A company finances its activities with its own resources (input from shareholders and reinvested income) and external resources (loans, all types of bonds, suppliers and others debts). Preference shares, within the framework of company capital structures, are hybrid products that are part of the resources of credit institutions and are financial instruments that, in terms of risk, can be placed between ordinary shares and debt, both senior and subordinated.

Concerning the structure of preference shares and their performance, preference shares have similar characteristics to those of a fixed income debt bond and of a share. The Spanish National Stock Market Commission places them within the category of private fixed income instruments.

Finally it must be noted and insisted upon that preference shares are not equities, but fixed income, according to how the Spanish National Stock Market Commission has specifically defined them, nor are they structured products.

Consequently, according to Mayorga Toledano, preference shares can be defined with the following basic features:

They grant the holder rights to a remuneration determined in the issue conditions and payment of such remuneration is conditional upon the existence of distributable profits or reserves in the issuing or dominant credit institution. However, we must take into account that the payment can be:

a) Cancelled at the discretion of the board of directors on a non-cumulative basis.

b) Cancelled compulsorily if the issuing credit institution or parent, or its consolidated group or subgroup, does not meet the capital requirements, which are set out in the standard

c) Cancelled if the Bank of Spain demands it based on the financial and solvency situation of the issuing credit institution or parent, or its consolidated group or subgroup.

2. They do not grant voting rights to their holders.

3. They do not grant pre-emptive subscription rights in respect of future new issues.

4. They must be perpetual, although the issuer may agree an anticipated net payment from the fifth year after the date of disbursement, subject to authorization from the Bank of Spain, which will only grant it if the financial position or solvency credit of the institution or its consolidated group or subgroup is not affected.

5. They must trade in organised secondary markets: in Spain, the AIAF market (Association of Financial Brokers).

6. In the event of liquidation or dissolution, they will be placed, in order of preference of claims, immediately after all creditors, subordinated or not, of the issuing credit institution or the dominant consolidated group or subgroup of credit institutions, and before ordinary shareholders and, if any, equity holders.

7. In the event where the issuer or parent or its consolidated group or subgroup, presents significant accounting losses, a relevant drop in indicator ratios of capital requirement fulfillment, the preference shares terms of issue should establish a mechanism to ensure participation of bondholders in the absorption of current or future losses which does not prejudice any recapitalisation process.

Differences from other financial products: stocks and shares

The preference shares you share with your payments bonus, also called coupons, are defined on the nominal amount; payment frequency is defined from issuance (annual or biannual), as well as the amount of coupons (or their calculation method). The coupons can be a fixed amount, a variable amount linked to an interest rate or reference or a combination of both.

They look like shares because of their perpetual financial condition and the fact that the coupon is paid only if there are benefits. On the other hand, unlike shares, preference shares incorporate an anticipated payment option that grants the issuer the right to cancel the instrument on payment of the nominal amount.

The concept ofin perpetuity of investment

The concept of perpetuity means that the financial instrument does not have a fixed maturity. But that does not mean its liquidation is not possible in an organized secondary market. Therefore, the perpetuity character of the preferred shares places them in the same plane as ordinary shares, currencies or investment funds, to mention just a few examples, not being synonymous with an investment from which its owner cannot leave.

There is a preference shares secondary market which has been traditionally characterized by a remarkable and deep liquidity.

In Spain, preference shares are traded on the Financial Brokers market which operates differently from the stock market. It is a bilateral market (not centralized like the stock market) where issuers and clients (in any form, entity-entity, client-client or client-entity) agree transaction prices that are subsequently communicated to the market. Therefore, the market price is a merely a guide since what is published is a weighted average price.

The National Stock Market Commission itself, when dealing with the Association of Financial Brokers) states that:

“… despite being assimilated in many cases the secondary market for equities presents very important differences on the subject of contribution, negotiation, confirmation, execution and settlement of securities admitted to trading, as it is a decentralized bilateral market.

The form of negotiation, as well as issuer contributions, is based on the existence of counterparts, who offer positions or prices, for both buying and selling and who reach a bilateral agreement on the transfer value when both positions marry without the existence of a system for matching orders and immediate and anonymous execution.

Therefore, the value that the claimants are entitled to, do not have immediate liquidity nor does any guarantee exist on the capital invested, but they are subject to the market rules that have been set out above.”

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