What Are American Depositary Receipts (ADR)? A Comprehensive Guide to Their Operation

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ADR is like an entry ticket for foreign stocks in the U.S. market, allowing you to buy and sell stocks of companies from China or other countries directly in USD on U.S. exchanges. You don’t need to open an overseas account or deal with complex foreign currency exchanges. When you check depositary receipt quotes, all information is displayed in USD, making it easier for you to compare and decide on your investments.

Key Points

• ADR allows you to easily buy and sell foreign company stocks in the U.S. market with USD, without the need to open an overseas account or handle currency exchanges.
• Each ADR represents a certain number of foreign stocks, and understanding the exchange ratio is crucial for calculating your actual holdings and dividends.
• Investing in ADR offers high liquidity and convenience, enabling you to tap into the growth potential of global markets.
• While ADR has multiple advantages, you need to be aware of risks related to exchange rate fluctuations and information transparency, which may affect your investment returns.
• Before deciding to invest in ADR, assess your risk tolerance and investment goals to better utilize ADR to expand your portfolio.

Introduction to ADR

Definition

American Depositary Receipt (ADR) is a security issued by a U.S. bank. You can think of ADR as a “ticket” representing the stocks of a foreign company. When you purchase an ADR, you actually hold a security issued by a U.S. bank, not the foreign company’s stock directly. The U.S. bank first purchases the foreign company’s stocks, stores them in a custodian bank overseas, and then issues ADRs based on those stocks. You can buy and sell these securities in USD on U.S. exchanges without opening an overseas brokerage account or dealing with currency exchanges.

You can buy and sell ADR directly in USD on major U.S. exchanges like the New York Stock Exchange (NYSE) or NASDAQ, with a process as simple as trading U.S. domestic stocks.

Main Functions

The primary function of ADR is to allow you to invest in non-U.S. company stocks easily. You don’t need to handle complicated cross-border transfers or worry about currency settlements. You can buy and sell directly in the U.S. market with USD, enjoying the same trading convenience as U.S. stocks.

• You can buy and sell foreign company stocks in USD without currency exchange.
• You can trade on U.S. exchanges or over-the-counter (OTC) markets, with a process identical to trading U.S. stocks.
• You can receive dividends equivalent to the original stocks, paid in USD.

The liquidity and popularity of ADR are very high. Take TSMC ADR as an example:

1. The trading price of TSMC ADR is sometimes 28% higher than its local stocks in Taiwan, reflecting strong investor demand and even a premium phenomenon.
2. Over the past three months, the daily average trading volume of TSMC ADR has been twice that of its Taiwan stocks, indicating better liquidity and more active trading in the U.S. market.
3. TSMC ADR is included in important indices and ETFs like the Philadelphia Semiconductor Index, requiring funds tracking these indices to hold TSMC ADR, further boosting its popularity.

You can see that ADR not only makes it convenient to invest in foreign companies but also offers high liquidity and market recognition. These features make ADR a vital tool for U.S. investors to participate in global markets.

How It Works

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Issuance Process

You can imagine the birth of an ADR as a rigorous process. First, a bank in the U.S. or Hong Kong purchases the stocks of a designated company on a foreign stock market. These stocks are then held by a professional custodian bank (e.g., JP Morgan) to ensure safety and legality. Afterward, the bank issues a corresponding number of ADRs to investors like you based on the number of foreign stocks held.

Here’s a specific process example:

1. The bank uses the DWAC (Deposit/Withdrawal at Custodian) mechanism to deposit foreign stocks into the designated custodian bank.
2. Taking ASLAN Pharmaceuticals Limited as an example, the bank first purchases ASLAN stocks, which are then held by the custodian bank.
3. The bank issues ADRs (e.g., ASLAN ADR ratio is 29:1) based on the number of stocks held and lists them for trading on the U.S. market (e.g., NASDAQ).
4. You can buy and sell these ADRs directly in the U.S. market with USD, without handling currency exchanges or overseas accounts.

This process ensures that when you trade ADR in the U.S. market, there are real foreign stocks backing it, safeguarding your investment rights.

Exchange Ratio

How many foreign stocks does each ADR represent? This ratio is called the “exchange ratio.” Different companies and banks set different ratios based on actual circumstances. For example:

• The ADR exchange ratio for ASLAN Pharmaceuticals Limited is 29:1, meaning one ADR represents 29 shares of ASLAN common stock.
• The ADR exchange ratio for TSMC is 5:1, meaning one ADR represents 5 shares of TSMC stock.

You can refer to the table below for common ADR exchange ratios:

This ratio affects the number of foreign stocks you actually hold. For example, if you buy 100 ASLAN ADRs, you effectively hold 2,900 shares of ASLAN common stock. When trading ADRs, you must pay attention to the exchange ratio, as it impacts your investment scale and dividend distribution.

USD Pricing

When you trade ADR in the U.S. market, all prices and dividends are calculated in USD. This allows you to trade directly in USD without currency exchange and without worrying about immediate exchange rate fluctuations affecting the trading process.

• The dividends you receive will be converted by the bank from the foreign company’s dividends into USD and distributed to you.
• When you check ADR quotes, all data (e.g., transaction price, price change, volume) is displayed in USD.
• You can place orders directly on a U.S. brokerage platform, just like trading U.S. domestic stocks.

This USD pricing makes it more convenient for you to invest in foreign companies and manage your funds and profits. However, you still need to be mindful of exchange rate changes, as the foreign company’s dividends are initially calculated in local currency, converted to USD by the bank, and then paid to you.

Depositary Receipt Quotes and Trading

Quote Method

You can directly check depositary receipt quotes on major U.S. exchanges, such as the New York Stock Exchange (NYSE) or NASDAQ. Depositary receipt quotes are displayed in USD, making them clear at a glance. You only need to enter the ADR ticker code on a brokerage platform to see real-time depositary receipt quotes. These quotes include the latest transaction price, bid-ask spread, volume, and other information. You can also look up depositary receipt quotes on financial websites or mobile apps. Depositary receipt quotes fluctuate based on market supply and demand, just like U.S. domestic stocks. Some ADRs are quoted on the OTC market (over-the-counter market), and these depositary receipt quotes are also calculated in USD. You can compare depositary receipt quotes across different platforms to choose the best time to buy or sell.

Tip: When checking depositary receipt quotes, remember to note the exchange ratio, as the number of foreign stocks represented by each ADR may differ.

Trading Process

The process of buying and selling ADR is almost the same as trading U.S. stocks. You only need to open a U.S. brokerage account, select the ADR you want to invest in, enter the quantity and price, and place the order. Depositary receipt quotes are reflected in real-time on your trading platform. After you place the order, the system matches the trade based on the depositary receipt quotes. You can choose a market order or a limit order to flexibly control your buying and selling timing. The dividends you receive will be paid in USD, making it easy to manage your funds. You don’t need to handle currency exchanges or overseas accounts, and the entire process is simple and straightforward. You can check depositary receipt quotes anytime to stay updated on market trends and make informed decisions.

Differences Between ADR and ADS

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Relationship

When learning about ADR, you’ll often encounter another term—ADS. In fact, ADR (American Depositary Receipt) and ADS (American Depositary Share) are closely related but distinct concepts. You can understand them as follows:

• ADR: Refers to the depositary receipt issued by a U.S. bank (e.g., HSBC’s U.S. branch in Hong Kong), serving as a document or proof that you hold shares of a foreign company.
• ADS: Refers to the actual shares represented by this ADR. Each ADR can represent one or more ADS, with the specific number set by the bank.

When you trade in the U.S. market, you are actually buying and selling ADR. Each ADR corresponds to a certain number of ADS. For example, if you buy 1 TSMC ADR and its exchange ratio is 5:1, you effectively hold 5 shares of TSMC ADS.

Tip: When checking ADR quotes, remember to also note the number of ADS and the exchange ratio, as this will affect the number of foreign company shares you ultimately hold.

Metaphorical Explanation

You can think of the relationship between ADR and ADS as similar to the relationship between a theater ticket and seats. ADR is like the ticket in your hand, giving you the right to enter the theater (U.S. market) to watch the performance of a foreign company (investment). ADS are the seats inside the theater, with each ticket (ADR) corresponding to one or more seats (ADS), depending on the theater’s rules (the exchange ratio set by the bank).

• If you buy 1 ticket (1 ADR), you might get 5 seats (5 ADS).
• If the theater rules state that 1 ticket can only occupy 1 seat, then buying 1 ADR equals holding 1 ADS.

This metaphor can help you better understand the difference between ADR and ADS. When you trade in the U.S. market, you mainly focus on the price and quantity of ADR, but you actually hold ADS, which are the shares of the foreign company. Remember that the bank will calculate your final investment value and dividend distribution based on the number of ADS and the exchange rate (e.g., 1 USD = 7.8 HKD).

Advantages and Risks

Investment Advantages

Investing in ADR offers several clear advantages, allowing you to easily participate in global markets:

1. Trading Convenience: You can buy and sell ADR directly in USD on U.S. exchanges without opening an overseas account or handling currency exchanges, greatly simplifying the cross-border investment process.
2. Expanded Investment Scope: ADR allows you to access stocks of non-U.S. companies, such as China’s Alibaba or Taiwan’s TSMC, which may have strong growth potential in regions outside the U.S. market.
3. USD Pricing: All transaction prices and dividends are calculated in USD, making it easy to manage your funds and reducing the hassle of currency settlements.
4. High Liquidity: Many ADRs are listed on major U.S. exchanges with active trading. For example, TSMC ADR typically has higher trading volume than its local stocks, making it easier for you to buy and sell.

Investing in ADR is not only convenient but also helps you diversify your portfolio, reducing the risk of relying on a single market.

Risk Factors

Despite the multiple advantages of ADR, you still need to be aware of the following risks:

• Information Transparency: Some foreign companies may not provide the same level of financial disclosure or transparency as U.S. companies, which may affect your understanding of the company and investment decisions.
• Market Risk: The price of ADR is influenced by fluctuations in the original stock’s market. For example, when the Chinese market experiences volatility, the price of Alibaba ADR may decline simultaneously
• Fees: Banks may charge additional fees for managing ADR, such as dividend distribution fees or custody fees. These fees can impact your actual returns.

Tip: Before investing in ADR, carefully research the financial condition and market performance of the related company, and understand any fees that may be involved.

Exchange Rate Impact

Exchange rate fluctuations are a factor you cannot ignore when investing in ADR. Although you trade in USD, the dividends paid by foreign companies are typically calculated in local currency. The bank will convert these dividends into USD and distribute them to you. If the local currency depreciates against the USD, the dividends you receive may decrease.

For example, if you hold TSMC ADR and TSMC pays dividends in New Taiwan Dollar (TWD), if the exchange rate changes from 1 USD = 30 TWD to 1 USD = 35 TWD, the USD dividends you receive will decrease.

Reminder: Exchange rate fluctuations not only affect dividends but may also impact ADR prices. When the local currency depreciates, the ADR price may decline, further affecting your investment returns.

Participation Methods

Account Opening

If you want to participate in ADR trading, you first need to open a U.S. brokerage account. You can choose to open an account directly with a U.S. online broker (e.g., Interactive Brokers, Charles Schwab) or through the overseas securities services of a Hong Kong bank. The account opening process generally includes the following steps:

1. Prepare identification documents, such as a valid passport or Hong Kong ID.
2. Prepare proof of address, such as a bank statement or utility bill.
3. Fill out an online application form and submit personal information.
4. Upload the required documents and wait for the broker’s review.
5. After the account is successfully opened, transfer funds (e.g., USD) to the designated brokerage account. You can arrange a wire transfer through a Hong Kong bank, remembering to include a reference note to identify yourself during the transfer.

Tip: You can pre-establish a designated account with a Hong Kong bank to facilitate future regular transfers to the U.S. broker, reducing processing time.

Trading Steps

After completing account opening and funding, you can start buying and selling ADR. The general operation process is as follows:

1. Convert to USD and arrange a wire transfer from a Hong Kong bank to your U.S. brokerage account.
2. Log in to the brokerage platform, search for the ADR you want to invest in (e.g., Alibaba, Tencent, TSMC).
3. Enter the quantity and price to buy, place the order, and wait for execution.
4. After the trade is executed, you can check your holdings and quotes on the platform anytime.
5. When dividends are received, the bank will automatically convert foreign currency dividends into USD and deposit them into your account.

You can refer to the table below to compare the trading process and costs of TSMC Taiwan stocks and TSMC ADR:

You can see that trading ADR is not only simple, but some brokers also offer zero-commission benefits. However, wire transfer and tax costs need special attention. Popular ADRs include Alibaba (BABA), Tencent (TCEHY), and TSMC (TSM), which are familiar choices for Hong Kong investors.

American Depositary Receipts (ADR) provide you with a simple way to invest in companies from China or other countries in the U.S. market. Its convenience and USD pricing features allow you to participate in global markets without handling currency exchanges or overseas accounts.

However, when investing in ADR, you need to be aware of some key risks. For example, exchange rate fluctuations may affect your dividend income, and some foreign companies may have lower information transparency, increasing investment uncertainty.

Tip: Before deciding whether to invest in ADR, carefully assess your risk tolerance and investment goals. This will allow you to better utilize ADR to expand your portfolio and achieve financial growth.

FAQ

Is ADR Suitable for All Investors?

ADR is suitable for investors who want to invest in foreign companies without dealing with currency exchanges or overseas accounts. If you seek a simple trading process and the convenience of USD pricing, ADR is an ideal choice. However, you need to consider risks related to exchange rate fluctuations and information transparency.

How Are ADR Dividends Calculated and Distributed?

The bank will convert the dividends paid by the foreign company into USD and distribute them to you. The dividend amount depends on the original stock’s dividend and the ADR exchange ratio. For example, if the exchange ratio is 5:1, you can receive dividends for 5 shares per 1 ADR you hold.

What Fees Are Involved in Investing in ADR?

You may need to pay bank management fees, such as dividend distribution fees or custody fees. Some brokers may offer zero-commission trading, but wire transfer fees to a U.S. brokerage account are typically around 33 USD.

Does the Price of ADR Sync Completely with the Original Stock?

The price of ADR is usually related to the price of the original stock but may differ due to exchange rate fluctuations or market supply and demand. For example, when the local currency depreciates, the ADR price may decline. Additionally, differences in trading hours can affect price synchronization.

How to Check ADR Ticker Codes and Quotes?

You can enter the company name on a U.S. brokerage platform or financial website to look up the ADR ticker code. For example, TSMC’s ADR ticker is TSM. Quotes are displayed in USD, including the latest transaction price, bid-ask spread, and volume.

Tip: Use free tools like Yahoo Finance or Google Finance to quickly check ADR quotes.

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