Rights: A question of rights

The move is aimed at reducing the potential for market abuse, which has become a hot topic in London following investigations of the spreading of false rumours that caused HBOS’s share price to plunge dramatically in March.

The FSA’s new rules require any short positions amounting to 0.25% or more of outstanding shares to be declared, and has sparked protests of unfairness from the hedge fund community. Significantly, the FSA’s new rule covers positions held through derivatives that give an equivalent economic interest as well as direct short selling.

The disclosure regime, which came into effect on June 23, has revealed the significant extent to which some hedge funds have been shorting the stocks of banks in the midst of rights issues. Hedge fund Harbinger Capital Partners, for example, has declared a short position of 3.29% in HBOS, which is trying to raise £4 billion, equivalent to almost two-fifths of its market capitalization, through a rights issue, and which has seen its share price come under pressure and dip below its rights issue price several times.

Tiger Global Management also revealed a short position equivalent to 3.4% of the outstanding shares in mortgage bank Bradford & Bingley, which is in the middle of a £258 million rights issue.

The Alternative Investment Management Association has described the rule change as "flawed" and accused the FSA of not playing fair with hedge funds and of favouring one section of the financial services industry over another.

However, investment banks, which put their own capital at risk when underwriting rights issues, have cautiously welcomed the proposals. Although concerned that the rules on shorting could disrupt legitimate trades and the ability of underwriters to hedge themselves, bankers believe that something should be done to improve the conditions for rights issues in the UK, which are particularly difficult to execute because of the lengthy subscription period, which can last up to 12 to 13 weeks and is significantly longer than in countries such as France and Germany.

Simply requiring the disclosure of significant short positions during rights issues is a relatively modest and reasonable step considering that investors always have to declare significant long holdings and that in the US shorting during capital raisings and covering short positions with newly issued stocks is completely illegal.

There are signs, however, that the FSA is considering an approach closer to US regulations. It is examining proposals to restrict stock lending to short sellers during rights issues and restricting short sellers from covering their positions by acquiring the rights to newly issued shares as part of a review of how the capital-raising process of listed companies can be improved.

Rights issues are the method of choice in Europe and the UK where investors have strong pre-emption rights but the volatility that bank stocks have suffered during recent rights issues has made banks seeking to raise capital anxious to find quicker ways of doing so. Moreover, as more and more banks are sent running to shareholders for cash, the risks that rights issues will have to be undertaken at unattractive prices, or that they might fail, is increasing, putting pressure on ECM bankers to find ways to secure capital raisings early on with anchor investors while respecting the rights of existing shareholders. Banks in Europe have raised more than $62.7 billion in rights issues so far this year, and more are on the way.

British bank Barclays, which this June announced that it had raised £4.5 billion-worth of new equity through a combination of a private placement and a clawback, may have found a solution. The bank sold £500 million-worth of new stock to Japanese bank Sumitomo Mitsui at 296p per share and £4 billion-worth of stock conditionally and subject to clawback by existing shareholders at 282p per share, to the Qatar royal family, Qatar Investment Authority, Temasek and China Development Bank.

The deal structure allows Barclays to raise cash far more quickly than it could through a rights issue without upsetting the pre-emption rights of existing shareholders.

Rights issues from non-financials that have been raising cash for strategic reasons such as acquisitions rather than because of financial distress, have so far had things much easier. But banks are often a barometer for equity issuance and some bankers expect that defence issuance from corporates could soon follow, raising the stakes for the FSA review.