Rights issues are expensive because shares are risky
In 1994 the Office of Fair trading investigated rights issue fees and suggested alternative ways to issue equity more cheaply. The alternatives have been adopted, but instead of fees falling, they have soared. Time for a new inquiry?
There is constant conflict between companies seeking capital and the City houses that underwrite it. Underwriting is insurance and we all object to paying the premiums when we don’t make a claim. And if calamity strikes and the underwriters suffer a loss, we show little sympathy because of the high fees they charged.
The OFT investigated 15 years ago because of grumbles from companies. Rights issue fees were always 2 per cent of the sum raised with issues priced at 20 per cent below the market price. The lead bank kept 0.5 per cent of that fee with the stockbroker taking 0.25 per cent and the other 1.25 per cent going to the dozens (sometimes hundreds) of City institutions that accept the sub-underwriting and thus guarantee to buy the shares if existing investors decline.
But despite the flat fee the OFT concluded there was no price fixing and the City thus avoided a full inquiry by the Monopolies Commission. Instead the OFT recommended other ways to raise equity, in particular deeply-discounted rights issues that are unlikely to fail, so required smaller fees.
Deep discounts are now the norm. Shares have been offered to investors at below half price in some of this year’s issues. But instead of falling, fees have risen. The 2 per cent fee has increased to 3.5 per cent in some cases. Rexam will be paying that on its £350m rights issue despite offering shares at a 46 per cent below the pre-offer price and les than half the price before speculation of the issue.
The secrecy normally associated with rights issues prevents firms shopping round between banks or holding beauty parades, and because companies cannot contemplate failing to raise capital (even if they can survive without the money, the loss of confidence could be devastating) they dare not risk being without insurance.
Shareholders do sometimes reject even a deeply-discounted rights issue – as HBoS’s investors wisely did a year ago. The underwriters were lumbered with £4bn of stock that sank in value fast. Indeed, when that bank returned for more capital later, the government had to act as underwriter – and bear the loss.
In volatile and falling stockmarkets, the underwriters’ risk rises. The sizes of rights issues has soared too, not only raising the risks but increasing demand for the underwriters’ services. Two UK banks have each reached raised more than £12bn in recent months.
The answer is not another OFT inquiry. Nor need it be a consortium of institutions that cuts out the investment banks. Companies could do more to test market forces but the fact remains, when you’re desperate for cash and the institutions are reluctant to provide it, you have to pay for it.
