Financial directors are rushing to take advantage of the benefits of hybrid capital – financial instruments that are a mixture of debt and equity – as they provide access to capital that is cheaper than equity and more flexible than normal lending.

Hybrid capital has become increasingly popular in mainland Europe, with the likes of German healthcare giant Bayer and Danish energy group DONG making hybrid capital issues in excess of 1bn euros (£692m).

Experts have yet, however, to see a UK company raise funds using such instruments but it is widely anticipated that it will not be long before UK plc begins to do so.

In a seminar hosted by PricewaterhouseCoopers, partner Mohammed Amin said that because hybrid capital was classified as debt for tax purposes, it attracted tax relief which made it significantly cheaper than equity.

But for credit rating purposes the instrument could be treated as equity if structured correctly, allowing companies to maintain a very strong credit rating despite carrying what could be viewed as debt by tax authorities and investors.

‘The cost of capital using a hybrid instrument is incredibly cheap,’ Amin said. ‘It is usually no more than 1.5% to 2% more expensive than normal debt, but it is deeply subordinated to normal debt,’ Amin said.

He added that companies issuing hybrid instruments also have the option of suspending interest payments if necessary, a choice that was not available on ordinary debt.

‘If a company stops paying interest it has to stop paying dividends and there are serious reputational risks associated with that, but it can do it. Investors are taking on the risk,’ Amin said.

As attractive as the instruments are, any finance directors considering a hybrid security issue need to be aware that regulators are also watching the development of these new instruments closely.

Earlier this year the National Association of Insurance Commissioners, the insurance regulator in the US, told insurers who owned a particular hybrid to treat it entirely as equity.

This saw companies lose the flexibility offered by the hybrid and carry more risk capital against the investment than was required for debt.

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