Everything you need to know about Rights Entitlements

Rights – A basic overview

Before we understand Rights Entitlements, let’s quickly understand what a rights issue is. 

In a rights issue, a company gives its existing shareholders the right to buy more of its shares at a discounted price. The rights share being issued by the company may either be a fully-paid share or a partly-paid share. In case of fully-paid shares, you don’t have any obligation to the company, that is, you cannot be called upon to pay any additional amount to the company because you’re a shareholder with limited liability.

If your company has issued a partly-paid rights share to you, it may call upon you to pay installments over a given period to make the shares fully paid. If you fail to pay the called amount, your partly-paid shares may be forfeited or you may be charged interest on the called amount or both.

You can read more about rights issues in this Varsity chapter.

Rights Entitlements – a new instrument?

In January 2020, SEBI issued this circular announcing the launch of rights entitlements tradeable in demat form. The instrument was first made available to the shareholders of Reliance Industries when its rights issue launched in May 2020.

Since then, many investors (both new & seasoned) have reached out to us to understand what rights entitlements are and how they work. We have listed related FAQs on our Support Portal but the confusion around the basics of the instrument prompted us to write this comprehensive explanation. 

In this post, we’ll attempt to cover everything you need to know about rights entitlements, rights issues, and rights shares of various paid-up categories.

Rights Entitlements = coupon code for stocks?

Firstly, let’s call these REs 😅

Yes, REs are pretty much like coupon codes for stocks. If you have received some, you get three options –

1. Use your REs to buy shares at a discount
2. Sell your REs to someone else who may want to buy the discounted shares
3. Do nothing

Like a coupon code, even REs have an expiration date. You need to figure how you would like to use these REs before the expiration date. 

If you choose to do nothing, then you lose the entire value associated with the RE. 

How do you get an RE?

If you are a shareholder of the company on the record date announced in the rights issue scheme, then you will automatically receive the RE units you’re eligible for in your demat account.

Along with the record date, the company also announces the ratio in which it will distribute the REs to its shareholders. 

For example, assume the company announces that the shareholder is entitled to receive 1 RE for every 15 shares. Now, if you have 200 shares in your demat account, then you will receive – 

~ 200/ 15

= 13 (rounded down) REs. 

These 13 REs will be credited to your demat account on or before the right issue opens, and the REs get listed to trade. 

Trading REs

In the example we discussed above, you receive 13 RE in your demat account. You can use these 13 REs to apply for 13 rights shares. 

If you wish to buy more than 13 right shares, say 20, then you need to buy 7 more REs from the market. If you don’t buy the additional REs and apply for 20 rights shares, you will be guaranteed to receive 13 and may or may not receive 7 additional rights shares depending on the demand. 

This is one of the reasons why REs were made tradable in the market. 

For a better understanding, it makes sense to dig into the past and understand another important need for REs to be tradable. 

Historical context 

REs were not traded on the exchange before 2020. Physical rights applications were sent to investors or could be downloaded from the Registrar’s portal. This application would be used to either apply from the investor’s bank or the application form could be sold to an interested buyer if the investor found one.

Yes, people literally sold the application forms. 

Consider this – 

In April 2019, Vodafone Idea had launched a rights issue in which the rights shares were issued at a significant discount to the prevalent market price. The market price was around 30 per share at that point. 

For every 38 shares held by a shareholder, one could apply for 87 more shares. 

The data for the right issue is as follows – 

Stock Price before the right = 30 

Assume an investor held 3000 shares of Vodafone, his total investment would be worth – 

3000 x 30 = 90,000

Now, by virtue of holding 3000 shares, the investor is eligible to apply for 6868 right shares. Let’s say the stock price stays fixed at Rs 30. Then,

Rights adjusted stock price = (Total value of rights shares + Total value of present shares)/Total number of shares after the rights issue

= (87×12.5)+(38×30))/(87+38)

= Rs. 17.82

Post rights value of original holdings = 3000 x 17.82

= Rs. 53,460

Rights Entitlement value = Right adjusted stock price – Price of rights share

= 17.82 – 12.50

= Rs. 5.32

Value of your 6868 REs = 6868 x 5.32

= Rs. 36,537.76

You now know the value of your 6868 REs but you don’t want to use them to apply for the Vodafone Idea rights shares. You decide to sell your REs but now you have to find buyers for it. If you’re unable to find a buyer during the rights issue period and also don’t apply for the rights shares yourself, then you lose the entire value your REs are worth i.e. Rs. 36,537.76. 

SEBI understood that a small investor might face difficulty in selling the physical rights application form if they don’t want to apply for the rights shares themselves. And so, the new demat way to trade REs was introduced allowing investors to make a decision on whether they should apply for rights shares more freely.

Things to note before you trade

REs are listed on the stock exchange on the day the rights issue opens and can be traded on the exchange for about a week before they are delisted permanently.

While trading the REs, you should keep in mind the intrinsic value of rights. The market price of the RE may sometimes be very far in discount or premium to the intrinsic value (i.e. (Rights Adjusted Price of Shares – Price to be Paid for Rights Shares).

You will not be able to transact them intraday as they are settled on a trade-to-trade basis. If you purchase an RE on Monday, you will receive it in your demat account on Wednesday and will be able to sell it from Thursday onwards. In other words, you will need to wait for three trading days (T+3) to be able to sell REs bought on the exchange.

This means, if you buy REs on the last two days of trading you will not have an option to sell them back on the market since they will be delivered to your demat account after the trading period has ended. You will, in this case, only be able to apply for the rights shares using the REs you’ve bought.

When you’re buying REs directly from the market, you get the right to apply for the rights shares being issued. You will need to apply for the rights shares to use your RE holdings or they will lapse worthless. 

Application Window

The application window opens when RE trading starts and stays open for at least 4 days after the REs have been delisted from trading. You will lose the entire value of any unused REs that remain in your demat account after the application window closes.

You can apply for the rights shares at any time during the issue period from the Registrar’s website by making a payment directly or by using net banking ASBA to block funds in your bank account for the rights issue if your bank supports it.

The details on the process of application can be checked on the website of the company’s Registrar. The company or its Registrar will also send the details to you on the email ID registered in your demat account.

TLDR

Here’s what you need to know about Rights Entitlements in form of a numbered list (arranged in order of importance):

1. You will lose the entire value of any unused REs that remain in your demat account after the application window closes.
2. You can either sell or use REs to apply for rights shares before the expiry date. Two dates that you need to keep a note of – one is the last date of RE trading, and two is the last date of applying for rights shares. REs expire or get extinguished after the last date to apply for the rights passes. 
3. You will need to wait for three trading days (T+3) to be able to sell REs bought on the exchange. REs bought on the last two days of their trading can only be used to apply for rights since you will not receive them in time to be able to sell back.
4. An instrument like REs can trade at a premium or discount to its intrinsic value (Rights Adjusted Price of Shares – Price to be Paid for Rights Shares). You should take this into account before entering into a trade.
5. If your company has issued a partly-paid rights share to you, it may call upon you to pay installments over a given period to make the shares fully paid. If you fail to pay the called amount, your partly-paid shares may be forfeited or you may be charged interest on the called amount or both.

Happy investing,