Preference shares -- keeping it simple

[GoSeigen]

It would be nice if someone could link to the OP on this thread https://www.lemonfool.co.uk/viewtopic.php?f=52&t=11253 or reply to him on similar lines. I'll be happy to answer any queries he or others may have...

Why not just register on that site and do it yourself? A little unreasonable to not do that but suggest somebody else do it for you IMHO.

The poster seems to managing very well on his own now. Just hope he doesn't start to get abuse now, as the conclusions he is reaching are not the same as other users' over there...

https://www.fixedincomeinvestments.co.u ... #post-2744

GS

[johnhemming]

To be fair he has accepted that there are preference shares which cannot be subjected to a return of capital as a consequence of a reduction of capital without a class vote. I don't think you have.

Once that is accepted then it is only a question as to how you determine which shares require a class vote. My view is that EU law requires all of them to have this, but in the absence of that is another question.

[Alaric]

Once that is accepted then it is only a question as to how you determine which shares require a class vote. My view is that EU law requires all of them to have this, but in the absence of that is another question.

The other point is that regardless of the legal or accounting methods by which it could be achieved, it was never the intention of those devising the issue terms that the "borrower" would be given unlimited powers to repay the capital at par should interest rates fall. Until Aviva, it was accepted that if the capital on this type of security was to be repaid, it would be at a market related price. The FCA seem to be trying to return to this position, or at least establish where issuers are intending to exploit the unintended loophole given by a requirement for class votes to not be as explicit as they ought to be.

A possible if unlikely resolution of these problems would be to convert all the Prefs standing well above par into ones that would currently trade at around par. Income investors would receive the same amount of income, but would have greater protection against being forcibly redeemed at par. You might expect though that a new issue would be very explicit about the issuers rights or lack of rights on this.

To clarify, if you have 100 "old" shares trading at 160, they are exchanged for 160 "new" shares trading at 100, the coupon being reduced to 100/160 of its previous value. This is equivalent to what's been happening in the Gilts market as stocks previously classified as "medium" and "high" coupon have disappeared.

[Wizard]

The FCA have now written to issuers of Preference Shares asking that they clarify their position regarding compulsory buybacks at other than a market price.

http://www.londonstockexchange.com/exch ... 10222.html

I have read this letter a number of times, trying to decide what it really means. My thoughts are as follows and I'd welcome the views of others.

Dear CEO,
Irredeemable preference shares and other similar capital instruments
The FCA is currently reviewing the prevailing market for certain fixed income shares, particularly those shares that are described as being perpetual, irredeemable or in some other way that suggests permanence.
The FCA wants to ensure investors have access to the information that they require in order to properly assess the risks and rewards attaching to such shares.

The FCA seems to suggest that it accepts there is confusion and that the use of words such as irredeemable or perpetual may have given investors a particular view on the nature of the preference shares. by saying they want to ensure investors have all the information they need it suggests to me that they think this may not have been the case up until now.

Recently, Aviva plc announced an ability to cancel certain irredeemable shares it had issued at or close to par value through a reduction of capital under the Companies Act. This announcement affected the market for and price of those irredeemable shares. The market prices of a number of other similar shares issued by other listed companies fell at the same time. One of these issuers announced subsequently that it did not intend to cancel the irredeemable shares it had issued. Aviva plc subsequently stated that it had decided to take no action to cancel its irredeemable preference shares. As far as we are aware, other listed companies with irredeemable shares, or similar types of shares, have not clarified their position.

The FCA has not challenged Aviva's assertion on capital reduction and so may very well think that in the case of Aviva the claim was valid.

Listed companies will need to consider whether any intention to cancel or otherwise retire a class of irredeemable shares, or similar shares, at a price based on factors other than the prevailing market price, or their company's deliberation on any such intention, constitutes inside information under Article 7 of the Market Abuse Regulation (MAR). Under Article 17 of MAR, inside information must be announced as soon as possible unless there are grounds for delay and must not be disclosed selectively or privately to individual investors.

Interestingly this does not cover decisions alone, even a discussion about doing it could be inside information, if for example an issuer concludes they can use the Aviva approach, even if they have not resolved to do so. The final part seems a clear warning not to speak to large institutional investors about this in private discussions.

In addition, you may wish to ensure that the following information is readily accessible to all holders and potential holders:
· The terms and conditions of the instrument as included in the original prospectus or similar document issued at the time of the offer and or admission of the shares;
· Details of any changes to the above that have been made post the issue of the shares;
· The articles of association of the issuer of the securities, especially those terms that are pertinent to the shares concerned, including the constituency and conduct of any relevant shareholder votes thereof; and
· A Q&A or similar publication, so that the information is clear and comprehensible for investors. Particular items that might usefully be clarified would include:
o The extent to which the rights attaching to the shares can be changed by the company without specific resolution of the affected class of securities;
o The existence of any ability to cancel the shares at a price that is less than the prevailing market price without the specific assent of the affected holders either individually or as a class; and
o Whether the company has made a decision regarding its approach to the use of either of the above, in particular where it has the ability to cancel the shares at par or at a price less than the prevailing market price (noting the point made above regarding the application of MAR).

The last two points are the most interesting to me, the FCA seems to be saying that the company should be pointing out a possibility of a capital reduction at par. It has previously been argued by some that if it is clear in legislation the company has no need to do these, I think the FCA may have a different view.

I would urge you to ensure that these details are available for your company's shares and also to consider, in conjunction with your advisers if necessary, whether there is a risk that the prevailing market price of any of your company's shares or other signals from investors suggest that there is a lack of understanding over the terms and conditions of those shares and/or your company's intention regarding them.

This suggests that if a company believes it can return capital at par and the shares trade well over par the company has an obligation to inform the market that it thinks the market is not taking account of this fact. The question then comes is whether this is a new obligation, or by not doing this in the past the company has opened itself up to action from investors who have bought instruments at prices well over par.

We recognise that there is a tension between investors' desire to see a permanent resolution to any remaining concerns and the desire of company boards not to limit their (and their successors') scope for action. However, in the event that you have publicly stated or propose to publicise your company's intentions regarding such securities, I would urge you to also set out the governance process and the approach to disseminating any future changes you might make.

Whatever you say now you have to explain how the position could be changed in the future, and this is not a one off, but an ongoing requirement to keep the market updated with any change in thinking.

I trust that you will understand the reasons for this letter and that you share our desire for the UK's securities markets to work well and in the interests of all their participants. If you have questions about the contents of this letter please contact the FCA's Market Integrity Unit via email at Primary.market.integrity@fca.org.uk. I would also note that the FCA will publish this letter on our website and via a Regulatory Information Service.

Terry.

[johnhemming]

The FCA has not challenged Aviva's assertion on capital reduction and so may very well think that in the case of Aviva the claim was valid.

I am pretty certain the FCA does not have any authority to challenge Aviva's assertion. It would be the courts that would have to determine this. They may as individuals have private views, but the organisation is a public authority, but not a court.

[stockton]

I am pretty certain the FCA does not have any authority to challenge Aviva's assertion.

Which takes us back to the old problem that, in practice, there is nobody to represent the purchasers of the securities.
Are regulators really so restricted that they cannot perform their functions effectively ?

[Alaric]

it suggests to me that they think this may not have been the case up until now.

Until Aviva suggested otherwise, presumably they believed like the market participants, that there were safeguards in place to prevent a series of future cash flows worth say 160 unencumbered, not to be capable of being arbitrarily compulsory purchased at 100. That such a proposed action would require a class vote and court sanction being a possible safeguard.

As others have suggested, if the Companies Act is deficient or poorly worded, the FCA don't have direct powers to change it.

[johnhemming]

I am pretty certain the FCA does not have any authority to challenge Aviva's assertion.

Which takes us back to the old problem that, in practice, there is nobody to represent the purchasers of the securities.
Are regulators really so restricted that they cannot perform their functions effectively ?

Its not a function of the regulator it is a function of the courts.

There are separate processes.

I think their request for a letter is a helpful step that will probably result in all of the issuers saying they won't try (or their instruments cannot be handled through a reduction in capital without a class vote.

[GoSeigen]

Stockton, this is a misrepresentation of the situation:

https://www.fixedincomeinvestments.co.u ... #post-2824
A reduction of capital is a reduction of issued capital. Companies are formed with issued capital and registered with companies house. In theory the amount of issued capital gives protection to creditors remembering that (the shareholders of) limited companies have limited liability.

There are rules about reducing the amount of capital that exist to protect creditors. Hence there are circumstances where capital needs to be reduced before shares can be redeemed.

The fact that there are shares that have call or put options are are called “redeemable shares” does not mean that other shares cannot be redeemed in some way or indeed changed to redeemable shares.

The reduction of capital is a separate step to paying anyone for their shares.




Below I repeat the above text with corrections in italics. If you have questions about any of it please ask me for legal references -- I am happy to supply them. Also, please read Chris Nix's posts where he explains exactly the same as I do below:

A reduction of capital is a decrease of issued capital in any manner including by repayment of paid-up capital. Companies are formed with issued capital and registered with companies house. In theory the amount of issued capital gives protection to creditors remembering that (the shareholders of) limited companies have limited liability.

There are rules about decreasing the amount of capital that exist to protect creditors. Redeemable shares have the absolute right to be redeemed whenever their terms allow [recall that redeeming a share cannot decrease the capital of a plc]. Irredeemable shares do not have this right: they cannot be redeemed at all. However, any share, even an irredeemable share, can still be repaid and cancelled in a reduction of capital, which may decrease the company's capital.

The fact that there are shares that have call or put options at issue or indeed the absolute right to repayment and are called “redeemable shares” does not mean that other shares cannot be repaid in some way. However these other shares can NEVER be changed to redeemable shares. Redeemable shares MUST be made redeemable at the time of allocation (issue) by inclusion of explicit terms of redemption.

GS
EDIT: I'll just note that it's very unhelpful in this discussion to use terms with a specific meaning in the Companies Acts (and therefore also in company Articles) using both that meaning and another distinct (everyday) meaning. Examples from the above quotation are:
redeem: used by the author in both the legal sense and with an everyday meaning of repay/buy back and cancel etc
reduce capital: used in both the legal CA2006 sense and the more general sense of decreasing capital

I have substituted different words above to make these distinctions absolutely clear. Legal language is precise and we would be well advised to use precision when discussing it.

[Alaric]

There was a grouping of undated Government debt frequently classified as "irredeemable". The Government when Osbourne was Chancellor redeemed them. I believe it was fully known and priced that he could do that. Perhaps just as well he did, imagine the protests had these issues been allowed to climb well above par and then repayment at par was proposed.

The term "irredeemable" is used outside the UK. An IT investing in international fixed interest publishes its list of holdings. Non-sterling issues feature the word in their title, so what the UK Companies Act does or does not permit is irrelevant in a broader definition.

My view is that it was never the intention of the issuers and original subscribers to the issues to grant the issuers unconstrained rights to repay at par should the issue price rise above par. If implementation of that relies on Directors "doing the right thing", there are evident deficiencies in the wordings of the Companies Act or the issue documentation or both.

[GoSeigen]

1. A reduction of capital is a decrease of issued capital in any manner including by repayment of paid-up capital. Companies are formed with issued capital and registered with companies house. In theory the amount of issued capital gives protection to creditors remembering that (the shareholders of) limited companies have limited liability.

2. There are rules about decreasing the amount of capital that exist to protect creditors. Redeemable shares have the absolute right to be redeemed whenever their terms allow [recall that redeeming a share cannot decrease the capital of a plc]. Irredeemable shares do not have this right: they cannot be redeemed at all. However, any share, even an irredeemable share, can still be repaid and cancelled in a reduction of capital, which may decrease the company's capital.

3. The fact that there are shares that have call or put options at issue or indeed the absolute right to repayment and are called “redeemable shares” does not mean that other shares cannot be repaid in some way. However these other shares can NEVER be changed to redeemable shares. Redeemable shares MUST be made redeemable at the time of allocation (issue) by inclusion of explicit terms of redemption.

GS
4. EDIT: I'll just note that it's very unhelpful in this discussion to use terms with a specific meaning in the Companies Acts (and therefore also in company Articles) using both that meaning and another distinct (everyday) meaning. Examples from the above quotation are:
redeem: used by the author in both the legal sense and with an everyday meaning of repay/buy back and cancel etc
reduce capital: used in both the legal CA2006 sense and the more general sense of decreasing capital

I have substituted different words above to make these distinctions absolutely clear. Legal language is precise and we would be well advised to use precision when discussing it.

Just quoting relevant parts of Chris Nix's reply this morning in the other place which corroborate my statements above, with my own commentary added [in bold in brackets]:

https://www.fixedincomeinvestments.co.u ... #post-2827
Although it is easy for non-professional investors to be confused by the ordinary meaning of redeem, its meaning in this situation is plain. [See my para 4. above about dual meanings and precision.]

The first operative sentence of Part 18 (Purchases of own shares by Companies) of the Companies Act states, ‘A limited company must not acquire its own shares, whether by purchase, subscription or otherwise, except in accordance with the provisions of this Part.’.

The exceptions are in effect exceptions from the need to get a court to approve a reduction of capital, before return and cancellation.

The terms in companies’ articles and which refer to redemption enable the exception to apply through compliance with Chapter 3 of Part 18: that is why a redeemable preference share is able to be redeemed without a court scheme. A non redeemable pref is simply one which cannot be redeemed under this exception. [See my para 3. above.] It can always be reduced/returned/cancelled, subject to court approval. [See my para 2. above, last sentence.]

So in this context redemptions are repurchases of own shares which don’t require a court sanction, which returns always do. [A bit unclear -- I'd say: "So in this context redemptions and repurchases of own shares are repayments which don’t require a court sanction, which returns of capital always do."]


GS

[GoSeigen]

There was a grouping of undated Government debt frequently classified as "irredeemable".

I don't dispute this or the subsequent text (yet), but it is couched in vague language which of course provides deniability if challenged!

Polite request: It would be very helpful if you would name the specific gilt(s) and the precise context in which the word "irredeemable" was used. Then one could judge the applicability of the reference without having to trawl the internet in the vague hope of hitting on what you mean! [EDIT: and link to its/their terms if possible please.]

Incidentally I'd doubt the CA2006 applies to that gov't debt, so a case for relevance to the current discussion might also need to be made. Further aside: the word irredeemable actually appears in CA2006, but in reference to debentures so I have never made anything of it -- helpful though it might be -- in the interests of not muddying the waters.


GS

[GoSeigen]

Quote: "A redemption is a subset of a return of capital."

I say it again. A redemption might reduce the specific share capital being redeemed but it NEVER decreases the capital of the company as a whole. (Because the company's redemption reserve is simultaneously increased in a redemption.) As such it is misleading or incomplete to call it "a subset of return of capital".

Further, a redemption is entirely distinct from a Reduction of Capital (as mooted by Aviva). Not a subset. Not a superset. Not a synonym.

GS

[Alaric]

Polite request: It would be very helpful if you would name the specific gilt(s) and the precise context in which the word "irredeemable" was used.

Surely as someone claiming to be an expert in financial matters you are familiar with the old divisions of the Gilt market into low, medium and high coupon and short, medium , long and undated/irredeemable classifications?

A dictionary for example
https://dictionary.cambridge.org/dictio ... able-gilts

The FT
http://lexicon.ft.com/Term?term=irredeemable-gilts

A text book
https://books.google.co.uk/books?id=4wi ... ts&f=false

Although regarded as part of the "Irredeemable" classification, the 3.5% War Loan was strictly speaking 1952 or later and back in the late 1940s when the UK government had kept interest rates low, the stock had been classified as a "short".

[stockton]

Further, a redemption is entirely distinct from a Reduction of Capital (as mooted by Aviva). Not a subset. Not a superset. Not a synonym.

This is probably the most appropriate point to ask for some form of legal authority.

[GoSeigen]

Polite request: It would be very helpful if you would name the specific gilt(s) and the precise context in which the word "irredeemable" was used.

Surely as someone claiming to be an expert in financial matters you are familiar with the old divisions of the Gilt market into low, medium and high coupon and short, medium , long and undated/irredeemable classifications?

I'm familiar with those divisions but am absolutely not expert on what you are thinking, which is why I asked for clarification.

A dictionary for example
https://dictionary.cambridge.org/dictio ... able-gilts

The FT
http://lexicon.ft.com/Term?term=irredeemable-gilts

A text book
https://books.google.co.uk/books?id=4wi ... ts&f=false

Although regarded as part of the "Irredeemable" classification, the 3.5% War Loan was strictly speaking 1952 or later and back in the late 1940s when the UK government had kept interest rates low, the stock had been classified as a "short".

Thank you, especially for the link to the wonderful textbook by the estimable Moorhad Chowdhry.


Irredeemable in these contexts of course means "undated" or having no fixed redemption date, which we note is the essence of the CA2006 usage in respect of shares.

It is obvious from Chowdhry's book that irredeemable does not mean a gilt cannot be repaid, merely that the date of such repayment is not known or specified a priori. The book is further very clear that this is a disadvantageous feature of a gilt and indeed holders of these undated gilts were routinely rewarded with higher yields than dated issues of similar duration.

Any preference shareholder reading the relevant parts of this text would have had ample warning of the risks implicit in the term "irredeemable".


GS

[GoSeigen]

Further, a redemption is entirely distinct from a Reduction of Capital (as mooted by Aviva). Not a subset. Not a superset. Not a synonym.

This is probably the most appropriate point to ask for some form of legal authority.

No problem.

Companies Act 2006 Part 17 Chapter 10 Reduction of Capital, sections 641-653 deals with Reduction of Capital. When you read it you will see that redemption is not mentioned at all in this context.

Companies Act 2006 Part 18 Chapter 3 Redeemable Shares, sections 684-689 deals with Redemption. When you read it you will see reduction of capital is not mentioned at all in this context. See also s733 and how it applies to Redemption but not to Reduction of Capital.


GS

[johnhemming]

A reduction of capital is a reduction of issued capital. There is no need for any payment to shareholders at the time of the reduction of capital.

[Alaric]

Further, a redemption is entirely distinct from a Reduction of Capital (as mooted by Aviva). Not a subset. Not a superset. Not a synonym.

I think it's just you and Aviva's lawyer who believes that. The term Irredeemable is used both historically and internationally, so definitions requiring interpretations of a 2006 Companies Act aren't particularly useful.

Whilst irredeemable stocks, bonds and Gilts can be repaid by various devices, it would have been a market understanding and practice that repayment using whatever accounting and legal devices were appropriate would only ever take place at the market value of the future income being cancelled. That is unless there was a clear understanding that an explicit pay back clause existed as with the UK Government's 3.5% War Loan that was dated 1952 or later but for as long as new borrowing required a yield in excess of 3.5% would not be redeemed. Markets up to the 2010s therefore classified it as irredeemable.

[Alaric]

There is no need for any payment to shareholders at the time of the reduction of capital.

You see this from time to time with ordinary shares. Either you get more shares of a lower nominal value or fewer shares of a higher nominal value. It's all to do with how the share capital is shown in the books and connects with the legality of paying a dividend.