China details rules on banks' preferred share issuance

China published detailed rules on commercial bank issuance of preferred shares on Friday, paving the way for lenders to begin fundraising designed to enable them to withstand an expected rise in bad loans. Chinese banks are facing pressure to raise funds after the banking regulator began phasing in stricter capital adequacy requirements last year in line with global rules on bank capital known as Basel-III.

Preferred shares are a form of hybrid security with characteristics of debt and equity. They enjoy seniority over common stockholders in the event of bankruptcy, but in other respects they have limited impact on common shareholders.

Such shares typically don't trade on the open market, carry no voting rights, and do not dilute net profits attributable to shareholders.

Stock market investors have been eagerly anticipating their introduction, hoping they will allow listed companies to raise necessary funds from stock markets with minimal dilution on equity valuations.

The need for capital among banks is especially acute. Regulators are implementing Basel-III aggressively in order to fortify banks against losses on bad loans as the economy slows.

China's bad loan ratio hit a two-year high at the end of 2013. Data released this week showed the economy growing at its slowest pace in 18 months.

China's largest banks must meet a Tier-1 capital adequacy ratio of 7.9 per cent by end-2014 and 9.5 per cent by end-2018. Preferred shares will count as additional Tier-1 capital.

In order to protect the interests of ordinary investors, preferred shares issued to the public must not contain provisions that allow preferred shares to be converted to common equity, under the guidelines published on the China Securities Regulatory Commission's (CSRC) Twitter-like micro-blog. In private placements, however, preferred shares must include such provisions, which force conversion of preferred shares when the bank's financial condition deteriorates, the guidelines said.

NEW NORMS

* Rules pave way for sale of new hybrid capital instruments

* Banks need funds to meet Basel III capital adequacy standards

* No equity conversion provisions allowed for publicly issued shares

* Strict disclosure requirements