Corporate Actions

Rights Issues Explained

A Rights Issue is an issue of new shares to existing shareholders pro-rata to the current shareholding at a fixed price (usually at discount to market price).

If the company you have invested in announces a rights issue, this means that they are placing more shares in the market to raise capital. To encourage people to buy the new shares, they offer shares to existing shareholders, often with a discount to the market, as an incentive to take them up.

A rights issue is offered to all existing shareholders individually and may be rejected, accepted in full or accepted in part. Rights are often transferable, allowing the holder to sell them on the open market.

Rights can be renounceable (can be sold separately from the share to other investors during the life of the right) or non-renounceable (shareholders must either take up the rights or let them lapse. Once the rights have lapsed, they no longer exist.).

A right to a share is generally issued on a ratio basis (e.g. one-for-three rights issue). Key terms:

  • Subscription price per new share, or the “call price”. This is the cost per new share to you.
  • Distribution ratio – this is the ratio of nil paid rights you will receive on ex-date, e.g. 1 nil paid for every 20 shares held.

Because the company receives shareholders’ money in exchange for shares, a rights issue is a source of capital.

The new shares issued are called ‘nil paid’ (as they are not yet paid for). Shareholders receive a nil paid allotment letter from the company, indicating how many nil paid shares the shareholder has been issued with. These nil paid shares are traded on the stock exchange, pricing around the difference between the market price and the ‘issue price’. Nil paid shares commence trading on effective/ex date. The shareholder has up until the ‘Last date for acceptance and Payment’ to pay for the nil paid shares if they decide to take up the rights issue.

Example of a Rights Issue

For a current example see the Prudential Rights Issue. An investor holds 200 shares of UKCompany PLC.  The market price of the shares stand at 100p and the company then announces a “one for four” rights issue. The subscription price for the extra shares is set at 80p.

The value of the holding before the rights issue was:
200 shares at 100p = £200.00
To take up all the rights, the investor will have to purchase 50 new shares at a price of 80p, so the total amount of money that will pass from the investor to RightsCo is:
50 shares at 80p = £40.00
So, after the shares goes ex-rights (usually a few weeks after the initial announcement and meaning that anyone buying them no longer has the right to buy the new shares) the share price, known as the ex-rights share price, will be:

Total value of investment              £200.00 + £40.00
___________________     =     _______________     =  96p
Total number of shares held             200 + 50

Rights issues are often underwritten by investment banks and asset management houses. The role of the underwriter is to guarantee that the funds sought by the company will be raised. The agreement between the underwriter and the company is set out in a formal underwriting agreement.

Options Available in a Rights Issue

Shareholders have following options of what actions to take.

  • Sell “nil paid” shares on the stock market
  • Let the rights lapse by taking no action
  • Pay the “call” and take up the rights
  • Pay the “call” on part of your holdings and let the others lapse

If you hold rights in an ISA, you can sometimes sell some of your nil paid rights to take up the remaining rights. This allows you to take advantage of a rights issue even if you have already invested your maximum allowance for the year.

Key Dates in a Rights Issue

  • Ex date – this is the date that the nil paid rights are issued, and often also the first trading day
  • Pay date for call – this is the date that you will be debited the call price if you chose to “take up” your rights, i.e. subscribe for new shares.
  • Pay date for receipt of new shares – physical settlement may occur after the call date in some cases.

European rights issues work slightly differently to UK issues, in that on ex-date sub-rights are issued at a rate of 1 sub-right per share. The conversion ratio is then applied on pay date.

What is a Corporate Action?

A corporate action is defined as an event instigated by a company that may affect the share capital. Events may be voluntary or mandatory, may impact stock (increasing, decreasing or changing the stock held) or cash (payment or receipt) or may confer a different right such as voting at company meetings or any combination of the above. Underlying shareholders often have to make decisions on voluntary events based on a set of options, such as cash or stock on dividends, or to accept a rights issue or convert warrants.

“When a publicly-traded company issues a corporate action, it is initiating a process that brings material change to the company and affects its stakeholders.  Corporate actions are typically determined by a corporation’s Board of Directors and authorised by the shareholders.” Source: SWIFT.com

SWIFT define around 60 different types of corporate action although in practice these can be grouped into about 25 different issues. Examples of corporate actions include rights issues, bonus issues, take-overs, liquidations, class actions and conversions. Corporate Actions administrators working for Asset Management Houses, Registrars, Custodians, Fund Administration Service Companies and various Information Providers all look after all types of equity and bond instruments and are responsible for processing corporate actions across a wide range of accounting systems. Types of fund include investment trusts, unit trusts & OEICs, life funds, pension funds, charities, international accounts, SICAVs, and retail accounts (PEPs, ISAs, savings schemes, investment funds).

The first stage of the corporate action process is to identify that an issue is occurring. The primary data suppliers for corporate actions are custodians and data vendors such as Bloomberg and FTS. Other data vendors including Reuters, and the LSE are used to validate data.

Many corporate actions require the update of fund accounting systems to amend stock and cash positions. Where updates are required, these need to take into account the timing of NAVs for individual accounts. Where corporate actions affect the price of the parent asset, this change in price is used to confirm an issue has occurred.

The decision you make on a corporate action can affect the future value of your shareholding. For example, if you are accept the option to receiving new shares by way of a dividend reinvestment plan, and later the stock market crashes, you potentially lose a greater part of your portfolio. However, the reverse can also be true. But the choice is yours.