What is ADR?

Views 118K Oct 14, 2024

What is ADR? -1

Before explaining ADR/ADS, let's first understand the issuance rules for non-US companies listing on US stock exchanges.

According to relevant US government policies, companies registered outside the US are not allowed to list directly in the US. Therefore, if overseas companies want to raise funds in the US market, there are two paths:

  1. Direct listing: Register a company in the US and then package the listing entity under a US company.

  2. Indirect listing: List through ADR/ADS.

Compared to places like Cayman Islands and the British Virgin Islands, the US government has much stricter regulations on listed companies, with longer listing times, higher costs, and heavier taxation. Therefore, many companies choose the indirect listing method, that is, listing through US depository institutions issuing ADR/ADS.

What is ADR?

ADR, or American Depository Receipts, are issued by US depository banks and sold to US investors and traded on US stock markets. Each ADR represents a certain number of shares of the corresponding listed company according to the corresponding exchange rate.

For example, assuming that ABC Company (a fictional Australian company) trades on the Australian Securities Exchange at a price of 6.7 Australian dollars (5 US dollars), a US bank buys a certain quantity of ABC Company stocks at a ratio of 2:1 and sells ADRs. Therefore, each ADR represents two shares of ABC Company's stock and should be sold at a price of 10 US dollars.

ADRs are held in the insurance warehouses of the U.S. banks that issue them. ADRs simplify the process of trading foreign stocks: because only receipts are traded, investors do not need to worry about any exchange rate differences or the need to open a specialized brokerage account, and they enable investors to receive all dividends and capital gains.

What are ADS?

ADS, or American Depository Shares, are the actual underlying stocks represented by ADRs.

You can think of ADRs as proof of ownership of ADS for investors, just as a property certificate is to a house. When trading, the property certificate is transferred, there is no need to move the house. However, typically one property certificate can only represent one house, whereas one ADR can represent multiple quantities of ADS.

For example, a British company XYZ Company can conduct ADR trading on the New York Stock Exchange. These ADRs can be issued at a ratio of 5 ADRs to 1 American Depository Share (5:1) or any other ratio chosen by the company.

What is the difference between ADR and ADS?

1. In terms of face value:

The face value of ADS is mostly only a fraction of the face value of the underlying stocks used as collateral, while ADRs mostly represent several units (such as 10 shares) of the underlying stocks as one unit of ADR.

2. Different ways of initiation:

ADS is initiated by stock issuing companies that wish to attract American investors without being listed on the US market. ADR represents the equity of foreign stocks that can be purchased by American citizens and is initiated by banks and brokerage firms.

3. Different principals:

ADS is issued in the US by authorized trustees of foreign companies. ADR is a transferable certificate issued by US commercial banks to assist foreign securities in trading in the US.

Is there a difference between Tencent Holdings ADR (TCEHY) and Alibaba ADR (BABA)?

Returning to a knowledge point we want to focus on today, why do some Chinese concept stock ADRs look different?

There are mainly two types: one is companies that have officially listed and traded ADS in the United States, such as Alibaba, PDD Holdings, Futu Holdings Ltd, Nio Inc, and so on; the other type is companies like Tencent Holdings ADR (TCEHY), Meituan ADR (MPNGY), BYD Company Limited ADR (BYDDY), which have not been formally listed on the US stock market and only trade in the OTC market.

Generally speaking, the first type of ADR, because it is officially listed and traded, has a good trading volume and market activity. The second type of ADR, being OTC traded, usually has a smaller trading volume and may have liquidity issues.

What is the relationship between Tencent (00700.HK) and Tencent ADR (TCEHY)?

In essence, both are stocks of Tencent, with one trading on the Hong Kong stock market and the other on the American stock market. Tencent ADR is a portion of Tencent's stocks held by a qualified US institution's Hong Kong branch, with the corresponding ADR traded in the US market by the institution's headquarters in America.

Both prices are linked, one in US dollars and the other in Hong Kong dollars. Generally speaking, the price of Tencent HK stock is the primary one, with trading taking place earlier. The trend of Tencent ADR will be influenced by the movement of Tencent HK stock.

It is worth mentioning that many companies now often release important information after the close of trading in Hong Kong, such as annual and quarterly reports. The timeliness of information in the capital markets is global. Therefore, based on the situation in recent years, after Tencent releases its financial report, during the U.S. trading session on the same day, its Tencent ADRs often experience significant price fluctuations due to the impact of major news. This kind of fluctuation can then affect the price of Tencent's Hong Kong stocks on the following day’s opening in the Hong Kong stock market.

The correlation of the stock prices mentioned above is not absolute but requires investors' close attention. Should there be noticeable price differences between the two markets, arbitrage opportunities may arise.

Disclaimer: The above content does not constitute any act of financial product marketing, investment offer, or financial advice. Before making any investment decision, investors should consider the risk factors related to investment products based on their own circumstances and consult professional investment advisors where necessary.

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