Change to NZX Listing rules will stack the deck against less knowledgeable investors

Announcements regarding capital markets policy rarely incite much excitement amongst retail investors. Whether you’re experienced or inexperienced as an investor, it can be hard to relate to the introspective, jargon-filled discussions that create the rules of the game when it comes to investing in New Zealand’s public capital markets. It’s ironic, really, when you consider that it is these types of policy and rule-setting discussions that have created hard-won investor protections – resulting in a very different (and safer) investing environment over the last two decades.

So don’t be surprised if you haven’t seen flashing headlines about the latest changes to the NZX listing rules. These are expected to take effect from October this year (following approval by the Financial Markets Authority).

And for retail investors, there is one significant and problematic impact – for the first time on the NZX, companies will be able to raise capital by way of an ANREO.

What’s an ANREO?

A good question. The acronym stands for an “Accelerated Non-Renounceable Entitlement Offer“. The ‘entitlement’ element is what is commonly known as a rights issue; that means that existing shareholders are offered the opportunity to purchase new shares in a company in proportion to their existing shareholding. NZSA supports the ‘pro-rata’ element of these offers, as it create fairness between different types of shareholders – regardless of size or status, every shareholder can participate equally. Happy days, at least so far.

The ‘accelerated’ part of the definition is not an issue for NZSA either. That means that the ‘institutional’ component of an offer can be completed relatively quickly, creating price certainty for the issuer and allowing access to the bulk of funds to be raised; so if a company has struck a deal to purchase assets and needs cash quickly for settlement, that helps everyone. Retail investors then have a bit more time to participate and find the funds required to do so. A win-win relationship indeed.

The issue for any retail investor are the two innocuous-looking middle initials, standing for “non-renounceable“. For an existing shareholder, this reduces any degree of freedom or flexibility associated with a capital raise. It means that to avoid being “diluted” – ie, a loss in value of your pro-rate shareholding – you have to participate.

Why renounceability matters

Ultimately, the right to buy a share in a company is worth something – especially where that entitlement is at a price below that of the prevailing market price.

Where an entitlement offer is “non-renounceable”, if you don’t – or can’t – participate in the offer, you don’t get anything back. In fact, you are more likely to suffer a significant loss in value as your shareholding is diluted away. Some might say this is no different to a share purchase plan (SPP) – a different form of capital raise structure that allows existing shareholders to subscribe for shares up to a fixed amount. And in this regard, indeed, they are no different. If you don’t participate – you lose, either by losing your proportionate shareholding in the company and its future income or by losing the value inherent in your entitlement to purchase more shares in the company.

ANREO’s are not possible on the NZX, so it’s not possible to illustrate the real impact of non-renounceability with a New Zealand ANREO example. But this can be shown via the non pro-rata (and inherently non-renounceable) process associated with a share purchase plan (SPP). Right now, Infratil is in the process of raising $100m capital from retail shareholders, having completed an institutional placement of $750m last week. The effective rate of capital raise is about 12.7% – so for every 10 shares owned, a shareholder is entitled to subscribe to 1.27 additional Infratil shares at the lower of $9.20 (determined by the institutional placement process) or the average share price over the preceding 5 days. The share price is around $9.60 – implying an approximate $0.40c value to each ‘entitlement’ – however, there is no way to access this value for non-participating shareholders; a shareholder that does not take up the SPP is likely to suffer an immediate value loss of $0.40 per share once the offer closes.

NZX has long-enabled more traditional entitlement offers and (more recently) AREO’s – the accelerated, renounceable version – that allow a non-participating shareholder the potential to receive the value associated with the ‘right’ to purchase additional shares. This is enabled through either the ability to trade rights on the NZX or the value received from an auction (known as a bookbuild) of unused rights amongst institutional holders, with the effective price paid for each entitlement passed back to the holder.

That is a key protection for shareholders. One group might comprise more sophisticated investors who lack cash to participate – they will be frustrated, but at least have some bias to action. There is a whole other demographic, however, that has grown in prevalence in New Zealand over the last few years. Many are simply unaware of the somewhat technical argument associated with capital raise and dilutionary impact. At NZSA, we have seen many Facebook posts associated with previous capital raise offers where a typical post has suggested that a holder will not participate “because I already have plenty of those shares“. If they are even aware in the first place, their bias is to a very different (non) action.

In a ‘renounceable’ entitlement process, supported by an institutional bookbuild, these two very different demographics are at least compensated for the inherent value in their entitlements. It is still possible, of course, that the inherent value is ‘zero’, but at least the process exists.

Above all else, of course, recounceability offers fairness to all shareholders. A key word indeed when it comes to building and sustaining confidence in capital markets.

Fairness

There is a natural tension between “issuer” and “investor” when raising capital; an issuer wants to raise as much as possible at the least expensive cost of capital, whereas as investor is attempting to buy into a company as cheaply as possible. The rules of the game are important in striking a fair balance between issuer and investor – but also between different types of investors.

NZSA made an extensive submission in September 2022 to the NZX on the proposed changes to its capital raise settings. We called for greater disclosure by issuers relating to both their choice of methodology and the quantitative impact on shareholders and ‘downside price protection’ for retail shareholders. We also were clear in stating that we did not think ANREO’s should be a feature of the New Zealand market as this creates an issue related to fairness for existing shareholders.

We weren’t the only ones.

We do not believe NZX has provided sufficient principled evidence to justify enabling ANREOS ‘as of right’.

NZ Corporate Governance Forum (comprising representatives from institutional and large shareholders)

We are of the view that ANREOs are an offer structure that should be used rarely and infrequently, primarily due to the fact that these offer structure shave the potential to significantly dilute the shareholding of non-participating shareholders

Forsyth Barr

Unsurprisingly however, most of the “sell-side” institutions and advisers were much more supportive of ANREO’s. That provides another tool that they can offer to issuers, with no downside for their own businesses.

Investor Protection

Pleasingly, though, the NZX has taken some steps that limit downside for investors and improve fairness for retail investors in other areas – in line with other points made by NZSA in its submission. Specifically;

• As a means of limiting dilution for non-participating shareholders, an issuer utilising an ANREO cannot issue new entitlements at a ratio greater than 1:3
  
• The NZX has also agreed with the NZSA submission (and NZSA’s capital management policy more generally) that issuers should provide disclosure as to the reasons for selecting any non-renounceable capital raise methodology and the impact on non-participating shareholders.
  
• Where a renounceable structure is selected, this MUST include an ability for non-participating shareholders to realise some form of value, through trading or a ‘bookbuild’ process. During 2022, NZSA was critical of the so-called ‘renounceable’ capital-raise structure implemented by NZ King Salmon, where there was no ability to trade rights and no bookbuild process.
  
• The NZX has also introduced downside price protection for retail shareholders.

The NZX is trusting that the ratio limit and enhanced disclosure requirements mean that defaulting to an ‘ANREO’ structure does not create the ‘easy ride’ for issuers that makes the structure more prevalent in Australia. The reality is that no-one genuinely knows for certain whether the rules regime will strike the right balance between issuer flexibility and investor protection.

The issue being, of course, that once an ability for ANREO’s is introduced, it can never be taken away.

That implies that the protection settings need to be exacting from day one. At NZSA, we’re unconvinced that the case for ANREO structures has been effectively made; is it simply a case of a kneejerk reaction to a short-term clarion call from investment banks and their advisors? Will this truly enable the NZX to better compete with its Australian counterpart in the market for capital?

Time will tell.

In the meantime, we’ll be keeping a close eye on capital raise structures following the implementation of the rule change. NZSA will continue to advocate for issuers to consider pro-rata, renounceable structures as a ‘default’ standard for capital raise methodology – with fairness as a key principle.

Oliver Mander

Oliver is the Chief Executive of NZSA. NZSA has made extensive submissions on capital raise policy to the NZX and continues to set expectations with listed issuers that capital raise methodologies should be fair to all investors.

Addendum – a summary of capital raise structures