Takers For Listed Prefs?

Non-convertible redeemable preference shares…it’s quite a mouthful; isn’t it? but i am saying it not for nothing. SEBI recently approved the listing of this instrument and guidelines are on their way. A preference share is a commonly used fund raising instrument – that’s neither fully equity nor fully debt. For companies, it’s a capital raising instrument that comes without equity dilution and yet does not need the backing of company’s assets. For investors, preference shares rank higher in dividend payout compared to equity shareholders and get repayment preference in case of winding up situations. But is there a market for listed prefs? Payaswini Upadhyay puts that question to experts.

In the past 3 years, more than Rs 25,000 crore was raised through non-convertible redeemable preference shares. In the last year itself there were 140 such issues – but all via private placements as currently, there is no framework that allows for the listing of preference shares of any kind. Prakash Nene
MD, Multiples Alternate Asset Management
“My guess is most of it would be for internal restructuring and the reason is very clear. What happens is that you want to give money to your group company or subsidiary- if you give as a debt, there is a deduction of tax at source, regulatory restrictions related to inter-corporate loans. Here you make a non-cumulative preference capital where if there is a profit, you pay. So the whole idea is not to get any return but just to give money without any hassles- it’s a very neat way of doing it.” For instance, in January this year, IITL Projects issued 12% non convertible cumulative redeemable preference shares to the promoter holding company- Industrial Investment Trust. In 2011, Aditya Birla Money allotted 8% Non Convertible Non Cumulative Redeemable Preference Shares to its holding company - Aditya Birla Financial Services D Muthukumaran
Head-Group Corporate Finance
Aditya Birla Group
“Currently, this particular instrument is reasonably niche and is issued by companies looking for an opportunity within a context- for eg- NBFC companies, by  nature, will raise lots of capital through variety of instruments, so they do such issuances. Also, infra companies who are having a backended tax income are also appropriately suited to do such capital raising because this is a subordinate capital issuance compared to any other form of debt and the company which is not currently paying much tax will not miss the tax deduction on the interest and they will be neutral to issue a irredeemable preference shares and they will also benefit from the tax angle.” And now, the listing of this instrument may prove to be an additional advantage. The detailed guidelines are pending but SEBI has already specified that non-convertible redeemable preference shares being sold via a public issue must carry a minimum tenure of 3 years and a minimum rating of AA-. In case of privately placed prefs issues that want to list, the minimum application size per investor has been set at Rs 10 lakh. 
Prakash Nene
MD, Multiples Alternate Asset Management
“Once you have a listing, especially when you have private equity kind of investors or mezzanine fund kind of an investor who have a limited life and who want to get out, now if company cannot return the money because of capital intensity or the nature of the business or anything, so you have a listing arrangement now whereby you can sell it to somebody else otherwise the exit mechanism was restricted to one person to another person; in the listing, it is one to many- you have much more options available.” D Muthukumaran
Head-Group Corporate Finance
Aditya Birla Group
“This is an important first step by SEBI to create one more avenue for capital raising for companies. I am not sure at this point in time if there are lots of issues pending waiting as soon as the detailed guidelines are issued. However, this opens up a big avenue for capital raising for companies because listed securities can attract lot more investors than unlisted security. For eg- FIIs, insurance companies, mutual funds, non-banking financial companies- some of them can only invest in listed security- and some of them can do bigger ticket transactions if it is a listed security.” But FIIs may not have access to listed non-convertible redeemable pref shares. At least not under the current regulatory framework which categorizes foreign investments in non-convertible, optionally convertible or partially convertible preference shares as debt finance, subject to strict ECB guidelines. That brings with it several restrictions including end use, eligible borrowers, recognized lenders, amount and maturity. Manan Lahoty
Partner-Capital Markets, Luthra
“There is an anomaly today in the RBI regulations- where FIIs are permitted to buy non-convertible debentures without them being called ECBs, that's not the case with non-convertible preference shares. So there is clearly a need for RBI to look at this again and bring it in line with a non-convertible debenture. It might be investor by investor i.e. category by category. So for FIIs, QFIs and may be for NRIs, RBI may look at it differently compared to FDI investors.” Listed prefs may draw FII attention as, despite carrying the best features of debt, they have a tax advantage over other debt instruments like NCDs the interest income of which is taxable. Prakash Nene
MD, Multiples Alternate Asset Management
“From the company’s point of view, dividend is paid out of the post tax money- that means you first pay tax on your profits and then you pay dividend. And secondly, you have to pay a dividend distribution tax which is currently around 17% - these are the tax payments which the company has to pay. Investors get the amount tax free. Now when you’ll try and sell you instrument to a third party, then its two ways- short term and long term. Unlike equity capital, beyond 1 year, the listed equity capital, you have an STT and you have to pay zero tax- now that’s not clarified as yet. So if the tax department is ready to do that amendment to cover even the pref cap into the STT bracket, then beyond 1 year, there will be no tax.” According to sources, a draft version of the impending guidelines indicates some restrictions on non-convertible redeemable pref shares. For instance companies may be prohibited from issuing such pref shares to fund a loan to or acquire of shares from any member of the same group, except subsidiaries of the issuer. The disclosures required are close to standard – including details of corporate structure, key operational and financial parameters, details of corporate guarantee issued by the company, issue rating, mode of redemption, issue price,, effective yield, and put and call option price and notification time.  Manan Lahoty
Partner-Capital Markets, Luthra
“I think it will take some time for investors and issuers to really understand how the pricing would work. Couple of legal risks that investors and issuers should keep in mind- pref shares don't come with voting rights like the way equity shares do. For investors, they also don't come with the same sort of upside that you would typically expect from a equity shares. For issuers, they have to keep in mind that preference shares are not a burden on their cashflow much like debt would be - debt has to be serviced year on year whether you make profit or not. So these issues have to be kept in mind while pricing these deals.” D Muthukumaran
Head-Group Corporate Finance
Aditya Birla Group
“These are not going to be traded like the listed companies or equity shares that you see. These probably are going to be akin to wholesale debt market kind of a liquidity which is available whenever there is a need. There will a lot of off-the-floor transactions. And this is not going to be small volumes because the minimum ticket investment size is very big. So tradeability, by nature and definition, will be low.” It’s clearly the first step by the regulator to develop the preference share market…and in an environment, where companies are finding it increasingly difficult to raise money via equity, listing of pref capital that comes with a set of special rights and high yield is definitely a welcome move. A lot will depend on the guidelines though that are likely to be notified soon.
 
In Mumbai, Payaswini Upadhyay