. If the original stock price is too high for easy trading, the company will adjust the ratio to make the ADR price more accessible.

Here are some reference ADR ratios for major Taiwanese companies:

Key Differences Between Taiwan Stocks and Taiwan ADRs

Investing in the same company’s Taiwan stock and its ADR involves multiple dimensions of difference, directly impacting investment decisions:

Nature: Taiwan stocks are directly issued equity certificates; Taiwan ADRs are representative depositary receipts with different legal nature.

Trading Venue & Regulation: Taiwan stocks trade on the Taiwan Stock Exchange under the Taiwan FSC; Taiwan ADRs trade on NYSE or NASDAQ under the SEC. Regulatory frameworks and disclosure standards differ significantly.

Ticker & Trading Hours: The same company has different tickers (e.g., Hon Hai Taiwan 2317, U.S. HNHAY). Trading hours differ—Taiwan from 9:00 to 13:30 Taipei time; ADRs from 9:30 to 16:00 Eastern Time. The time difference introduces arbitrage and risk considerations.

Investor Base & Liquidity: Taiwan stocks are mainly traded by local investors; ADRs attract global U.S. investors. Liquidity differences can cause large gaps in bid-ask spreads and trading volumes. For example, Chunghwa Telecom’s ADR has an average monthly volume of only 145,000 shares in the U.S., compared to 12.24 million shares in Taiwan—hundreds of times difference.

Premiums & Discounts: Although trends are similar, daily movements often diverge, creating premiums or discounts. For example, if the ADR price (converted) exceeds the Taiwan stock price, it’s a premium; if lower, a discount. These differences stem from exchange rates, market sentiment, liquidity, and other factors, creating arbitrage opportunities but also risks.

Comparing A-shares and A-shares ADRs

Similarly, A-shares and A-shares ADRs also have structural differences:

Four Major Risks and Considerations Before Investing in ADRs

( Liquidity Risk

ADR trading liquidity is often much lower than the company’s domestic shares. As foreign companies’ recognition in the U.S. declines, fewer investors are willing to trade ADRs. Limited issuance volume can lead to wide bid-ask spreads and difficulty executing large trades. Investors should reserve sufficient liquidity when holding ADR positions.

) Exchange Rate Risk

All ADR transactions are conducted in USD, introducing exchange rate fluctuation risk. For example, if an investor uses TWD 30,000 to buy ADR at a TWD/USD rate of 1:30, it equals USD 1,000. If the ADR rises 20% to USD 1,200, the profit is 20%. But if USD then depreciates to 1:25, converting back to TWD yields only TWD 30,000, erasing gains. If the foreign company’s local currency fluctuates significantly against USD, ADRs face additional risks.

Hidden Costs of Premium/Discount Arbitrage

In arbitrage involving premiums or discounts, investors often try to sell ADRs at a premium and buy the local stock, or vice versa. Each trade involves:

• Cross-market timing risk (markets are not perfectly synchronized)
• Additional exchange rate fluctuations during arbitrage
• Transaction and tax costs
• Slippage due to low liquidity

Seemingly simple arbitrage is actually fraught with hidden costs.

Information & Compliance Risks

Especially for Level 1 ADRs and unsponsored ADRs, companies are not required to disclose full financial reports in the U.S. Investors must actively obtain financial info published on the home exchange, increasing due diligence costs. Differences in accounting standards across countries may also lead to misinterpretation.

Practical Pros and Cons of Investing in ADRs

Core Advantages:

Lower tax burden is attractive for Taiwanese investors—if ADR profits are under NT$1 million, no income tax is payable; additionally, U.S. stock trading generally incurs no transaction tax (Taiwan stocks have a 0.1% transaction tax), and many overseas brokers offer zero or very low commissions. Frequent traders can significantly reduce costs through ADRs.

Diversification is a strategic value of ADRs. U.S. investors can simultaneously invest in U.S. companies (like Tesla TSLA) and overseas firms (like NIO) within the same industry, achieving true international diversification.

Practical Disadvantages:

Non-U.S. investors face more complex procedures—opening overseas broker accounts, currency exchange, fund transfers, each step adding costs and risks. Compared to directly buying ADRs through Taiwanese brokers, which often charge 1-2% per trade, this can be more expensive.

Currency risk is hard to fully hedge—good performance of the underlying does not guarantee gains if exchange rates move unfavorably. This is a long-term hidden risk for medium-term investors.

Summary and Investment Recommendations

ADRs serve as a bridge connecting global capital markets, offering investors a low-cost, convenient way to cross borders. However, their advantages (cost, convenience) are tightly linked to the U.S. stock ecosystem, and risks (liquidity, exchange rates, information asymmetry) are also heightened.

Before investing in ADRs, consider:

• What level does the ADR belong to? Does liquidity meet your trading needs?
• Can you withstand exchange rate fluctuations over the long term?
• Are you capable of reading and analyzing the company’s local financial reports?
• Can the cost disadvantages of ADRs be offset by the benefits of the U.S. ecosystem compared to direct local stock purchases?

A rational ADR investor weighs these factors carefully rather than blindly chasing arbitrage or cross-market speculation.