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City Column: Pre-emption wrong

31 Dec 08

Barclays stirred up a storm by finding much-needed cash in the Middle East instead of calling on existing shareholders, but Angus McCrone defends the tactic

by Angus McCrone

When I joined the City desk of a Sunday newspaper some 17 years ago, my first assignment was to write about the esoteric subject of pre-emption rights.

I tried to look wise about the subject over lunch with a suave

corporate financier, who was immaculately attired in pinstripe, with – I noticed – a pin through his collar. I hid my ignorance by nodding frequently and scribbling notes vigorously, while attempting to eat.

 

In the intervening period, the issue never really caught fire. In general, UK-listed companies raised new equity via rights issues, unlike their US equivalents, which sometimes used other options. Rights issues gave first refusal (“pre-emption”) on the new shares to existing holders. If they did not want the shares, they could sell the rights in the market to investors who did want to participate.

However, good things come to those who wait: the issue of pre-emption rights has finally burst into a major row in the Square Mile, as a result of Barclays’ decision to raise £7.3 billion from outside investors, mainly from the Middle East.

This heated argument was also of note because the UK bank introduced some unusual capital instruments that may recur in other financings if the crisis of 2008 drags on into 2009.

First, the basics: in October, Barclays rejected the government offer of ordinary share capital and preference share capital with a 12 per cent coupon, that was accepted by Royal Bank of Scotland, Lloyds TSB and HBOS.

Barclays decided to raise £4.3 billion in “mandatorily convertible notes” (MCNs) and £3 billion in “reserve capital instruments and associated warrants”. The latter, the “RCIs”, were placed with Qatar Holding and Sheikh Mansoor Bin Zayed Al Nahyan and bear a 14 per cent coupon until June 2019.

The MCNs bear a 9.75 per cent coupon, payable quarterly, and have to be converted on or before 30 June 2009 at 153p, a 22.5 per cent discount to the average close price of Barclays shares just before the financing announcement. The subscribers to the MCNs were announced as, once again, Qatar Holding and Sheikh Mansoor, plus another shareholder, Challenger, with £300m, and a general institutional placing of £1.5 billion.

Barclays said the financing would “enable rapid and certain execution”, and strengthen links with “existing large shareholders and introduce substantial new investors”.

But it unleashed a storm of protest from the existing Barclays shareholder register. Complaints could have centred on whether the ugly word “mandatorily” really exists, but instead they were about two points of high principle.

The first was whether the company was serving the interests of shareholders by accepting RCIs on a 14 per cent coupon from Middle Eastern investors, when it could have taken preference shares on a 12 per cent coupon from the UK government.

The second concerned my old friend, pre-emption rights. Why were Barclays’ existing shareholders not given first opportunity to buy shares via a rights issue, rather than a big chunk of the equity getting passed exclusively to selected investors via the MCNs?

At the Royal Bank of Scotland, by contrast, there was a £15 billion rights issue at 65.5p. The fact that existing holders took up virtually none of it, leaving almost the whole issue, and a 58 per cent stake in RBS, in the hands of the government, does not alter the fact that in this case, the principle of pre-emption rights was observed.

To try to placate established institutional investors, Barclays in mid-November made £500 million of the RCIs available to them rather than to the Middle Eastern investors – and at an extraordinary general meeting on 24 November, the capital raising was narrowly approved by shareholders.

My view is that Barclays was within its rights to raise money in this way. Company law says that a director’s prime responsibility is to the company, rather than to the shareholders. That does not prevent shareholders from voting that director out later if they wish.

Barclays clearly took the view that the Middle Eastern players would be tamer and less intrusive investors than the UK government, and therefore worth the difference in the coupon. Whether that was right, only time will tell.

On pre-emption rights, yes, existing investors should normally be given first right of refusal. But October 2008 was not a normal time. The markets were more dangerous than at any time in our adult lives, and the traditional rights issue timetable of seven weeks

and an “appropriate” discount to the prevailing share price was fraught with hazards.

 

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