Securities Exchange Board of India the top regulator of stock markets in India have made the process of buying and selling Rights Entitlements simple. After these changes in the method, there is a lot of buzz about these in the stock markets. This is one of the potentially preferred modes of raising capital by the companies.
The rights issue is one method of raising capital by publicly listed companies. in this method, the company issues its existing shareholders the right to buy more shares and at a price that is usually at a discount to the present market price of the stock. These new issued rights may be fully paid up or partially paid up.
If the rights that are issued are fully paid up, it means that you pay the full amount at the time of issuing the shares and you are in no obligation with the company to pay any additional amount to the company in future. But is the rights that are issued are partially paid up, then you have to pay the remaining amount either in the form of EMI or full at a later stage and if you fail to pay the amount you will have to face the consequences such as forfeited the rights issue or paying the interest on the pending amount as decided by the company.
These rights that are issued by the company are tradable in the Demat form as announced by the SEBI in 2020. Before January 2020, there is a physical application process in case of transacting in REs but laters to simplify the process and also make the process, transparent SEBI has streamlined the process to a completely electronic form.
How Rights Entitlements Work
Rights entitlements are issued to the existing shareholders and in the form of a particular ratio. For example, Reliance is announcing a Rights issue in the ration of 1 rights issue for every 10 shares held by the investors.
In the above case, if you are holding 20 shares, then on the date of rights entitlements issue date, 2 REs are credited to your Demat account and will show on your portfolio. These rights will have a separate security identification number and usually have “-RE” at the end of the token of the instrument. In the case of our example Reliance, the Rights entitlements will be identified as “Reliance-RE”
Now as you have received 2 REs in you Demat account the you can subscribe to 2 shares of rights issue. Now you will have multiple option infront of you and you have to make a decision before the specified timeline of the rights issue. The following are the different options
Subscribe to the Rights Issue as it is
Don’t want to subscribe to Rights Issue and Hence exit
Subscribe to Rights Entitlements
In the first option, you have decided that you wanted to subscribe to the rights issue. Now you are entitled to a minimum of 2 shares allotment if you subscribe. But you can even apply for more shares. That is you can subscribe to more than 2 shares, but it is not guaranteed that you will be allotted more than 2 shares. The allotment of more than 2 shares depends on the number of people who have subscribed to the rights issue.
To mandatorily get more than 2 shares, you have one option. These rights entitlements are tradable on the stock exchanges. It means you can either buy more right entitlements from others who have no interest to subscribe to the rights issue. And you can sell your rights entitlements if you decide not to subscribe to the rights issue of shares. For getting more than 2 shares, you have to buy rights entitlements from the market.
Don’t want to subscribe to the Rights Issue
If you have decided that you don’t want to subscribe to extra shares that are issued as rights issue by the company, then you can sell your rights entitlements on the open markets. As said earlies, the right entitlements are tradable on the stock exchanges and hence you can easily find a seller for your rights entitlements. Previously before 2020, the selling of rights entitlements is offline and you are supposed to literally sell the applications of rights entitlements. But now the process is simplified, thanks to SEBI new rules and procedures of REs.
In the case, you did nothing about the right entitlements you have received before the deadline as per the timeline announced by the company, then the rights entitlements will become zero-valued after the end of the timeline. These REs will be exact expire after the timeline. In this case, you will be on the losing side.
The best option is to either subscribe to the Rights issue if you wanted to buy more shares at the discounted price or you can sell your Rights entitlements to other investors in the stock exchanges.
What happens to the price of the stock
After investors have subscribed to the rights issue, on the day the shares are credited to the Demat account of the investors, the price of the stock will be adjusted because the number of shares that are outstanding in the market changes because of the new rights issue by the company.
The adjusted share price is = (Total value of new rights issue + value of share already in the market) / (Total number of outstanding shares after the Rights issue)
Hence the price of the stock will usually be reduced on the day when the rights are available on your trading portfolio. The price is adjusted by the stock exchanges. If you have neither subscribed to the rights issue of shares or sold your rights entitlements, you will be on the losing side as the price of the stock will drop and also the Rights entitlements that are in your Demat account is worthless and expired.
It is suggested and important that you either Subscribe to the rights issue or sell your rights entitlements to other investors.