Focus: What we learned from the GFC: ASX's view on the state of capital raising in Australia
17 February 2010
In brief: The Australian Stock Exchange recently released a paper that examines capital raising in Australia during the global financial crisis. Partners Robert Pick (view CV) and Steve Clifford and Senior Associate Charlie Harrison report on the paper that gives a positive report card to the relevant regulatory regime.
- How did the Australian equity capital market fare in the GFC?
- Flexibility of the Australian regime
- There is a place for placements
- The rise of accelerated rights offers
- Underdeveloped bond market
- Messages for company directors
How does it affect you?
- The paper casts a positive light on the current regulatory framework in this area, finding that companies had sufficient flexibility to adjust quickly to changing circumstances, and accordingly to tailor their capital raising arrangements to suit the prevailing market conditions.
- The paper stressed the onus on the board of directors when deciding the most appropriate capital raising mechanism.
- It also foreshadowed some possible changes to the Listing Rules.
The paper Capital Raising in Australia: Experiences and Lessons from the Global Financial Crisis asserts that the equity capital market remained healthy in Australia during the GFC. A record $106 billion of new equity capital was raised in calendar year 2009, with over half of all ASX-listed companies raising additional capital. Most of the capital raised was generated in the secondary capital market, with IPOs almost non-existent during the peak of the GFC.
The strength of the secondary capital market was vital since it allowed companies to reduce their debt exposures and strengthen their balance sheets at a time when debt issuance capital, such as corporate bonds and bank funding, was not readily available. The capital injections from government required by many global financial institutions were accordingly not required in Australia.
The paper, which was released on 29 January this year, concludes that Australia's capital raising arrangements held up well during the GFC because of their flexibility. Under Australia's equity capital raising laws, there are a number of means that a corporation can choose from to raise equity capital. The primary means are:
- rights issues of shares (or entitlement offers) to all of the shareholders in a company on a pro rata basis having regard to their existing shareholding (often in an accelerated form under which institutional shareholders receive the offer prior to retail shareholders). Rights issues may be renounceable or non-renounceable;
- placements of securities to a limited number of sophisticated/professional investors, who may or may not be existing shareholders;
- share purchase plans (SPPs) under which companies can offer existing shareholders up to $15,000 of additional discounted securities over a 12-month period, subject to restrictions; and
- dividend reinvestment plans under which shareholders can reinvest their dividend payments in new shares of the company.
There are many possible variations of structures under the above categories, particularly in relation to rights issues.
A company has a large amount of discretion in determining which approach to take, obviously fettered by certain restrictions under the Listing Rules and the Corporations Act 2001. Importantly, in Australia, a listed company is able to issue shares of up to 15 per cent of issued capital on a non-pro rata basis in a 12-month period without seeking shareholder approval.
In comparison, the UK regime is much more rigid. In the UK, secondary issues by a listed company must first be offered to existing shareholders on a pro rata basis, unless the company's shareholders otherwise approve. Furthermore, accelerated rights issues are generally not supported by the UK regulatory framework the disclosure requirements are more extensive and the raising timetables are longer than in Australia.
Placements to institutions are controversial, due to the dilutive effect that they can have upon the holdings of retail shareholders. Rights issues are therefore seen as a fairer and more preferable means to raise equity capital. Some commentators have questioned whether there should be a stronger regulatory push towards mandating rights issues, such as in the UK.
The paper concluded that it was important to retain placements as a readily available option for companies to raise finance. Placements were a very common form of capital raising in Australia during the GFC.1 They were advantageous for companies during that risky period because:
- they allow companies to access capital in a short time period (they are often open for just one to two days), which minimises the underwriting costs and market risks;
- given the longer offer period, underwritten rights issues will generally be conducted at a significantly larger discount to a placement, especially during a falling or volatile market;
- they have reduced compliance costs due to reduced disclosure requirements since the offers are being made to 'professional' investors (although we note that the new 'low doc' regime for rights offers means that there is less of a difference in this respect);
- retail investors sought to heavily reduce their exposure to equity investments during the GFC, so an offering to retail investors would have been a risky proposition; and
- institutional investors were more active investors during the GFC because of the ongoing need to invest superannuation funds.
The paper made the point that, although placements may be seen as discriminatory to retail shareholders in the short-run, if they enable a company to remedy any balance-sheet issues and stabilise itself financially, then they will have long-term benefits for all shareholders.
The paper did state, though, that if companies were considering a placement they should seriously consider the interests of retail investors, and the risk of dilution to their shares, and ensure that all other capital-raising options have been properly canvassed, including the possibility of offering SPPs to the retail investors in combination with the placement.
In the paper, the ASX mentioned that they are currently seeking to amend the Listing Rules to ensure that the record date for SPPs is set before the SPP announcement to prevent new shareholders subscribing for shares just before the record date in order to access the discounted shares offered under the SPP.
Accelerated rights offers involve an initial offer just to institutional shareholders, followed by an offer to retail shareholders. This allows companies to access the majority of capital in a short timeframe, while also providing retail investors with the opportunity to participate in the offering on similar terms, but with a longer time period to consider their position.
As the paper notes, new variants of accelerated rights offers have emerged over the past few years to respond to market volatility and other perceived needs within the marketplace. Three examples include:
- the accelerated non-renounceable offer (or Jumbo), where the offer to institutional shareholders is accelerated ahead of the offer to retail shareholders and is often conducted concurrently with a placement. Shares not taken up by institutional shareholders under the institutional offer are then offered to other institutional shareholders and new institutional investors. The offer price under a Jumbo may be fixed or determined under a bookbuild process conducted as part of the institutional offer.
- the accelerated renounceable entitlement offer (or AREO), which has a similar structure to a Jumbo but under which shares are offered at a fixed price and any rights not taken up by institutional shareholders under the institutional offer are then offered to other institutional shareholders and new institutional investors under a bookbuild undertaken after the close of the institutional offer. Where the bookbuild price is above the fixed offer price, the excess is remitted to non-participating institutions on a pro rata basis. A similar bookbuild and remittance process occurs for the retail offer.
- the simultaneous accelerated renounceable entitlement offer (or SAREO), which is identical to an AREO with one key difference the two bookbuilds are run simultaneously as a single shortfall bookbuild, conducted after the completion of the retail offer.
The SAREO structure, in particular, was developed as a response to a concern arising from the volatility within the stock markets during the GFC and a perceived weakness of the AREO structure. Under an AREO, the two bookbuilds are run separately and priced differently, resulting in institutional and retail shareholders receiving different values for their renounced entitlements. This risk of differential pricing was heightened during the GFC, where falling markets often saw retail shareholders receiving significantly less value for their renounced entitlements than their institutional counterparts. In some offerings in the past two years, retail investors have received no return premium for renounced entitlements, while institutional investors have received significant returns.
The SAREO structure avoids this disparity in returns by conducting a single bookbuild (and thereby providing identical treatment to each group of investors). However, the ASX notes in the paper that questions have been raised about the willingness of institutional investors to renounce their rights, and wait approximately four weeks to find out what price they will get for their rights.
The fact that the Australian market was able to generate a new structure to cope with difficult market conditions was seen in the paper as being an endorsement of the flexibility of the regulatory system. The ASX signalled that it will consider amending the Listing Rules to formally acknowledge and allow accelerated rights issues.2
The ASX believes that the corporate bond market in Australia is underdeveloped (particularly in relation to long-term bonds) and that companies should concentrate on developing a vibrant corporate bond market in order to ensure greater funding stability and reduce reliance on offshore funding.
The ASX states in the paper that it is committed to developing an exchange-traded bond market accessible by retail investors. Currently, the corporate bond market is generally only accessible to wholesale investors through primary issuance and OTC trading.
In the best interests of the company
Directors have duties under the Corporations Act and the general law to make decisions, including on capital raisings, that are in the best interests of the company as a whole. They are therefore the most appropriate body to decide which capital raising mechanism to adopt in particular circumstances.
Weighing up the costs/risks
Boards need to weigh up all the costs, benefits and risks of the available capital raising options before making a final decision. The range of considerations to ensure that the decision is in the interests of the company as a whole include:
- the size and urgency of the funding required;
- the market conditions at the time of the raising;
- the company's size and industry sector;
- the purpose for the capital raising;
- the overall cost of capital associated with the option chosen;
- the costs and availability of alternate sources of funding;
- the availability of underwriting support; and
- the interests of all existing and potential shareholders (including retail shareholders).
Company boards should clearly communicate with shareholders about the factors that influenced their choice of capital raising mechanism. The ASX has signalled that it will give consideration to whether such communications should be required under the Listing Rules.
- According to the ASX paper, during the worst of the crisis (six months to March 2009) placements made up 55 per cent of the value of secondary raisings, and rights issues made up only 20 per cent. The big four Australian banks all raised capital through placements during 2008 and 2009.
- Currently, listed companies require waivers from certain Listing Rules in order to structure their capital raisings in such a manner.
- Robert PickPartner,
Ph: +61 3 9613 8721
- Andrew PascoePartner,
Ph: +61 8 9488 3741
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