Reliance Industries popularized the concept of rights entitlement (RE) in India after it issued a RE to its shareholders in May 2020.
The market regulator, SEBI, made the process of buying and selling Rights Entitlements (REs) more convenient and straightforward through electronic credit last year. For a Rights Issue, shareholders would otherwise have to submit paper application forms.
It came into being when all of the country was locked inside their homes, thus benefiting shareholders.
Let’s explore what rights entitlement is in detail.
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.
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.
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 Rs. 100 and the record date is 21st Dec 2021. The company is offering 10 rights per share @ Rs. 80.
In order to determine the rights price, we need to have two variables.
- Share price on the record date
- Right issue price
Let’s suppose the closing share price of the company on 20th Dec 2021 is Rs.120. Therefore, the RE trading price will be set at Rs 40 (120-80), after which the price will fluctuate depending on the demand and supply of the RE.
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.
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.