How to sell rights entitlements on the stock exchange?

The COVID-19 pandemic has triggered a fundraising wave in the Indian corporate world for various reasons such as funding growth, repaying loans and working capital requirements. One of the ways in which some companies raise money from the public is by selling a small stake to its existing shareholders, by way of a rights issue. If you are a shareholder of a company, which has just announced a rights issue, you have the option to pay and subscribe to the rights issue. But these days many individuals’ financials are also in financial stress. Some may have money but may not be keen to invest more in a company in an uncertain environment. If you are one of those, then you have the option to encash your rights entitlements. But it comes with some caveats.

What are Rights Entitlements (RE)?

The concept of RE came into existence after SEBI's (Issue of capital and disclosure requirements) – ICDR regulations Amendment on December 26, 2019. When a company announces rights share, the offer clearly specifies the ratio in which the shareholders are offered to buy additional shares. For example, in the ongoing rights issue, shareholders of Deepak Fertilisers & Petrochemicals (DFPCL) are offered three equity shares for every 20 equity shares held. Such shares on offer by way of rights are termed as RE. After the aforesaid amendment, the regulator instructed crediting the RE to the eligible shareholder’s demat account. In simple words, a rights issue gives the shareholders a right to buy shares. You can choose to exercise the rights by buying these shares or you can choose not to buy the shares. Post-December 2019, you can sell your RE if you want to make some money.

How does it work?
Shareholders holding shares on the rights issue’s record date are eligible to receive RE. The RE are credited at least one day before the rights issue opens for subscription. The RE have a separate International Securities Identification Number (ISIN) code. They appear like any other share listed in your demat account.

How to sell rights entitlement in the secondary market?

RE can be sold in the secondary market the way you sell any other share held. RE sold are marked for delivery. Intra-day trading is not allowed in RE. Selling RE on the stock exchange is permitted until a few days before the issue closing date.

“Shareholders not keen to subscribe to their rights can sell it easily to those who want to buy at the traded price on the stock exchange,” says Kkunal Parar, Senior Research Associate, Choice Broking. Do assess the demand and supply for it looking at bid and ask quotes. Key in the order and hit the sell button. Your broker account reflects money credit after two days since the trades are settled following T+2 settlement system, like any other cash market sale. If you are a shareholder eligible to participate in the rights issue, then there is no need to pay any money to the company to obtain RE. The price of RE in the secondary market depends on various factors such as the difference between the rights issue price and the price of the share in the secondary market. It also depends on the investors’ interest.

Before the introduction of RE, the renunciation of rights used to happen offline. The investors used to fill up the renunciation form which used to come along with the rights application form. “Pricing was not derived through market mechanism and it was completely offline,” says Narendra Jain, Chief Operating Officer, IIFL Securities.

However, after the introduction of RE in demat form and allowing trading in it on a stock exchange has changed the scene. Since stock exchange can offer wide participation from both buyers and sellers, there is a fair chance of price discovery. For example, in the aforesaid rights issue of DFPCL, on the first two days of trading in RE has seen the price oscillate between Rs 26.65 and Rs 16.55 with volumes in excess of 1.5 lakh RE on both days, both exchanges put together.

As there is no cap or floor price as such and market forces are in control of the price, expect high volatility, sometimes much more than the stock price volatility. The price of RE and the price of fully paid equity share listed on the exchange will not be the same.

What if you do not sell on the exchange?

If you do not sell the RE on the stock exchange before the last date specified in the rights issue offer, still you can monetise RE offline. There is generally a gap of three days between the last trading date of RE and date of issue closing date. In this period, you can identify a buyer and transfer the RE to the buyer’s demat account using a transfer instruction. Ensure that such a transfer happens in such a manner that the buyer gets some time to apply for the rights, that is, before the issue closing date. Since the buyer knows that you do not have much options left, he may have an edge at the negotiation table. If both parties agree on the price, then you still take home some money.

If you neither sell your RE nor apply for rights, then the RE lapse with the closure of the rights issue.

What about Physical Shares?

You can submit your demat account details to RTA well before the rights issue starts in writing, if you are holding shares in physical certificate format. RE are credited in your demat account. If you do this well in advance, then you can sell your RE. If you apply after trading in RE stops on exchange, then also you can sell RE as explained above. “If you submit your details at least two days before the issue closes, then the RE are credited in your demat account and you can apply for rights, which are allotted to you after following due process in demat account only,” says Makarand Joshi, partner, MMJC and Associates LLP - a corporate compliance firm. No physical RE are issued to eligible shareholders holding physical shares.