Aviva's unethical hunt for a loophole in its preference shares

On 8 March, insurance firm Aviva detonated a landmine under the preference-share market destroying value for its own preference shareholders and causing widespread collateral damage for other issues. The firm announced that it had the ability to cancel its irredeemable preference shares at par (although it had yet to make a decision to do so).

Investors thought irredeemable meant the prefs were irredeemable. Market makers thought they could not be redeemed. I thought they could not be redeemed. The opening page of the prospectuses describes them as "Cumulative Irredeemable Preference Shares". Aviva seemed to agree: its website described the securities as perpetual (although the word "perpetual" has now mysteriously disappeared).

The change in value has been material. Aviva's prefs (Aviva 8.75%, Aviva 8.375%, General Accident 8.875% and General Accident 7.875%) had been trading in the region of 175% of par value because the (fixed) dividends were high and there was the understanding they were perpetual. They promise a fixed and certain yield in perpetuity (providing Aviva continues to exist). This made them popular with pensioners, prospective pensioners and investment companies in need of income streams with a long horizon. Prices have declined 50% huge for what were considered stable instruments. Should Aviva carry out its threat there is an additional 25% to lose.

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Aviva's argument is that it can use the Companies Act to redeem the preference shares by applying to the court for a reduction of capital; in effect bypassing the prospectuses (although the wording contained within may still prove relevant). The legal arguments on both sides and the differences of wording between the various issues are complicated (probably the most impressive analysis can be found in this online posting). However, beyond the legal arguments there are important principles at stake.

The importance of integrity

Should Aviva be combing through the small print to find ways of stuffing one class of shares? Does integrity count for nothing? Any application to court to cancel capital has to be preceded by a vote in which both preference and ordinary shareholders vote not as separate classes but as one. The ordinary shareholders outnumber and can outvote the pref shareholders and by voting through the measure they would be voting through a transfer of wealth from their brother shareholders to themselves.

Should Aviva's management be facilitating this?At least in spirit, the issue of the protection of minority shareholders is raised. The conflict is even greater for the two General Accident issues as they are internal subsidiaries and Aviva's management controls 100% of the shares. They have announced they will prevail in any vote. Should they not abstain from voting to impose losses on one class of their own shares to benefit another class (and the management)?

Preference shares are antique instruments no longer issued. The unique feature of a perpetual fixed income stream is very valuable and should be preserved at all costs. There is the danger of precedent. For instance, that some of the most active preference shares are issued by Lloyds Banking Group and the bank has form in this regard. Two years ago, it called its high-coupon enhanced capital notes (ECNs a type of bond) at par (causing widespread losses) although it was pointed out to them that the conditions of the call had not been met according to the wording of the prospectus. The bank's argument was that it had meant to write something different (a "drafting infelicity")! Bizarrely the judges all the way up to the Supreme Court ruled in Lloyds' favour. Investors were meant not to rely on what was actually written by Lloyds, but on what it (subsequently) claimed it had intended to write.

But I finish on a positive note. Ecclesiastical Insurance, which is owned by a Church of England charity, came out with this magnificent statement: Ecclesiastical Insurance Office plc ("Ecclesiastical") notes the recent movement in the price of its 8.625% preference shares. Ecclesiastical assumes this is a result of Aviva's announcement on 8th March, in which Aviva stated that it has "the ability to cancel [Aviva's and General Accident's] preference shares at par value through a reduction of capital, subject to shareholder vote and court approval". Ecclesiastical notes Aviva's governance statement that "as one of the biggest companies in our sector, we aim to make our industry work better for everyone. That starts with us building trust with our customers, investors and shareholders by running our business honestly and transparently." Ecclesiastical trusts that Aviva will follow the principles set out in that statement when considering whether to pursue this course of action Ecclesiastical has no plans to cancel its own 8.625% preference shares at par value through a reduction of capital.

Top stuff; rarely will any institution criticise another, particularly a competitor. Will it make any difference? I don't know, but it makes me proud to be an Anglican.