SK Hynix’s 51% Arbitrage Trade Stymied by Strict Conversion Cap

One of the world’s most enticing arbitrage opportunities will remain off limits.

SK Hynix Inc. has capped the amount of its South Korea-listed shares that can be converted into its US-traded American depositary receipts at 2.5% of total shares outstanding, the Korea Securities Depository said, shedding light on a key issue that has been closely watched by investors since the company’s blockbuster US listing.

The limit is already fully used up through SK Hynix’s $26.5 billion ADR offering on July 10, KSD Chief Executive Officer Rhee Yunsu said in a phone interview. That means investors cannot turn Seoul-listed shares into ADRs unless existing ADR holders first convert their US-traded receipts back into Korean shares, creating room under the cap.

SK Hynix didn’t respond to a request for comment.

The issue has been a major focus for arbitrage traders since SK Hynix completed the largest-ever US share sale by a foreign company on July 10. Traders had been waiting for clarity on whether Korean shares could be freely converted into ADRs, a mechanism that typically helps keep prices in different markets closely aligned.

Without the ability to freely create new ADRs, traders have fewer ways to profit from price differences between Seoul and New York. That can allow the US-listed shares to trade at a persistent premium to the Korean stock.

SK Hynix’s ADRs have traded at premiums of as much as 51% to the Seoul-listed shares and were about 33% higher as of Wednesday. The conversion cap raises the possibility that the gap could remain wider for longer.

The ADR books are closed for issuance and cancellation until July 29, as newly issued common shares in Korea are not transferable until they are listed on the Korea Exchange, according to a notice from Citigroup Inc., the depositary bank for the ADRs.

The Korea Securities Depository acts as the country’s central securities depository and oversees the issuance and cancellation of depositary receipts linked to Korean stocks.

The structure resembles that of Taiwan Semiconductor Manufacturing Co., whose ADRs can be converted into local shares but not freely created from Taiwan-listed stock. As a result, TSMC’s US-traded shares have historically commanded a premium, trading on average 12.6% above the local listing over the past five years, according to data compiled by Bloomberg.

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