I. Introduction
Recently, the majority of banks, which had previously marketed preferential shares to their clients, have started to make offers to buy them back or exchange them for shares in the bank. The majority of banks have sold this initiative to clients as an option to make financial instruments, which are essentially unliquid, liquid. The characteristics of such instruments and the real interests of the banks to exchange them are set forth below.
II. Description of preferential shares
Preferential shares are debt issued by financial entities or companies with a long term or even perpetual expiry date. This means that they may only be negotiated in secondary markets, for example the Spanish AIAF (Association of Intermediaries in Financial Assets – a wholesale market dealing in private fixed interest investments), provided that there is a party willing to purchase them.
A priori, these financial products worked out to be very attractive to investors due to their high earnings. Whereas a fixed term deposit would earn at the most 2% or 3% interest, these products made earnings of up to 7%, paid quarterly, always provided that the issuing company made sufficient profits for distribution.
In times of prosperity, liquidity problems did not exist, given that their were always people willing to negotiate shares in secondary markets, however, this situation changed with the arrival of the economic depression.
The majority of those who acquired these shares were not really properly informed of the conditions and thought that they were contracting deposits. In fact, despite the majority of investors having passed the so-called MiFID advisability test, in reality they did not have the sufficient financial knowledge for contracting these products. We should remember that the MiFID test qualified those clients taking it according to their greater or lesser financial knowledge, in the following groups: retail (less knowledge), professional or eligible party (greater knowledge).
For the banks these products were a quick form of obtaining funds to reinforce their capital or Tier 1 (capital, reserves and preferentials), until the reforms made as a result of the new accounting standards (BASEL III), changed the classification of these instruments, which ceased being capital and became debt. On the other hand, the European Banking Authority (EBA) advised that the minimum “core capital” (that is to say, capital reserves) must be above 8% as from 2013. This implies that the total of shares and funds available to the banks when the time comes must be equivalent to 8% of all assets.
BASEL III blew a hole in the flotation of many entities for whom no other option remained than to initiate the exchange of the preferential shares for shares in the company, in most cases in order to directly reinforce the capital, or to buy back the shares at prices well below to their value at the time of their contracting, meaning great losses to their clients.
As explained above, clients were only able to negotiate these instruments in secondary markets. On the other hand, the banks have the option to buy back these instruments once 5 years from the date of issue have elapsed, at their market price. That is to say, that if on a secondary market they are quoted at 50% below their nominal value, the client automatically loses 50% of their investment.
III. Conclusion
Having observed the evolution of these financial products, we may conclude that given their complexity, they should have been restricted and only offered to clients with extensive knowledge of the financial sector and not offered to clients classified as “retail” in the MiFID advisability test. The latter group consists of a multitude of retired pensioners completely alien to this sector who have seen how the ups and downs of the economic depression have converted a product they considered to be safe into an unliquid product which in the end has converted them into shareholders of the banks, and in the majority of cases, against their wishes. This new scenario gives rise to two alternatives to the holders of these financial instruments
a) To keep hold of them and risk: firstly, not finding a buyer in the secondary market and therefore not obtaining liquidity, secondly, that once 5 years from the date of issue have elapsed the bank may redeem the instruments in advance at the price fixed by the secondary market, and finally that the bank is not able to pay the coupon owing to lack of profits as is occurring with some entities at the moment.
b) On the other hand if they turn to the exchange offer of the banks they must accept what is offered without any possibility of negotiation on conditions or prices, the latter being higher than their quotation on the stock exchange and consequently the holders suffer a latent depreciation on their investment from the beginning.
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