Listing of Preference Shares and Perpetual Securities

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.
Perpetual
Securities
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.

While these moves provide
greater flexibility to companies to raise capital, it is necessary to pay
attention to the risks involved, particularly because these are novel in the
Indian capital markets. Even in the Asian markets, which have seen a greater
use of these instruments, there continues to be concerns on the part of
investors and regulators (
here
and
here).

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

4 comments

  • Hello Sir,

    I have two observations:-

    a) The article on one hand states- "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." ("First Part")

    But in the following para it states-
    "On the other hand, all corporates (whether banks or otherwise) are free to issue perpetual debt instruments." ("Second Part")

    I observe that in the First Part you have mentioned that only banks are qualified under the said guidelines to issue Both- perpetual NCRPSs AND innovative perpetual debt.

    However, in the Second Part you have diluted the above limitation stating that when it comes to issuance of perpetual debt "All corporates (whether banks or otherwise" are free to issue them.

    Could you please clarify what can be issued by whom? and that whether perpetual debt can be issued by corporates which are not banks?

    Thank You

    Rushab Dhandokia
    IVth Year
    institute of Law, Nirma University.

  • @Rushab. It appears that while banks can issue both perpetual non-convertible preference shares as well as perpetual debt, non-banking companies can issue only perpetual debt and not perpetual non-convertible preference shares.

  • @rushabh : even I agree with umakanth. Rushabh you can get your answer in your observation it self…as in first observation you found that banks are qualified under the said guidelines to issue Both- perpetual NCRPSs and innovative perpetual debt.i.e both PERPETUAL NCRPS and PERPETUAL DEBT
    And in second observation you found All corporates are allowed to issue perpetual debt. I.e corporates other than bank can not issue perpetual NCRPS.

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