## f16-subscription-rights — SECTION I: THE ISSUE

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### Background and definition
- Subscription rights (SRs) are rights corporate shareholders have to participate in acquisition of shares newly issued by the corporation to raise additional funds; exercising SRs allows investors to maintain their percentage ownership.
- “Issuance of SRs” denotes the market and corporate practice of separating those rights from the original shares when a new equity issuance is announced, making them transferable so shareholders may obtain cash compensation for dilution by selling them if they do not wish to subscribe the additional capital.
- Upon separation, each original share is split into two assets: the ex-right share and the SR (which usually receives a separate ISIN code). At inception, the sum of the values of the ex-right share and the SR equals the value of the original share; each value then evolves with market perceptions.
- The GN reports the theoretical value at inception as: 푠푠=푟푟(표표−푛푛)/(1 +푟푟).
- Standards context:
  - The 2008 SNA and BPM6 are silent about classification of detached SRs.
  - “Handbook on National Accounting: Financial Production, Flows and Stocks in the System of National Accounts” (paragraph 4.205) indicates SRs are to be treated as financial derivatives as a “special kind of warrant”.
  - “Handbook on Securities Statistics” (paragraph 6.45) explicitly requires SRs to be treated as equity as they “represent a claim on the residual value of the corporation”.
- The Guidance Note (GN) examines two alternative treatments (financial derivatives or equity), discusses pros and cons, clarifies accounting treatment under each, and proposes a single treatment for updating the manuals.

### Issues for discussion — Option 1: Equity
- Equity definition cited: 2008 SNA paragraph 11.81 — “equity and investment fund shares have the distinguishing feature that the holders own a residual claim on the assets of the institutional unit that issued the instrument. Equity represents the owner’s funds in the institutional unit.” (underlining by GN authors).
- Arguments for classifying SRs as equity:
  - The corporate (residual) value is viewed as the (market) value of accumulated and future earnings; separation of SRs does not change total expected earnings, so total equity liabilities should remain unaffected by the split.
  - For total equity to remain unchanged after SR issuance, both ex-right shares and SRs must be classified as equity. SRs contain the value diluted from existing shares; added to ex-right shares they sum to the original corporate value.
  - SRs’ main purpose is to ensure shareholders can maintain their percentage ownership and therefore maintenance of a claim on the assets of the corporation.
  - By analogy to bonus shares (2008 SNA, paragraph 11.89 and BPM6, paragraph 11.29), issuance of SRs requires no transaction when rights are detached; only a third-party sale of rights would be recorded as a transaction in equity.
  - By analogy to stripped securities, the economic substance of the individual stripped assets (ex-right share and SR) is the same as the original asset and should be classified under the same instrument category (equity).

### Issues for discussion — Option 2: Financial derivatives
- Derivative definition cited: 2008 SNA paragraph 11.111 — assets “linked to a specific financial instrument” whose value “derives from the price of the underlying item”.
- Arguments for classifying SRs as financial derivatives:
  - SRs can be viewed as call options: holders have the right (not obligation) to buy new shares; premium corresponds to dilution value at inception; strike price corresponds to issuance price for new shares.
  - SRs could be considered akin to detachable warrants (BPM6, paragraph 5.87). Typical maturities contrasted: SRs commonly have around 15 to 60 days maturity, whereas warrants commonly have 5 years or more maturity.
  - SRs share mechanics with employee stock options (ESO): both give rise to newly issued shares, cause dilution effects, and may serve purposes other than risk trading (BPM6, paragraph 5.96). ESO are grouped with derivatives under “financial derivatives and employee stock options”.
- Counterarguments and complications if SRs are recorded as derivatives:
  - SR holders lack shareholder rights prior to exercise (no dividends, no voting, and SRs expire), so SRs do not meet the equity characteristic of acknowledging claims on residual value (2008 SNA, paragraph 11.83).
  - Identifying the counterpart flow when booking SR creation as a derivative is problematic: possible counterparts include dividends, transfers, transactions in equity, or “other flows” in financial derivatives; each choice raises interpretability or consistency issues.
  - Treating SR emergence as a dividend would imply recording equity redemption followed by issuance transactions equal to market value of newly issued shares (including holding gains), conflicting with corporate economic substance.
  - Recording SR emergence as “other flows” in derivatives to offset dilution would produce claims with no cash-flow and values that change only via holding gains/losses, creating statistical artefacts.
  - The joint price determination and intrinsic dilution at inception between ex-right share and SR differs from standard derivatives whose issuance does not directly affect the underlying’s price.

### Outcomes and recommended treatment
- FITT majority recommendation:
  - A majority of FITT members support including SRs within equity liabilities of the issuing corporation (Option 1) (paragraph 16).
  - Rationale: Failure to include SRs in equity would hamper interpretability of equity as the market value of corporate own funds (see paragraphs 6–10).
- Key implications of the recommended equity classification (paragraph 23):
  - When the subscription right is issued (separated for separate trading) no flow is recorded.
  - Purchase of a subscription right by a third party is booked as a transaction in equity between the old shareholder and the buyer, compensated with cash payments.
  - The values of subscription rights and ex-right shares experience holding gains and losses between issuance of the rights and issuance of new capital; these are booked as holding gains and losses in existing equity.
  - Issuance of new capital is recorded by the cash provided (funds raised), issued by the corporation and acquired by those holding and exercising the SRs.
  - SRs, like standard shares, can be quoted or unquoted.
- Dissenting and practical views:
  - One FITT member supported Option 2 (financial derivatives) on grounds of SRs’ similarities with derivatives (in particular warrants) and preferred treating their emergence as other flows.
  - Another member viewed Option 2 as theoretically superior (treating derivative issuance as an income payment) but supported Option 1 for practical implementation reasons, given the short time between SR issuance and corresponding equity issuance.

### Accounting and recording issues under Option 2 (illustrative problems)
- Possible counterparts if SRs were derivatives and creation were treated as income/dividend or transfer:
  - Recording a dividend/superdividend as counterpart would require recording equity redemption by the value of SRs at inception and subsequent share issuance by funds raised plus SR value (including holding gains), producing transactions in equity equal to market value of newly issued shares rather than funds raised.
  - Treating SR emergence as other flows in financial derivatives to offset dilution would yield claims with no attached cash-flow and values that change only via holding gains/losses—a statistical artefact.
  - Alternative recording variants produce flows and extinctions of derivatives that are hard to interpret and inconsistent with corporate perspective that records equity issuance by funds raised.
- FITT notes that other instruments (ESO, warrants) are classified under financial derivatives or the broader category “financial derivatives and employee stock options” in current standards, but SR economic substance is not easily considered similar to those instruments.

### Questions for discussion (posed by the GN)
- Do you agree with the classification and treatment of subscription rights as equity (Option 1)?
- If not, and Option 2 is preferred, what would be the counterpart of the flow of creation of the new financial derivative? Options suggested include:
  - Non-financial transaction — dividend or transfer;
  - Transaction in equity;
  - Other flows in equity.
- How would the extinction of the financial derivative be recorded (transactions or other flows, with counterpart in equity)?

### Member views and illustrative numeric parameters
- Summary of member views during review:
  - Three indicated support for Option 1 (equity).
  - One indicated support for Option 2 (financial derivatives).
- Common parameters for illustrative examples:
  - Corporate value before the SRs offer; 10
  - IPO terms (dilution by 0.5)
  - Ratio capital increase; 1:1
  - New capital raised; 9
  - SRs are sold to new investors; no change in corporate value occurs between issuance of SRs and capital issuance
  - T-accounts labeling used in examples: F2 Currency and deposits; F5 Equity; F7 Financial derivatives.

### Annex accounting outcomes (selected highlights)
- Annex I — Recording Under Option 1 (SRs are equity)
  - No transaction is booked at inception.
  - Only transactions in equity between investors are booked; the decline in the equity portfolio of the old shareholder is a transaction.
  - Issuance of capital is valued by 9, the funds raised.
- Annex II — Recording Under Option 2 (SRs are financial derivatives) — sub-options and highlights:
  - Sub-option 2.1 (Derivative counterpart of a payment — Dividends, Current or Capital Transfers):
    - Net lending/net borrowing of the old shareholder and the corporation is affected by the dilution value.
    - The decline in the equity portfolio of the old shareholder is a devaluation.
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value).
  - Sub-option 2.2 (Derivative counterpart of equity withdrawals):
    - The decline in the equity portfolio of the old shareholder is a transaction.
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value), but, combined with the equity withdrawals of -0.5 (dilution value) at SRs inception, a total equity issuance of 9 (funds raised) is booked.
  - Sub-option 2.3 (Derivative changes in value booked as other flows):
    - The decline in the equity portfolio of the old shareholder is a devaluation.
    - Issuance of capital is valued by 9, the funds raised.
  - Sub-option 2.4 (Derivative created as other flows; extinction as transaction against equity):
    - The decline in the equity portfolio of the old shareholder is a devaluation.
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value).

*Prepared by the IMF Financial Instruments Task Team (FITT) Guidance Note; FITT majority recommends classifying subscription rights as equity.*

### SECTION I: THE ISSUE

### f16-subscription-rights - SECTION I: THE ISSUE

### Background
- Subscription rights (SRs) are the rights corporate shareholders have to participate in the acquisition of shares newly issued by the corporation in order to raise additional funds. SRs are designed to offset any potential dilution effect in the value of the stake of current shareholders; by exercising the rights, the investor maintains their percentage of ownership by buying a proportionate number of shares of the issuance.
- “Issuance of SRs” denotes the market and corporate practice of separating those particular rights from the original shares when a new equity issuance is announced, making them transferable so shareholders may obtain cash compensation for dilution by selling them if they do not wish to subscribe the additional capital. This Guidance Note (GN) discusses the treatment in national accounts and balance of payments/international investment position of this detachment of SRs.
- Upon separation, each original share is split into two distinct assets: the ex-right share and the SR (which usually receives a separate ISIN code). At inception, the sum of the values of the ex-right share and the SR equals the value of the original share; each value then evolves to reflect market perception of the rights remaining in each asset.
- The value of the SRs at inception corresponds to the dilution in the value of the original individual shares caused by the terms of issuance of the new capital should the SRs not be exercised. The GN reports the theoretical value at inception as: 푠푠=푟푟(표표−푛푛)/(1 +푟푟).
- The 2008 SNA and BPM6 are silent about classification of detached SRs. The “Handbook on National Accounting: Financial Production, Flows and Stocks in the System of National Accounts” (paragraph 4.205) indicates SRs are to be treated as financial derivatives as a “special kind of warrant”. The “Handbook on Securities Statistics” (paragraph 6.45) explicitly requires SRs to be treated as equity as they “represent a claim on the residual value of the corporation”.
- The GN examines two alternative treatments (financial derivatives or equity), discusses pros and cons, clarifies accounting treatment in each case, and proposes a single treatment for updating the manuals.

### Issues for discussion — Option 1: Equity
- Equity definition cited: 2008 SNA paragraph 11.81 — “equity and investment fund shares have the distinguishing feature that the holders own a residual claim on the assets of the institutional unit that issued the instrument. Equity represents the owner’s funds in the institutional unit.” (underlining by GN authors).
- Arguments for classifying SRs as equity:
  - The corporate (residual) value is viewed as the (market) value of accumulated and future earnings; separation of SRs does not change total expected earnings, so total equity liabilities should remain unaffected by the split.
  - For total equity to remain unchanged after SR issuance, both ex-right shares and SRs must be classified as equity. SRs contain the value diluted from existing shares; added to ex-right shares they sum to the original corporate value.
  - SRs’ main purpose is to ensure shareholders can maintain their percentage ownership and therefore maintenance of a claim on the assets of the corporation.
  - By analogy to bonus shares (2008 SNA, paragraph 11.89 and BPM6, paragraph 11.29), issuance of SRs requires no transaction when rights are detached; only a third-party sale of rights would be recorded as a transaction in equity.
  - By analogy to stripped securities, the economic substance of the individual stripped assets (ex-right share and SR) is the same as the original asset and should be classified under the same instrument category (equity).

### Issues for discussion — Option 2: Financial Derivatives
- Derivative definition cited: 2008 SNA paragraph 11.111 — assets “linked to a specific financial instrument” whose value “derives from the price of the underlying item”.
- Arguments for classifying SRs as financial derivatives:
  - SRs can be viewed as call options: holders have the right (not obligation) to buy new shares; premium corresponds to dilution value at inception; strike price corresponds to issuance price for new shares.
  - Given exercising SRs leads to creation of new liabilities and dilution effects, SRs could be considered akin to detachable warrants (BPM6, paragraph 5.87). Characteristics contrasted: SRs commonly have around 15 to 60 days maturity, whereas warrants commonly have 5 years or more maturity.
  - SRs share mechanics with employee stock options (ESO): both give rise to newly issued shares, cause dilution effects, and may serve purposes other than risk trading (BPM6, paragraph 5.96). ESO are grouped with derivatives under “financial derivatives and employee stock options”.
- Counterarguments and complications if SRs are recorded as derivatives:
  - SR holders lack shareholder rights prior to exercise (no dividends, no voting, and SRs expire), so SRs do not meet the equity characteristic of acknowledging claims on residual value (2008 SNA, paragraph 11.83).
  - Booking the creation of SRs as issuance of a derivative requires identifying the counterpart flow: possible counterparts include dividends, transfers, transactions in equity, or “other flows” in financial derivatives; each option has interpretability or consistency issues.
  - Treating SR emergence as a dividend (or superdividend) would imply recording equity redemption followed by issuance transactions equal to market value of newly issued shares (including holding gains), conflicting with corporate economic substance where issuance is recorded by funds raised.
  - Recording SR emergence as “other flows” in derivatives to offset dilution would produce claims with no cash-flow and values that change only via holding gains/losses, creating statistical artefacts.
  - The intertwined relationship between ex-right share and SR (joint price determination and intrinsic dilution at inception) differs from standard derivatives whose issuance does not directly affect the underlying’s price.

### Outcomes and recommended treatment
- The FITT majority recommendation:
  - A majority of FITT members support including SRs within equity liabilities of the issuing corporation (Option 1) (paragraph 16).
  - Rationale: Failure to include SRs in equity would hamper interpretability of equity as the market value of corporate own funds (see paragraphs 6–10).
- Key implications of the recommended equity classification (paragraph 23):
  - When the subscription right is issued (separated for separate trading) no flow is recorded.
  - Purchase of a subscription right by a third party is booked as a transaction in equity between the old shareholder and the buyer, compensated with cash payments.
  - The values of subscription rights and ex-right shares experience holding gains and losses between issuance of the rights and issuance of new capital; these are booked as holding gains and losses in existing equity.
  - Issuance of new capital is recorded by the cash provided (funds raised), issued by the corporation and acquired by those holding and exercising the SRs.
  - SRs, like standard shares, can be quoted or unquoted.
- Dissenting views and practical considerations:
  - One FITT member supported Option 2 (financial derivatives) on grounds of SRs’ similarities with derivatives (in particular warrants) and preferred treating their emergence as other flows.
  - Another member viewed Option 2 as theoretically superior (treating derivative issuance as an income payment) but supported Option 1 for practical implementation reasons, given the short time between SR issuance and corresponding equity issuance.

### Accounting and recording issues under Option 2 (illustrative problems)
- Possible counterparts if SRs were derivatives and creation were treated as income/dividend or transfer:
  - Recording a dividend/superdividend as counterpart would require recording equity redemption by the value of SRs at inception and subsequent share issuance by funds raised plus SR value (including holding gains), producing transactions in equity equal to market value of newly issued shares rather than funds raised.
  - Treating SR emergence as other flows in financial derivatives to offset dilution would yield claims with no attached cash-flow and values that change only via holding gains/losses—a statistical artefact.
  - Alternative recording variants produce flows and extinctions of derivatives that are hard to interpret and inconsistent with corporate perspective that records equity issuance by funds raised.
- FITT notes that other instruments (ESO, warrants) are classified under financial derivatives or the broader category “financial derivatives and employee stock options” in current standards, but SR economic substance is not easily considered similar to those instruments.

### Questions for discussion (as posed by the Guidance Note)
- Do you agree with the classification and treatment of subscription rights as equity (Option 1)?
- If not, and Option 2 is preferred, what would be the counterpart of the flow of creation of the new financial derivative? Options suggested include:
  - Non-financial transaction — dividend or transfer;
  - Transaction in equity;
  - Other flows in equity.
  - How would the extinction of the financial derivative be recorded (transactions or other flows, with counterpart in equity)?

*Prepared by the IMF Financial Instruments Task Team (FITT) Guidance Note; FITT majority recommends classifying subscription rights as equity.*

### 3.    Do you have any other views on the treatment of SRs?

### 3. Do you have any other views on the treatment of SRs?

### Summary of member views
- A few members of the AEG and the BPTT expressed preferences during the review of the GN in preparation of the public consultation:
  - Three indicated support for Option 1 (equity).
  - One indicated support for Option 2 (financial derivatives).

### Common parameters for the illustrative examples
- Corporate value before the SRs offer; 10
- IPO terms (dilution by 0.5)
- Ratio capital increase; 1:1
- New capital raised; 9
- SRs are sold to new investors; no change in corporate value occurs between issuance of SRs and capital issuance
- T-accounts labeling used in examples: F2 Currency and deposits; F5 Equity; F7 Financial derivatives. Assets/changes in assets are shown on the left-hand side of the T-accounts; liabilities/changes in liabilities are shown on the right-hand side of the T-accounts.

### Annex I — Example of Recording Under Option 1 (Subscription Rights Are Equity)
- Highlights of the accounting entries:
  - No transaction is booked at inception
  - Only transactions in equity between investors are booked; the decline in the equity portfolio of the old shareholder is a transaction
  - Issuance of capital is valued by 9, the funds raised

### Annex II — Examples of Recording Under Option 2 (Subscription Rights Are Financial Derivatives)

- Sub-option 2.1: The Financial Derivative is the Counterpart of a Payment (Dividends, Current or Capital Transfers)
  - Highlights of the accounting entries:
    - Net lending/ net borrowing of the old shareholder and the corporation is affected by the dilution value
    - The decline in the equity portfolio of the old shareholder is a devaluation
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value)

- Sub-option 2.2: The Financial Derivative is the Counterpart of Equity Withdrawals
  - Highlights of the accounting entries:
    - The decline in the equity portfolio of the old shareholder is a transaction
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value), but, combined with the equity withdrawals of -0.5 (dilution value) at SRs inception, a total equity issuance of 9 (funds raised) is booked

- Sub-option 2.3: Financial Derivative Changes in Value are Booked as Other Flows
  - Highlights of the accounting entries:
    - The decline in the equity portfolio of the old shareholder is a devaluation
    - Issuance of capital is valued by 9, the funds raised

- Sub-option 2.4: Financial Derivative Created as Other Flows; Extinction as Transaction Against Equity
  - Highlights of the accounting entries:
    - The decline in the equity portfolio of the old shareholder is a devaluation
    - Issuance of capital is valued by 9.5 (funds raised plus dilution value)

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_Source: https://www.imf.org/-/media/files/data/statistics/bpm6/fitt/f16-subscription-rights.pdf_