Financing S.A. through Hybrid Securities (Part II)

Legal Insight

February 2025

Anta Tsogia, LL.M. (mult.)

Summary: As mentioned in our previous newsletter entitled Financing Public Limited Companies through Hybrid Securities (Part A) (see here), the modern financing of public limited companies is shaped by market developments and technological advancements. This evolution has led, among other effects, to the development of hybrid financing securities. Traditional forms of capital enhancement are being reconfigured to offer greater flexibility and adaptability. The objective is to create financial instruments that meet both the needs of issuing companies and the demands of the investor community, thereby contributing to an optimized capital structure and the attraction of investors. Moreover, valuation factors of the securities for interested investors are the primary criterion in obtaining the necessary funding for the enterprise.

In this document, we continue with a concise overview of the most common hybrid securities, some of which have already gained significant traction in the investment realm and have, in certain cases, been regulated by legislation. We will discuss hybrid forms of bonds and warrants.

1. Hybrid Forms of Bonds

a. Bonds with the Right to Exchange for Shares (of the Issuing or Another Company)

Exchangeable bonds (Article 70, paragraph 1 of Law 4548/2018) are financial instruments that, in addition to providing the right to receive interest and the return of principal (characteristics typical of ordinary bonds), offer the possibility of being exchanged for shares or other securities, either of the issuing company or of third parties. This exchange is executed in accordance with the terms of the bond loan agreement, using either existing shares or other securities, which may be owned by the company itself (under the provisions of Article 49 of Law 4548/2018) or acquired from a third party, provided that the conditions for the exchange are met. The terms of the loan may stipulate that the exchange is mandatory, subject to condition, or executed at the discretion of the issuer in relation to the bondholders. The bonds must be free from encumbrances, except for any potential lien in favor of the bondholders. It is emphasized that the exchange replaces the cash payment of the principal. Because of this advantage, exchangeable bonds typically carry a lower and fixed interest rate compared to ordinary bonds. Essentially, this mechanism constitutes a repayment of the principal in installments rather than a lump-sum payment (cf. Article 419 of the Civil Code).

b. Bonds with the Right to Convert into Shares (of the Issuing or Another Company)

Convertible bonds (Article 71 of Law 4548/2018) combine the characteristics of ordinary bonds with the additional right for holders to convert them (either mandatorily or optionally) into shares of the issuing or another company, not using existing shares but by issuing new shares through a capital increase. The issuance of a bond loan with convertible bonds is tantamount to a deferred capital increase under a suspensive condition. This may serve as a deterrent, as it can lead to frequent adjustments of the share capital, particularly if there is a large number of bondholders, thereby potentially affecting the company’s capital structure. Consequently, when convertible bonds are issued into shares of the issuer, the pre-emptive right of the existing shareholders is maintained, ensuring that shareholders do not suffer an abrupt dilution of their participation in the company. Furthermore, the conversion price or ratio may be adjusted to reflect the company’s capital structure and financial condition. Finally, the conversion terms are set out in the bond loan program, similar to the case with exchangeable bonds.

c. Bonds with a Right to Participate in Profits

Bonds with a profit participation right (Article 72 of Law 4548/2018) combine the characteristics of ordinary bonds with the possibility for investors to receive a share of the issuer’s profits or another performance-related benefit (either concurrently with the interest payment right or in place of it). As a result, bondholders share an interest in the successful business performance of the company. It may even be stipulated that the profit share is allocated to bondholders prior to the minimum dividend ordinarily paid to shareholders. The interest rate on these bonds is usually lower than that of ordinary bonds, which benefits the company as a borrower.

d. Perpetual Bonds

Perpetual bonds, in contrast to ordinary bonds, do not have a predetermined maturity date (often classified as subordinated bonds) and are issued without the right to redeem the principal. The issuing company retains the option to redeem them at a time of its choosing (call option). Bondholders receive a fixed interest rate which, however, is often higher than that of ordinary bonds to compensate for the increased investment risk. Accounting-wise, they are classified within the company’s equity, as the absence of a redemption obligation renders them akin to preferred shares without voting rights. The investment risk is elevated given that there are no guarantees of repayment, while their yields (typically high due to the associated risk) depend on the financial stability of the issuing company.

e. Subordinated Bonds

Subordinated bonds are a category of bonds that either lack collateral or possess a lower priority for repayment in the event of the issuer’s bankruptcy or liquidation (ranked after ordinary creditors and holders of senior bonds). They are primarily utilized by financial institutions and enterprises with high funding risk, usually offering higher yields to investors. They may be issued as hybrid instruments, for example as Tier 1 capital (they may be perpetual, have the possibility of conversion into shares, or be subject to write-off under certain conditions, and include clauses that suspend coupon payments).

f. Payment-in-Kind (PIK) Bonds

PIK bonds constitute a special category of financial instruments with certain hybrid characteristics, whereby instead of paying interest in cash, the issuing company issues new bonds to the bondholders. Under the bond loan program, interest payments may be stipulated as mandatory—if they are paid exclusively in new bonds; combined—if the company pays part of the interest in cash and the remainder in kind; or optional—if the mode of repayment is left to the discretion of the issuer. PIK bonds allow companies to maintain their liquidity by deferring cash interest payments and are considered high-risk debt instruments, with yields that are typically higher than those of conventional bonds. Due to these features, they are favored by companies undergoing debt restructuring or that exhibit a high degree of leverage. They are also employed in leveraged buyouts (LBOs), where investors seek to minimize cash outflows during the initial stages of the investment.

2. Warrants

Warrants are securities that confer a preemptive right to acquire shares of a company at a predetermined price. This right can be exercised within a specific amortization period defined contractually (for example, it may be provided that the right can be exercised on specific dates until the stipulated expiration date, or only on a designated final date). The warrant holder does not automatically acquire shareholder status but may do so upon exercising the warrant. The warrant agreement may include additional restrictions or, conversely, a buyback right by the issuer. Warrants are frequently issued as adjuncts to other securities, such as corporate bonds, preferred shares, or common shares, sometimes without additional consideration, functioning as an inducement for the acquisition of the underlying security. The main disadvantage of warrants is that the investor pays the premium without immediately acquiring shareholder rights—in effect, they become a potential shareholder in the future—thus undertaking increased investment risk relative to bonds. Their value, however, is influenced by numerous factors such as the volatility of the underlying share and the time remaining until their expiration. If the price of the underlying share does not exceed the exercise price, the holder may suffer a total loss of the capital invested in the warrants. Moreover, warrants may be subject to more specific restrictions, enshrined in contractual clauses, or even be subject to a buyback right by the issuing public limited company.

3. In Conclusion

Recent developments have led to the international adoption of financial securities with specialized characteristics, such as dividend securities and accumulating shares, securities dependent on the enterprise’s profitability (e.g., preferred shares, tracking stocks), securities with additional rights (e.g., shares with the option to acquire additional shares, stock warrants), specialized debt securities (e.g., subordinated bonds, perpetual bonds), securities with interest rates based on the company’s revenues, convertible or exchangeable securities, and so forth. The subsequent evolution of the capital markets has rendered these instruments globally accessible through digital transactions. At the level of Greek legislative regulation, the legislator, through Law 4548/2018, has systematized and, to an extent, modernized the existing framework by introducing innovative securities such as warrants, thereby broadening the choices available to investors and companies. Consequently, companies gain the ability to craft a more flexible financial strategy, while investors can select securities that align with their objectives and risk tolerance.