ADR-Ordinary Arbitrage

A company listed in London also trades in New York as an American Depositary Receipt (ADR) — a US-listed certificate representing a fixed number of the London ordinary shares, held in custody by a depositary bank. Both instruments are claims on exactly the same company. Once you convert the ADR's dollar price back into pounds at the current exchange rate, it should match the London share price almost exactly, and when it doesn't, that gap is tradable.

The fair-value relationship

For an ADR representing $n$ ordinary shares, fair value is:

$$P_{ADR} = n \times P_{ordinary} \times \text{FX}$$

In words: the dollar price of one ADR should equal the number of ordinary shares it represents, times the ordinary share's local-currency price, times the exchange rate converting that currency into dollars. Because both instruments track the same underlying equity risk, any gap between the ADR's actual price and this fair value is — in principle — pure friction: temporary supply-demand imbalance in one listing versus the other, not a difference in what the company is worth.

Worked example

An ADR represents 2 ordinary shares. The ordinary trades in London at £24.00, and GBPUSD is 1.27, so fair ADR value is 2 \times 24.00 \times 1.27 = \60.96. The ADR is actually trading at \61.50 in New York — about 54 cents rich, or roughly 0.9%. A desk shorts the ADR and buys the equivalent 2 ordinary shares per ADR in London (hedging the FX exposure separately with a forward), locking in the 54-cent gap per ADR as the two prices converge, regardless of which way the underlying stock or GBPUSD subsequently moves.

What this means in practice

The trade is executed by market makers and arbitrage desks that can access both listings and the FX market simultaneously, keeping the gap small and short-lived in normal conditions — which is exactly why ADR prices usually track their ordinaries so tightly that most investors never notice the mechanism working underneath.