In its board meeting yesterday, SEBI announced that it would issue a new set of regulations governing the listing of non-convertible redeemable preference shares and perpetual securities. More than a decade ago, companies used the issue of preference shares as a mode of raising capital from the public, particularly because that did not result in a dilution in equity shareholding (and consequently control of the company) since preference shares do not carry voting rights except in very specific circumstances. However, lately, the issue of preference shares has been of our favour, at least as a method of raising capital from the public. This new set of regulations proposed by SEBI seeks to reinstate preference shares as a form of capital raising instrument for companies, and also to enable the issuance perpetual debt instruments.
Redeemable Preference Shares
The proposed regulations provide a framework for public issuance of non-convertible redeemable preference shares (NCRPSs) and also for listing of private placed redeemable preference shares. As these instruments are perceived to be risky, SEBI proposes a minimum tenure of 3 years for the instruments and a minimum rating of “AA-” or equivalent.
Apart from commercial considerations for companies and investors, a lot would depend upon the exact process for issuance of these instruments, and whether that would be more attractive compared to plain-vanilla equity offerings. The severity or ease of disclosure requirements is one such factor.
Moreover, from a regulatory perspective, while these instruments can be made readily available to domestic investors, there could be some regulatory hoops to jump through for foreign investors. Under the current FDI Policy, only fully and mandatorily convertible preference shares are available for foreign investment under that policy. Any non-convertible instrument would be treated as debt and subject to the more onerous terms of RBI’s external commercial borrowings policy. Hence, unless specific provisions are made under the FDI policy for public issuance of NCRPSs or unless RBI is willing to provide specific approvals for foreign investment in public issue of NCRPSs, the new method may not be attractive. This is particularly because a substantial part of the interest in public offering of securities of Indian companies is usually generated from overseas.
A perpetual security, usually in the form of a corporate bond or other debt instrument, is issued by a company without any obligation to redeem it from the investors. Such an instrument only provides a steady income flow to the investor. In that sense, it is akin to equity, and ranks fairly low in priorities. The issuer may, however, retain a call option whereby it might wish to redeem the security at some point in time. Although a fairly old instrument, I have begun to notice its use more often in the last couple of years, especially in the Asian markets.
In the new proposal, SEBI would allow banks to issue perpetual NCRPSs and innovative perpetual debt instruments. Judging from the limited information available from SEBI’s press release, this facility is available only for banks and not for other types of issuers. This also ties in with the fact that such instruments are permissible for inclusion in additional tier I capital for banks under the Basel III norms, as SEBI’s press release itself emphasizes.
This move follows the Banking Laws Amendment Act that came into effect earlier this year. Previously, banks were not allowed to issue preference shares. However, following this recent legislative change, banks have the flexibility to issue both equity and preference shares (“whether perpetual or irredeemable or redeemable”). This facility of issuing perpetual or irredeemable preference shares is available only banks because other types of companies are bound by the Companies Act, 1956 (section 80(5A)) which prescribes a maximum tenure of 20 years for preference shares, following which they must be redeemed. This position is set to continue in the Companies Bill, 2012 as well (section 55(1)).
On the other hand, all corporates (whether banks or otherwise) are free to issue perpetual debt instruments. There appears to be no restriction either in the Companies Act or the Companies Bill for issuance of such securities. In fact, there is evidence of the recent use of such instruments in India to raise debt.