The market regulator, SEBI, has streamlined the process of buying and selling Rights Entitlements (REs) through electronic credit. Previously, shareholders had to submit physical paper application forms. Now, the entire process is digital, making it significantly more efficient for shareholders.
Let's explore what rights entitlement is in detail.
Key Takeaways
-
Rights entitlement is temporarily credited to the Demat accounts of eligible shareholders on the record date.
-
Each rights entitlement grants the opportunity to subscribe for new shares at a set issue price.
-
During the defined trading window, rights entitlements are tradeable on the stock exchange.
-
Unused rights entitlements expire when the rights issue is closed and are no longer worth anything.
What is Rights Entitlement?
In order to meet their needs, companies raise funds from time to time. An example of a funding method is rights entitlement.
The company offers its shareholders the right to purchase its shares at a discount on a predetermined date known as the record date in a rights entitlement.
Shareholders are granted rights entitlements by temporarily crediting their Demat accounts with shares, giving them the right to participate in a rights issue. The fact that you have rights entitlements does not automatically entitle you to rights shares.
The shareholders have an option to either subscribe to the right issue or let the right lapse. The recent update allows shareholders to renounce their right to another person at a price by trading them on an exchange.
Therefore, investors have a chance to gain some value from RE shares. In the past, shareholders who did not want to apply for an RE had to let it lapse or transfer it for free. By trading their rights, shareholders can now see the intrinsic value of their shares.
Also Read, What is Demat account
Why Rights Entitlement?
Rights entitlement offers a simplified way for existing shareholders to participate in a rights issue. It removes the need for physical paperwork and replaces it with an electronic entry directly in the Demat account of eligible investors. This makes the entire process faster and more convenient for all market participants.
A major advantage is the reduced timeline for completing a rights issue. Previously, companies required close to two months to finish the process. With electronic credit of REs, this timeline has shortened significantly, improving operational efficiency and reducing delays.
Eligible shareholders also gain greater flexibility. They can choose to apply for the new shares or sell their entitlements on the secondary market. This makes REs tradeable instruments that offer investors additional liquidity.
Another important benefit is accessibility. Even investors who do not originally qualify for a rights issue can purchase REs from the market. This widens participation and gives more people the opportunity to subscribe to shares at a discounted price.
Overall, rights entitlement supports a transparent, faster, and more inclusive system that benefits both companies and investors.
Also Read, What is a Shareholder?
What is Rights Renunciation?
Renunciation of rights occurs when a shareholder does not accept the rights offer and, in turn, renounces the shares for the benefit of someone else.
It is possible for a shareholder to renounce his RE either entirely or partially. However, the renouncers and renounces are prohibited from obtaining additional shares over and above the REs that they already own.
Renunciation rights credited to your demat account can be accomplished in two ways:
(a) through the secondary market platform of the Stock Exchanges ("On Market Renunciation") (b) via off-market transfers ("Off Market Renunciation") through a depository participant.
What is Rights Entitlement Trading?
As a result of SEBI's dematerialization of rights entitlements, companies must now credit the rights issue entitlements to the Demat accounts of all eligible shareholders.
Right trading is the process of transferring rights renounced by shareholders to someone else. Traders on a stock exchange can trade rights entitlements for a price and transfer rights to other investors. The process of RE trading is similar to that of equity trading, with a few minor differences.
As a general rule, rights issues are offered in proportion to existing holdings. As a result, there may be fractional rights entitlements. The fractional portion of the entitlement is ignored in such cases, and the credits are rounded to the lower whole number.
How Does It Work?
Rights entitlement is credited to the Demat account of eligible shareholders based on the proportion of shares they already hold. For example, if an investor owns 140 shares and the company announces a ratio that gives ten REs for that holding, the Demat account will show ten RE units.
Each RE represents the right to subscribe to new shares at a predetermined issue price. A part of the amount is usually paid at the time of application, while the remaining balance may be collected later in one or more tranches, depending on the structure of the offer.
Once the rights entitlement appears in the account, the investor can subscribe to the new shares or sell the REs in the secondary market. The REs trade like regular securities for a limited period, giving flexibility to investors who may not wish to apply.
If the REs are neither subscribed nor sold before the window closes, they expire and lose all value. This temporary credit system ensures transparency and a smooth process for shareholders.
What Happens If You Don't Apply?
If you do not act on your rights entitlement, it simply expires once the subscription window closes. Since REs are temporary credits, they hold value only for a limited period.
If you neither subscribe to the new shares nor sell the REs in the market, they are extinguished as per regulatory rules.
This means you lose the opportunity to buy shares at the issue price and forfeit any potential value the REs could have offered.
Rights Entitlement Share Price
Right entitlements are determined by the share price of equity and the price at which rights are being offered. This difference between the two prices is used as the base price for rights entitlement trading. Based on market sentiment and the supply and demand of RE, the price may move further once the base price is set.
Right Entitlement Share price (Base price on the first day of trading) = Closing price of the stock at the time of issue opening less Right Issue Offer price.
Example: Assume the share of Company X is currently trading at ₹120 (Market Price). The company announces a Rights Issue at an offer price of ₹80.
To determine the theoretical price of the Rights Entitlement (RE) on the first day of trading, we calculate the intrinsic value:
Formula: Market Price - Rights Issue Price = Intrinsic Value of RE
Calculation: ₹120 - ₹80 = ₹40
Therefore, the RE trading price will ideally open around ₹40. From there, the price will fluctuate depending on the demand and supply of the RE on the stock exchange.
How Can Equity Holders Who are Eligible for the Rights Issue Exercise Those Options?
The Rights Entitlement Letter will state clearly how many equity shares each eligible equity shareholder is entitled to. A shareholder who applies for the issue may:
• Obtain full rights entitlements;
• Apply for his rights entitlements partly without reneging on other part entitlements;
• Accept a part of the rights entitlements and renounce the other part;
• Application for rights entitlements in full and for additional rights equity shares;
• Fully renounce all rights and entitlements.
Note: To apply for the rights shares (Option 1 or 2), investors typically use the ASBA (Application Supported by Blocked Amount) facility available through their net banking portal, similar to applying for an IPO.
Conclusion
By transforming the physical rights issuance process to an online mode, the dematerialized rights entitlement has transformed the old fashioned, time-consuming process into a fast track, bringing complete transparency.
Nevertheless, before investing in the rights issue, shareholders should consider the company's performance, the reasons for raising funds, and its purposes - whether they are for expansion, acquisition, takeovers, debt reduction, etc. Ultimately, a growth in top-line revenue, efficient procurement, and supply chain efficiencies is expected to drive fundraising.
