Rights Issue Processing

Rights issue processing is the set of operational steps by which the securities industry carries out a rights issue on behalf of shareholders. In a rights issue a company offers its existing shareholders the chance to buy new shares, usually at a discount, in proportion to what they already hold. Processing covers everything that custodians, brokers, depositories and the issuer's agents must do to announce the offer, credit the rights, collect holders' decisions and money, and deliver the new shares.

It is regarded as one of the more demanding corporate actions because it combines a compulsory distribution with a voluntary choice, involves cash moving from investors to the issuer, and runs to fixed deadlines. The legal basis for the offer lies in shareholders' pre-emption rights; this entry deals with the operations rather than the reasons a company raises capital this way.

Operationally, a rights issue is normally handled as two events. The first is the distribution of rights, which is mandatory: every holder on the record date receives them. The second is the exercise of those rights, which is a voluntary corporate action on the rights themselves. In the ISO 15022 and ISO 20022 corporate action standards these are identified by the event codes RHDI (intermediate securities distribution) and EXRI (call on intermediate securities). Treating the rights as a separate, short-lived security allows them to be held, traded and settled like any other position.

The usual order is as follows:

1. Announcement and event capture. The issuer publishes the terms: subscription price, entitlement ratio, key dates and the prospectus. Custodians record the event from the depository, data vendors and the issuer's agent, and reconcile the sources.
2. Notification. Holders are sent a corporate action notification setting out their options and the reply deadline.
3. Ex-date and rights credit. From the ex-rights date the shares trade without the entitlement. The depository credits the rights, and intermediaries complete the rights allocation to client accounts.
4. Rights trading. Where the rights are renounceable, they trade on the exchange for a set period, often called nil-paid trading.
5. Elections. Each holder chooses to exercise, sell or lapse. A rights exercise needs both an instruction and cleared funds.
6. Instruction to the agent. The custodian totals client elections, checks them against holdings, and instructs the depository or receiving agent before the market deadline, paying the subscription money.
7. Close and delivery. After the offer closes, the rights line is removed, new shares are credited and cash is debited on the payment date.

What happens to rights that are not exercised depends on the market. In the United Kingdom, shares not taken up are typically sold by the underwriters, and any amount raised above the subscription price is paid to the holders who let their rights lapse. In many other markets, unexercised rights simply expire worthless, which makes the default option important for holders who do not reply. Some custodians sell rights automatically for clients who give no instruction, where the market allows.

Offers may include an oversubscription privilege, under which holders apply for extra shares that are allotted pro rata if others do not subscribe; money for unallotted shares must then be refunded. Ratios that do not divide evenly create a fractional entitlement, handled by rounding or by sale of the aggregated fractions.

Between institutions, the event is communicated with standard SWIFT corporate action messages: MT 564 for the notification, MT 565 for the holder's instruction, MT 567 for its status and MT 566 for confirmation of the resulting movements, with ISO 20022 equivalents in markets that have migrated. Each intermediary in the custody chain sets its own election deadline ahead of the one above it, so the end investor's cut-off can fall several days before the issuer's. Trades in the shares that straddle the ex-date can give rise to a market claim for the rights.

Errors in rights issues are costly because a missed deadline cannot usually be repaired and the client's loss is the value of the rights. Common failures are late or incorrect instructions, exercising without sufficient cash, miscalculating entitlements on positions that are on loan or pending settlement, and overlooking restrictions that prevent holders in certain countries from taking part. Controls include independent checking of event terms, daily corporate action reconciliation of rights and elections against depository positions, chasing of non-responders, and dual authorisation of instructions and payments.