SK Hynix Sets ADR Conversion Cap, Leaving Arbitrage Traders Unable to Access Opportunity

According to Bloomberg, the Korea Securities Depository (KSD) said SK Hynix has set a cap of 2.5% of outstanding shares on the conversion of its Korean-listed ordinary shares into American Depositary Receipts (ADRs), indicating that this highly attractive arbitrage opportunity will remain underutilized in the short term.

Rhee Yunsu, CEO of KSD, said in a phone interview that the 2.5% quota has already been fully allocated to SK Hynix's $26.5 billion ADR issuance on July 10. In other words, unless existing ADR holders first convert their ADRs back into Korean ordinary shares to free up capacity, investors cannot convert Korean-listed shares into ADRs.

### Arbitrage Opportunities Restricted, Premium Likely to Persist

Since SK Hynix completed the largest foreign corporate IPO in U.S. history on July 10, the ADR conversion mechanism has been a focal point for arbitrage traders. The market had initially expected Korean ordinary shares to be freely convertible into ADRs, as such mechanisms typically help align prices between the two markets.

However, with no ability to freely increase ADR supply, arbitrage traders’ ability to profit from price differences between Seoul and New York is significantly constrained, allowing the U.S.-listed ADR to potentially maintain a premium over the Korean ordinary shares for an extended period.

The premium of SK Hynix ADRs over its Seoul-listed shares once reached as high as 51% and, as of Wednesday (22nd), still stood at approximately 33%. With conversion quotas limited, the ADR premium could persist for a long time.

### Mechanism Similar to TSMC ADR

SK Hynix’s ADR structure is similar to that of TSMC. TSMC ADRs can be converted back into Taiwan-listed ordinary shares, but new ADRs cannot be freely created from Taiwan shares, resulting in a long-term premium for its U.S.-listed stock. Bloomberg data shows that over the past five years, TSMC ADRs have on average traded at a 12.6% premium to their Taiwan shares.

Each unit of SK Hynix ADR represents one-tenth of a Korean ordinary share. According to regulatory filings, ADR holders can still apply to cancel their ADRs and receive the corresponding Korean ordinary shares.

According to an announcement by Citigroup (Citibank), the depositary bank for the ADRs, new issuance and cancellation of ADRs will be suspended until July 29 because the newly issued Korean ordinary shares cannot be transferred until they are officially listed on the Korea Exchange (KRX).

At the time of writing, SK Hynix’s U.S. ADR (SKHY-US) surged 6.7% in pre-market trading on Thursday. The company’s Korean ordinary shares closed up 4.9% in Seoul on Thursday.