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Fund groups urge Treasury to close prefs 'loophole'

Fund groups urge Treasury to close prefs 'loophole'

by Daniel Grote Apr 12, 2018 at 07:00

 

Fund groups have urged the Treasury to close a 'legal loophole' that allowed insurer Aviva to threaten to cancel its high-yielding preference shares, sparking a big sell-off in the investments until an investor backlash forced it to climb down.

M&G, Invesco, GAM, EdenTree and Legal & General, which all hold the Aviva and General Accident preference shares that had been threatened with cancellation, have written to economic secretary to the Treasury John Glen urging him to take action.

The fund groups were instrumental in forcing Aviva's climbdown, having met with chairman Adrian Montague to urge him against the move.

After Aviva backed down, the fund groups urged other preference share issuers to reinforce the 'true irredeemable nature' of the investments in their documentation.

Barring Ecclesiastical Insurance's statement reassuring investors, issued just day's after Aviva first made its cancellation threat, issuers have not been forthcoming.

Writing on behalf of the fund groups, Rupert Krefting, M&G head of corporate finance and stewardship, urged the Treasury to amend the Companies Act 2006 to protect preference shareholders from similar moves.

'Although Aviva has decided not to pursue its action to repay its preference shares at par, the issue has highlighted the legal uncertainty surrounding the rights of preference shareholders, and indeed other classes of shares, which are in a relative minority compared to ordinary shareholders,' he said.

'Attempting to persuade all issuers of preference shares to change their articles of association does not solve the fundamental issue that the basic rights of a shareholder asset class should be easy to establish and be transparent.

'We therefore urge that HM Treasury, the Treasury Committee and the Financial Conduct Authority look, with a matter of urgency, at closing the legal loophole in the Companies Act 2006 that has allowed this situation to develop.' 

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Comments  (23)

  • Norman E: 

    Closing that loophole is the only approach that will make holders of "irredeemable" preference shares safe. Lloyds in particular have avoided giving any assurance and cannot be trusted.

    08:56 on 12 April 2018

  • Tim Kempster: 

    This is clearly a very big issue for the UK. If investors can't rely on an "irredeemable preference share" being irredeemable then it puts a whole class of securities within the UK market at risk. The UK is totally out of step with the rest of Europe and in fact world markets.

    At a time where the UK Government should be doing everything they can to attract investors and companies to remain in UK markets rather than move to Europe after BREXIT it is imperative that HMG acts quickly.

    It is not enough to expect companies to regulate themselves here. In fact directors have a fiduciary duty to ordinary shareholders which may mean they are prevented from issuing assurances. Further ordinary shareholders would need to vote it through anyway.

    Clearly HMG needs to act quickly to close off this loophole and restore market integrity.

    10:29 on 12 April 2018

  • Michael Loveridge: 

    The whole idea of `irredeemable' prefs that could never be redeemed under any circumstances is inherently absurd. A company should not be able to tie its own hands in that way.

    In fact, I would take the view that for a company to issue such securities could well be ultra vires.

    They should certainly amend the law, but not so as to enshrine the ridiculous concept of irredeemability. On the contrary, the law should in future compel every issuer of such securities to spell out the exact terms on which they could be redeemed.

    15:23 on 12 April 2018

  • James Wilson: 

    @Michael Loveridge - I do not think anyone is saying that they can never be redeemed or cancelled it is more who votes on redemption or cancellation. The loop hole does not exist in the law governing every other modern capital market I have looked at. They have a clear directive requiring a separate vote for each class of shares proposed for cancellation.

    Whereas in the UK you need to understand a lot more than the Companies Act to get to the loophole for cancelling preference shares at par without a separate class vote. The CA says a Special Resolution is required for a reduction of capital and elsewhere defines a Special Resolution as a vote requiring 75% of the relevant class of shareholders. So you then need to look at the Articles to establish what the relevant class is. There you will read that a separate class vote is required for any variation or abrogation of rights. Many would stop there believing they are safe. But you then need to look at case law to appreciate the authorities that cancellation has been held not to constitute a variation or abrogation of rights. Then if you look at EC law (with which our CA is supposed to be consistent) you will find that the directives have been transposed into French law such that a separate class vote is required for 'chaque classe' proposed for cancellation. And you probably need a legal adviser who specialises in this area to guide you through all that. Hardly the sort of clear directive modern law should have to establish the fundamental rights of shareholders in a leading capital market.

    15:33 on 12 April 2018

  • Tim Kempster: 

    Michael obviously the company can effectively redeem these instruments if the holders vote which is usually as a result of the company making them a fair offer usually at a small premium to market prices during a tender or LME.

    That's the way the market has operated for decades until some clever lawyers came out with a way to effectively force redemption at par. Some of these preference share were trading at nearly double that value.

    16:04 on 12 April 2018

  • Alan Selwood: 

    If a class of shares is launched on the market as 'irredemable', then that is how it should be. The fact that the company distributing its Offer Documant has done a foolish thing or acted beyond its remit should not change the contract that was created by the document and the reasonable interpretation of its wording.

    The main gripe was that Aviva was trying to take back shares at far below current market value : that market value itself must have been influenced in the past by the fact that the shares were considered irredemable.

    It was unfair of Aviva to try to bend the accepted rules, and was as close to 'gaming the system' as could be found. It was in essence what a government that did not accept the rule of law or common accepted practice might do if it attempted to nationalise a private industry at other than a fair market price establish by an independent 3rd party, and based on a market price that had not already been influenced by the news.

    So in any situation like this, the perpetrator should be able to prove that what it intended to do did not go against previously established practice, did not bend the accepted truth, and was done at a fair, independently-arbitrated price. Then it MIGHT just have a case.

    22:01 on 12 April 2018

  • Norman E: 

    The point now is that the Government could and should make an Order in Council amending the 2006 Companies Act to make it a requirement that a majority of holders of the class of shares affected by any proposed change or cancellation have to vote for it, and that it cannot be forced on them by votes from holders of different classes of shares. Imagine the howls of protest if the preference shareholders could force a vote to cancel the Aviva ordinary shares at par (10 pence). I have written to my MP asking him to request the appropriate minister to take action on this. I have no doubt that Parliament never foresaw or intended the consequence that Aviva intended to carry out.

    22:21 on 12 April 2018

  • Norman E: 

    The point now is that the Government could and should make an Order in Council amending the 2006 Companies Act to make it a requirement that a majority of holders of the class of shares affected by any proposed change or cancellation have to vote for it, and that it cannot be forced on them by votes from holders of different classes of shares. Imagine the howls of protest if the preference shareholders could force a vote to cancel the Aviva ordinary shares at par (10 pence). I have written to my MP asking him to request the appropriate minister to take action on this. I have no doubt that Parliament never foresaw or intended the consequence that Aviva intended to carry out.

    22:29 on 12 April 2018

  • Dennis Russell: 

    The upcoming AGM of LLoyds Bank includes a provision for shareholders to approve buying in Lloyds Preference shares!!!

    17:53 on 13 April 2018

  • Nicholas Blake: 

    I'm afraid I'm with Michael on this.

    What's more 'irredeemable' in this context means not much more than 'undated', which would be a better description given their terms.

    It's not just a pref issue. This is from the Debt Management Office, which administers gilts: "Irredeemable" gilt -- An inaccurate term sometimes used in connection with undated gilts, all of which have now been redeemed. (!!!)

    10:49 on 14 April 2018

  • Norman E: 

    Nicholas, you should read the prospectus for some of these shares, which provide that a majority of holders of the class of shares is needed to make changes to their terms. They were clearly intended to be, and sold as, irredeemable unless the holders agreed. What Aviva tried to do was use a badly thought out provision in the 2006 Companies Act to use a vote of all classes of shareholders to carry out their dishonest intentions. Aviva and Lloyds, and any other issuer are perfectly at liberty to buy these securities in the market and cancel them, or hold them as Treasury shares. They could also make a tender offer which could be made binding on all holders if a majority accepted. As far as I know the Government simply bought back most undated gilts in the market, or at reasonable market prices because most traded below par anyway. What Aviva attempted was nothing less than an opportunistic grab of shareholders assets at a knock down price and would have caused many holders to suffer significant losses . I wonder how ordinary shareholders would have reacted if it had been their shares under threat.

    11:28 on 14 April 2018

  • Nicholas Blake: 

    Norman,

    Sorry, but your understanding is NOT the legal position.

    UK companies law for at least the last seventy years has continuously been that all share capital (both ords and pref’s) CAN be returned. The 2006 Act merely continued the position.

    Then one looks at the articles to see HOW MUCH pref holders are entitled to on a capital return: BP 10% premium to market; Aviva par; and Bristol Water price based on gilt yields. It is interesting that Lloyds is the only one I've seen where the prospectus comes in -- the articles tell one to see the prospectus, which says the issue price.

    Doing what the articles/prospectus state is the 'deal' on a capital return is NOT a variation in terms -- it is instead in COMPLIANCE with the terms.

    Irredeemable in company law simply means UNDATED. It would be much clearer for retail investors if they were generally described as such.

    It is patently obvious that if the 'deal' was that the pref's could not be cancelled without the consent of the class the prospectus would have to have said so, because that would be an EXCEPTION to the law. In all the ones I've looked at THERE WAS NO SUCH WORDING.

    The harsh reality is that, given most of the pref's can be cancelled at £1, their market price should not rise much beyond this. An issuer has no proper responsibility for investors who do not do sufficient research to understand correctly what they're buying. If in doubt retail investors ought to seek professional advice.

    I suggest if you hold Aviva or Lloyds pref's you consider swapping them for BP ones. I think the yield is broadly similar (but you need to check yourself) and it seems fairly bomb proof to me that they cannot be cancelled below market.

    I hope that makes the legal position clear.

    Nicholas

    12:33 on 14 April 2018

  • Michael Loveridge: 

    Nicholas is quite correct. I have read the original Listing Particulars, and it's entirely clear that on a return of capital the pref holders would receive just £1 plus any accrued dividend. Paragraph 4(iii) states:

    "(iii) On a return of capital (otherwise than on a winding up or on a redemption or purchase by the Company of shares of any class), the holders of the Further New Preference Shares shall be entitled to receive an amount per Further New Preference Share equal to the nominal amount of a Further New Preference Share ..." (i.e. £1.00)

    It really couldn't be much clearer. The people who should be taking the blame for this debacle are not Aviva, who were simply doing what they were entitled to do, but the highly paid analysts and professional advisers / investors who had been trading the prefs at a premium of 70%+ having never bothered to look at the terms on which the prefs were issued.

    It also needs to be borne in mind that in 1992, when the shares were issued, 8% was not at all a high rate of interest. The base rate in November 1992 was 7.88%. Consequently, it was probably not envisaged that these prefs would ever trade at much above par.

    In this context it's notable that the earlier prefs, which were in all other respects identical but had an interest rate of just 3.5%, DID have a provision whereby on a return of capital they would be bought out at market value.

    Where I disagree with NIcholas is his recommendation to swap these for BP prefs. It's quite clear that Aviva have now effectively surrendered their right to pay par for these shares. However. as they are expensive debt they will still want to get rid of them, so I anticipate they'll make a tender for them which will be not far short of their market price before this happened.

    As they were trading at around £1.70 I consider the present market price of around £1.45 to be a bargain.

    19:18 on 14 April 2018

  • Tim Kempster: 

    Michael / Nicholas while the legal position to you seems obvious (in hindsight) it was certainly not market practice. Market practice was to LME at a price around the current trade price. It is also not all obvious that this legal right was obvious nto even veteran market participants and financial advisors. Rather it was a legal loophole uncovered by some margin circle lawyers.

    It's also not as straightforward as it sounds. Lloyds current prefs were exchanged from old HBOS Prefs with "substantially the same terms". The HBOS Prefs had a clause stating a cancellation and capital return was a variation. The court sanctioned the exchange based on Lloyds claim that the terms were substantially the same.

    It should not require a QC plus a trawl through company law, case law and different company documents to determine these fundemetal properties.

    Another school of thought suggests than redemption is a prior step to cancellation so the HoF case law would not apply to irredeemable Prefs.

    It's a mess and needs legislation to bring things into line with the normal Europe implementation of the EU Directive which seems to have been badly translated from the original French.

    19:39 on 14 April 2018

  • Tim Kempster: 

    PS I don't 100% agree the BP Prefs have protection either and there is some wiggle room. Further this brings up all sorts of other problems like CCDS being cancelled by building society members.

    NWBD does seem to have articles protecting cancellation at par.

    Sorry for the typos on a phone.

    19:45 on 14 April 2018

  • Nicholas Blake: 

    Michael,

    What a breath of fresh air your post is!

    As for the swap, the fundamental point for me is that, post the Aviva prelim results, which correctly stated that the pref's could be cancelled at par, Aviva pref's were trading around 118%, which seems a reasonable proxy for what they SHOULD ALWAYS have been trading for. They now sell for about 146%, yielding 5.6%, which is a substantial premium to the 'fundamental' position. The recent Aviva statement does mean that Aviva is in baulk for a few years, but not forever. Personally I would be astounded if Aviva were interested in cancelling the pref's at a price of 170%. So the shares may rise from here, but gravity would tend to be pulling them down.

    Switching now into BP pref's at 166% generates a yield of about 5.4%, which based on my read of the articles ought to be safe from capital returns.

    At the end of the day the right approach down to one's personal risk preferences!

    Nicholas

    09:53 on 15 April 2018

  • Nicholas Blake: 

    Tim,

    Market practice is an extremely dubious concept. If one goes back twenty years the big UK institutions which invested in listed pref's probably held in general more than 25% of UK listed companies' ords. So they had a practical rather than legal method for protecting themselves against clearly legal returns of capital at issue price. Suitably 'armed' they could simply choose to ignore the issuer's cancellation option and buy high yielding pref's at above their fundamental value. A good lurk while it lasted.

    If a company had the temerity to canvas such a return of capital the ABI could just tell it that their members would use their ord votes to ensure the requisite approvals could not be achieved (as an aside it may well be that this is what happened behind the scenes on Aviva).

    I'd query if one should place much emphasis on such self serving threats, dressed up as 'market practice'.

    Of course, the diligent pref investors would have insisted on protective wording being inserted in the articles. Your HBOS language is a good example.

    What appears to have happened since is that institutional ownership of UK listed companies is much lower, meaning they can often no longer use their ord holdings to thwart the legal rights of an issuer!

    It would appear that many such institutions had forgotten the underlying legal position and blissfully carried on regardless. Extremely sloppy on their part.

    So no loophole involved -- more a case of the emperor's got no clothes.

    UK companies law for at least the last seventy years has continuously been that all share capital (both ords and pref’s) can be returned. Including pref shares this provision of the law has served participants exceptionally well over the period and the mechanics are entirely understood and uncontroversial.

    So no QC required: a student law textbook would suffice!

    There is no requirement to change the law to remedy incompetence on the part of professional investors, but it may still happen prospectively.

    As for the HBOS in substance exchange point, as you note the court sanctioned the exchange. If HBOS holders had wished to complain they had the legal right to do so AT THE TIME, and the court would have considered their claims carefully. From where I stand the opportunity is long gone and the pref terms are as they say 'on the tin'. I'm afraid Taber's bombshell is no more scary than a wet firework!

    Interested in why you feel there is wriggle room at BP. I may take a look at NWBD if I have some spare time...

    Nicholas

    10:24 on 15 April 2018

  • Tim Kempster: 

    Well you say no QC required then go on to say your laymen's (assuming you are not a QC) reading of the BP Prefs has reassured you that there is no chance of a par cancellation. Krep reading I would say! Further the market has obviously, since Aviva partially priced the chance of cancellation at par here. Dito NWBD.

    If it was all as obvious as you say why are prices all over the place?

    Re Lloyds legally speaking you may be right but is that all that matters here. There were a huge number of retail holders in these Prefs and they were told the terms were substantially the same. Lloyds made a statement to that effect that seems to be false. Further Lloyds made clear the material differences and made no mention of removal of an extremely important clause. One might argue that the SoA took place on false pretences.

    It could well be that we are in a new world where issuers will screw over [retail] investors at every opportunity but I don't think that is the sort of UK market anyone wants and it's incredible myopic especially given Brexit issues.

    12:34 on 15 April 2018

  • Nicholas Blake: 

    Tim,

    The basic position is that all pref's which have provision for returns of capital in their articles (i.e. 99.9%) are cancellable. You don't need a QC to tell you that. A third year law student could answer it.

    How much a pref holder gets in such a return is as set out in the articles. Most just specify the issue price. Quite a few suggest something else. I grant you that the BP articles are somewhat convoluted.That's articles for you!

    In my view the cancellable pref's, which is most of them, ought to sell at no more than 120%.

    There is no real debate regarding the 'default' legal meaning. The pricing mystery is why the institutions have bought pref shares as though they weren't cancellable. Perhaps they forgot they no longer hold enough ords to use the votes thereon to block returns?!

    Unless one was an HBOS pref holder there is no possible gripe about the Lloyds prefs. If you could get 150% for them now I'd sell, because 30% is a lot to pay for 'emotional blackmail' hope value.

    I can sympathise with ex-HBOS holders, but if they sell at 150% they've made good money against the 100% issue price. That said, the stark reality is that, given the COURT blessed the Lloyds pref issue as being in substance the same, Lloyds is free and clear on this (which happened nearly ten years ago).

    Making 50% on capital in ten years with a 9% coupon is not my definition of being 'screwed'.

    A better way to look at this is for the FCA to issue guidance that in future in respect of issues with no fixed redemption date (aka 'irredeemables') issuers must ensure the prospectus states prominently that the pref's CAN BE CANCELLED AT THE ISSUE PRICE following a court sanctioned return of capital.

    Do you think that would be clear enough for retail investors so they could understand what they were investing in?

    Nicholas

    13:54 on 15 April 2018

  • Tim Kempster: 

    Nicholas no issuer would get a new pref away again without a clause stating that cancellation is a variation after this so your solution isn't particularly helpful. Further I actually don't think the FCA has this power. What about non financial companies? Further still this does nothing to restore order in the current pref market.

    My solution would be to change the companies act to properly implement the EU directive and bring the UK inline with the rest of Europe/the world thereby restoring an orderly market. The FCA can lead on this and the TSC can do the necessary.

    Changing tack a wee bit can you show me one piece of evidence that suggests that for example Aviva or Lloyds or any market participants were of the view that their Prefs could be cancelled at par? In fact Aviva published corporate debt profiles on their site showing they were perpetual. Lloyds currently submit capital reports counting their Prefs as capital which they can't do if they have the ability to redeem or cancel them at par. Also Lloyds have in the past bought back Prefs via a tender based on market price. Why not just cancel them? You scoff at general market practice but that's how trust is engendered and how commerce is possible. The system has a legal loophole. It was assumed that no issuer would be so disingenuous to exploit it. Now we know that's only barely the case it needs the law to act and make sense of what is obviously a situation that should not exist.

    I'm sorry but I just don't believe all the "we knew all about this" types that have cropped up since Aviva. Not a single one of them has uttered a word of warning despite seeing prices as high as 180p.

    On the court sanction issue the court were in my opinion misled as Lloyds failed to make clear that a key clause had been removed while at the same time claiming the terms were substantially the same. As for having made good money since it's irrelevant. The point is they had a key right removed and this was not only not disclosed, they were told that the new prefs were substantially the same. I'd agree though that legally it's probably too late.

    There is a bigger issue here than legal technicallities. Normal people who own these Preference shares are not being treated fairly and in my opinion they deserve to be.

    14:24 on 15 April 2018

  • Nicholas Blake: 

    Tim,

    My 'solution' is helpful if one cares about retail investors going forward, which was the 'new world' I thought the last paragraph of your penultimate mail was referring to.

    FCA guidance on the contents of prospectuses would apply to all issues.

    If you're an existing holder of cancellable pref's and unhappy that what you bought wasn't what you thought I'm afraid it is highly unlikely any third party is going to disturb the contract between holders and the issuers.

    The European directive is pretty irrelevant to the Companies Act, which has been around for decades longer. As for an 'orderly' market, statements by issuers clarifying for retail pref holders that their pref's are cancellable would certainly ensure the market was fully informed. After that orderliness would surely follow.

    It is a sacred tenet of UK law that contracts should not be varied retrospectively by regulation. That principle makes it extremely unlikely that any changed law would impact the cancellable nature of existing issues. One would imagine that such a t'wo type' scenario might confuse punters even more?

    I have no idea if any market participants knew before Aviva that these pref's were cancellable, but that is not the point. Professionals OUGHT to have known. I have been involved in returns of capital as far back as 1991. When I saw the ruckus I was curious. Ten minutes perusing the articles were enough to make it clear the Aviva pref's were cancellable. See also what Michael said above.

    A provision which over the last seventy years has applied in essence to all UK companies and has been applied in court numerous times is NOT a loophole. As Michael quotes above, the prospectus is clear. The legal meaning isn't the slightest bit contentious. It is the 'market practice' which has a tiny loophole: it has no legal bearing and retail investors are properly advised not to place any reliance on it!!! Fulfilling a contract under its terms is plainly not disingenuous.

    I'd suggest you are in fact angling for a favour from companies which sees the pref's rise from their current prices around 150% to the ludicrous 170% that there were selling for when purchasing investors did not realise they were cancellable.

    For the 'normal' people out there, fair value is less than 120%, so if you don't like what you've bought, why not take your profits and sell/switch rather than asking for everyone to believe in fairies?

    Nicholas

    15:19 on 15 April 2018

  • Tim Kempster: 

    Ok Nicklas I think we've got as far as we can here. In essence you are of the opinion that people should have known about this feature despite the fact that basically everyone including the issuers didn't.

    That's certainly a point of view it may even be the one that prevails. It didn't prevail at Aviva for good reason. If we are to believe what they say that was largely due to them wishing to protect their reputation and do right by their investors.

    We both know that the legality isn't likely to get tested with Lloyds or other issuers. They'll just remind folk of their right to cancel and launch an LME with a sweeper at a lowish price.

    If that's the way you want the UK market to operate then I guess that's your point of view. I disagree.

    Also FWIW I think the EU directive is important. It predates the CA 2006 I think. Further case law like HoF may not apply to irredeemable Prefs or at least there is an argument to that effect. Legislation often interferes with contracts. How about a contract involving slavery? Changes in employment law?

    Anyhoo let's agree to differ.

    16:23 on 15 April 2018

  • Nicholas Blake: 

    Tim,

    I think you're right that we ought to draw a line under it.

    But one thing I must reiterate -- the large institutions should have OR DID know that the pref's were cancellable. I am a retired professional, and I can assure you that anyone at my shop who'd claimed ignorance of the same would have been halfway to the door!

    Will be very interesting what will happen if Lloyds simply stays shtum.

    Nicholas

    17:13 on 15 April 2018

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