Against the backdrop of continued growth and deepening of the GCC’s equity markets, as well as the tightening of lending criteria by many traditional commercial lenders post-COVID, convertible bonds and sukuk could provide corporates in the GCC region with an alternative source of funding in circumstances where other debt or equity financing options may not otherwise be possible.
In this article, we examine some of the key legal and regulatory considerations relevant to the issuance of convertible securities in the United Arab Emirates (the UAE) and the Kingdom of Saudi Arabia (KSA). Such considerations apply to both conventional and Shariah compliant convertible securities, although the structuring of Shariah compliant securities is not discussed in this note.
What are convertible securities?
Convertible securities are hybrid in nature, in that they combine elements of both debt and equity. Such securities will typically pay investors a set amount of interest or profit for a given period of time, but will allow for conversion into shares of the relevant issuer/obligor at a prescribed conversion price and time. As such, convertible securities can typically allow investors the possibility to capitalise on the future growth of a company (which can be particularly attractive for companies with high growth potential), while at the same time maintaining certain credit protections such as the accrual and payment of fixed interest/profit until conversion.
The key advantage for companies issuing convertible securities is that they can provide a way to raise additional or alternative capital at what can be advantageous rates in circumstances where other forms of financing may not be available to them. From an investor’s perspective, subscribing to such instruments would give them exposure to the growth potential of an issuer’s stock, while at the same time giving them the benefits of a fixed income instrument until conversion.
Any issuance of convertible securities will need to comply with local corporate law requirements and regulations in the jurisdiction of incorporation of the issuer/obligor and the rules of any stock exchange on which the company might be listed. We set out below some of the key requirements for companies in the UAE which are public joint stock companies and companies in Saudi Arabia which are joint stock companies.
Convertible securities in the UAE
The Federal Law By Decree No. 32 of 2021 on Commercial Companies (the UAE Companies Law) sets out some of the key requirements for the issuance of convertible securities by UAE public joint stock companies (UAE PJSCs), which are as follows:
From an approvals perspective:
- an issuance of convertible securities must be approved by the majority vote of shareholders who own at least three-quarters of the shares represented in the general assembly meeting of the relevant UAE PJSC (Article 232 of the UAE Companies Law); and
- approval of the prospectus and terms and conditions of the issuance is required by the UAE Securities and Commodities Authority (SCA).
Where the original shareholder approval for the issuance is obtained, Article 231(4) of the UAE Companies Law appears to provide an exemption to the statutory pre-emption rights which would otherwise apply in the context of the capital increase needed to facilitate the conversion (where the express right existed in the previous companies law and SCA approval was needed to proceed on a non-pre-emptive basis). However, in our experience, it would be prudent for it to be confirmed with SCA at an early stage in any event that no such pre-emption rights would apply in the context of a specific issuance.
Under the UAE Companies Law, upon issuance of convertible securities and until the date of conversion or maturity, the issuer may not decrease its capital or increase the dividends previously determined to be distributed to the shareholders. If the share capital of a company decreases due to losses incurred as a result of the forfeiture of a number of shares or due to a decrease in the nominal value of the shares, the share capital of the company must be decreased as if the holders of the securities were actually shareholders themselves. This statutory provision is designed to protect investors from certain dilutive actions which the company may take prior to conversion and add to the usual protections holders would typically be offered through the contractual terms of the convertible securities (particularly those dealing with conversion price adjustment) (Article 233 of the UAE Companies Law).
Other investor protections
The UAE Companies Law seeks to protect investors' returns emanating from the conversion of their instrument into shares. The Law confirms that shares received by the holders of convertibles will be entitled to a share of the profits that a company has resolved to distribute in respect of the fiscal year during which the conversion was exercised (the entitlement to such profits being calculated by reference to the period from the date of such conversion until the end of the fiscal year) (Article 234 of the UAE Companies Law).
The UAE Companies Law appears to allow for the mandatory conversion of convertible securities into shares where such conversion was made a requirement in the original offering terms contained in the prospectus (by virtue of Article 231 of the UAE Companies Law), but it would again be prudent for this to be confirmed in the approval process with SCA as early as possible in the context of the particular transaction.
Convertible securities in Saudi Arabia
The Saudi Companies Law enacted by Cabinet Resolution No. 678 dated 29/11/1443H (corresponding to 28/06/2022) and ratified by Royal Decree No. M/132 dated 01/12/1443H (corresponding to 30/06/2022) and which came into force on 19 January 2023 (the Saudi Companies Law), together with the implementing regulations of the Capital Market Law (specifically the Rules on the Offer of Securities and Continuing Obligations (the OSCO Rules), set out some of the key requirements for the issuance of convertible securities by Saudi Arabian joint stock companies (Saudi JSCs), which are as follows.
From an approvals perspective:
- an issuance of convertible securities must be approved by an extraordinary general assembly of shareholders whereby a three quarters majority (75%) of votes present (to the extent that the issuance will involve a capital increase) or two third majority (66.6%) of votes present (to the extent that no capital increase would be required) approve the issuance and the maximum number of shares that may be issued against such securities. Once approved, the board of directors may approve the issuance of new shares at time of issuance without further shareholder approval (Article 117 of the Saudi Companies Law).
Cap on issuances for private placements
For Saudi JSCs that are listed on Tadawul and which propose to issue convertible securities on a private placement basis:
- the number of shares into which such convertible securities may be converted cannot exceed 15% of the company’s total number of shares; and
- convertible securities cannot be offered by way of private placement more than once during the twelve months following the end of a previous offering, (Article 10(i) of the OSCO Rules).
Additional requirements for public offers
With respect to public offers of convertible securities by Saudi JSCs:
- such securities may only be offered if the shares into which they will be converted are already listed;
- additional prospectus disclosure requirements apply compared with other debt instruments; and
- the Capital Market Authority’s approval of the public offer application shall be also regarded as approval of the issuance of the relevant shares once converted (Article 43 of the OSCO Rules).
The Saudi Companies Law allows for the mandatory conversion of convertible securities into shares where such conversion was agreed upfront in the original offering terms, and so mandatory conversion terms would be permissible (Article 117 of the Saudi Companies Law).