Preference shares: what is it – Dictionary of Economics

Participation concept Preferred

Also called preferred shares, they are a debt instrument issued by a company that does not grant political rights to the investor, offers a fixed remuneration (conditional on obtaining profits) and has an unlimited term, although the issuer reserves the right to amortize them at after five years, prior authorization from the supervisor (in the case of financial institutions, the Bank of Spain). Although they are generally aimed at institutional investors, when they are marketed among private clients, they must assess their real return very well, taking into account the difficulties they may encounter in liquidating them (obtaining the return of the nominal amount) and the low priority right (order of preference in the collection in case of bankruptcy of the entity), which only exceeds that of ordinary shares. In the past they were issued by instrumental subsidiaries located abroad -fundamentally offshore centers to take advantage of tax advantages-, but since 2003 their issuance from Spanish territory has been regulated.

At the end of 2011, banks began to launch swap offers to preferred stock holders to adapt to the Basel III regulation, according to which preferred shares will no longer count in Tier 1, that is, they will no longer serve the bank to reinforce his capital. This regulation enters into force on January 1, 2013.

Characteristics of preferred shares

– The capital is not guaranteed. Once you want to recover the investment, you have to put them up for sale on a secondary market. This means that its value is subject to listing.

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– High risk. These types of products pay well above deposits, with figures that exceed 7% per year (even in the past they reached figures greater than 15%), but just as they can generate profits, they can also generate losses. The remuneration agreed as payment of interest is conditioned to the obtaining of profits by the issuing company.

– The Deposit Guarantee Fund (FGD) does not cover preference shares. Therefore, if the bank fails, the holder loses his investment.

– They have very low liquidity. As they are in perpetuity, the process to recover the investment depends on a purchase-sale, so it is a complex process and can take even months, which can be a serious problem if the client has an urgent need to sell.

– They do not grant political rights to the investor (voice and vote at the general meeting).

– They are instruments without a fixed or indefinite maturity, although the issuer usually reserves the right to cancel after the fifth year.

– They are not listed on the Stock Exchange. They have their own organized market, the AIAF (Association of Financial Asset Intermediaries).

Acquisition and commercialization

Since 2003, the issuance of preference shares has been regulated by Law 19/2003, which establishes the obligation to list them on the fixed-income markets, and established their tax regime.

As it is a financial instrument that is listed on organized markets, its acquisition can be carried out both in the primary and secondary securities markets. Like the vast majority of issues of this type, preference shares are represented by book entries.

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If we acquire in the primary market, the acquisition cost will be the issue nominal.

If we acquire in the secondary market, the acquisition cost will be represented by a percentage of the issue nominal, where the nominal will be 100%.

The important detail about this profitability is the possibility of suspending the payment of interest if certain adverse conditions occur for the issuer, such as incurring losses or facing new investments that recommend not paying interest.

Taxation

At the fiscal level, the consideration of the yields obtained is that of the transfer of capital to third parties, paying taxes at 18% for the interest collected and integrating part of the tax base of the savings and not subject to personal income tax or corporate withholding. In the case of selling below or above the acquisition value, the difference is taxed as capital gain or loss.

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