29/05/2008
Article on rights issues for Financial Times
Signs are emerging that the process of repairing the financial system has not only begun but is starting to bear fruit. There has been a tentative reopening of the securitisation market and bank re-capitalisation is well underway.
As the ultimate providers of long-term capital, institutional investors have always been ready to play their part in this process. We rely heavily on the health of the financial system and recognise our obligation to play a part in repairing it. We believe a healthy financial system requires appropriately capitalised banks and equity is a key component of core capital.
Yet, after a long period when the emphasis has been on debt and companies have been paying back equity, we need to remind ourselves of some basic principles with regard to the raising of new shares.
Investors firmly believe that respect for pre-emption rights is critical. There may be a temptation to opt for US style placements which can be arranged quickly, but these are normally much more costly in terms of fees and involve value being transferred away from long-term holders.
The process, moreover, should be an orderly one in which costs and burdens are shared out fairly. A striking aspect of recent issues is the way in which some appear to have been strategically leaked into the market. By the time of the formal announcement the market was aware through press reports both of the amount of the rights issue and the size of the write-downs.
The share price had thus already reacted downwards, reducing the potential underwriting risk for the lead managers. Whatever the origin of the leaks, this conflicts with the requirement for price sensitive information to be released formally to the market so that everybody can respond at the same time. Investors will ultimately lose confidence in markets that do not respect this principle and the authorities need to ensure that the high standards expected in London are maintained and enforced. If it is determined to root out market abuse the FSA should take a long hard look at this aspect of recent issues.
Ideally, fees for new share issues should be kept to a minimum. Shareholders ultimately bear them and this is a deadweight cost. Deep discounting of new issues can be used to minimise fees while ensuring the funding objective is achieved. The discount on a rights issue does not affect the cost of capital, and in theory an issue that is deeply enough discounted could be launched without any underwriting.
Given present market uncertainty, we understand why banks still prefer new issues to be underwritten. However, the fees should be equitably shared out between the lead managers and the sub-underwriters who bear the ultimate risk.
Investors will look askance if lead managers retain a large portion of the underwriting and associated fees with attractive issues while passing on to sub-underwriters a much larger portion of less attractive issues. If it appears that lead managers are cherry picking in this way, the whole process of raising new capital will become harder and more expensive.
The boards of banks and others who come cap-in-hand to the capital markets have a duty of care to ensure that the fees paid to their lead managers and underwriters are fair, reasonable and in the best interests of shareholders. Above all it is institutional investors and their clients who provide the capital that facilitates repair. We are currently being asked to provide unprecedented amounts.
The financial system’s dependency on this source of capital at the bottom of the cycle is in sharp contrast to its reliance on short-term capital to pump up demand for new public offerings and boost bankers’ bonus pots at the top of the cycle.
In future, the boards of those banks issuing shares should expect institutional investors to focus increasingly on the marginal costs of rights issues so as to ensure that the marginal rewards accrue to the long-term risk-takers that facilitate systemic repair rather than to the bonus pots of investment bankers who helped to create the problem in the first place.
Keith Skeoch, Chief Executive, Standard Life Investments Chairman, ABI Investment Committee
This was published in Financial Times on 29th May 2008.
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
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