A listed company can issue additional shares to raise funds, i.e. equity fundraisings. Rights issues and open offers are common equity fundraisings.
When a company is short of capital, it would propose a rights issue or open offer to invite existing shareholders to purchase additional shares. Shareholders have to decide whether to take up the rights shares or not. In a rights issue, the shareholders can choose to sell the rights in the market if they decide not to take up the rights shares, while open offers do not cater for trading of the rights in the market. This is the major difference between the two.
The shareholders will subscribe for the rights shares in a specific subscription ratio, which is the amount of additional shares that the shareholders can buy based on their existing shareholding. If the shareholders would like to subscribe extra shares beyond the rights entitlement, they may apply for “excess rights shares”, i.e. rights that are not taken up by other shareholders. The rights shares will invariably be offered at a discount over the market price to encourage existing shareholders to take them up.
Rights and protection to retail shareholders
Under the listing regime in Hong Kong, certain rights issues and fundraising activities require the approval of the minority shareholders. For example, if the proposed rights issue will increase the company’s issued share capital or market capitalisation by more than 50%, whether it is on its own or in aggregate with any other rights issues or open offers made in the previous 12 months, approval of the minority shareholders is required. If retail shareholders believe that the proposed fundraising activity is not in line with the interest of shareholders or the company, they should exercise their vote to veto the proposal.
With effect from 3 July 2018, there will be additional measures in the Listing Rules to curb abusive practices such as highly dilutive fundraising activities and transfer of ownership via fundraisings, to enhance retail shareholder protection. Here are the key amendments to the Listing Rules:
- Ban against rights issues, open offers and specific mandate placings that would individually or in aggregation within a rolling 12-month period, result in share dilution of 25% or more, unless there are exceptional circumstances, e.g. the company is in financial difficulties.
- Require minority shareholders’ approval for all open offers, unless the new shares are to be issued under the authority of an existing general mandate. Under the general mandate, the company can issue up to 20% more of its existing issued shares without seeking shareholder approval.
- Regarding the underwriting arrangements in fundraising exercises, remove the underwriting requirements for all rights issues and open offers and require independence of underwriters.
- Require issuers to adopt either excess application arrangements or compensatory arrangements for the disposal of unsubscribed shares in rights issues or open offers.
- Require issuers to disregard any excess applications made by the controlling shareholders and their associates in excess of the offer size minus their pro-rata entitlements.
Rights issues and open offers can be a dilemma for shareholders. In face of fundraising activities proposed by the companies, you should take into account the following when making your decision: The terms and conditions of the fundraising exercise, the fundamentals of the company and if the company has a valid need to raise funds, your financial capability to take up the rights shares, and if you can sell the rights in the market.