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What is hybrid debt?

In the context of this guidance, the term ‘hybrid debt� means debt instruments which have features of both debt and equity. An example is non-voting, fixed rate convertible preference shares. The holders of these shares get a return which is indistinguishable from debt, but the convertible element allows the instrument holder to subscribe for equity shares. Another example is subordinated debt which gives the holders a higher reward but which will be repaid after other types of debt, perhaps ranking only above ordinary shares.

The two main types of hybrid instruments are asset-linked securities and debt which is convertible into the equity of a company. Where the conversion right relates to the equity of the issuing company the debt is termed ‘convertible�. If the right relates to the equity of another company, usually a subsidiary of the issuing company, it is termed ‘exchangeable�.

Asset-linked securities are those linked to the performance of some underlying asset.

The advantage of a hybrid instrument is that it can allow a lender to participate in the success of a growing entity, while having more protection than ordinary shareholders if things go wrong. For the borrower, the right to convert may be given in exchange for a lower interest rate, which could help a developing business, and there will be less risk of the lender taking a short-term view. But in the case of convertibles, the existing equity of the business will be diluted if the conversion takes place.