In the investment industry or stock market, a backstop is the last support or security provided for newly issued securities or shares that are being offered in a particular transaction. Newly issued shares that have less interest or subscriptions are regarded as unsubscribed shares. Investors or companies who want to purchase shares of this nature get a backstop from an underwriter or an investment bank before making the purchase. The backstop guarantees the payment for unsold portion of the offering.
A Little More on What is a Back Stop
A backstop is a type of insurance used in securities offering to guarantee that a portion of shares (unsubscribed) will be purchased by a party, usually an underwriter or an investment bank. It is often called the last-resort support provided for the offering on unsubscribed shares in the stock market. The provision of a backstop is often contained in an underwriting contract.
A company who wants to raise funds from the purchase of unsubscribed portion of shares goes to an underwriter or investment banking firm to get a backstop. If the company is unable to sell a portion of the offering in the open market, the underwriter or investment bank is obliged to purchase the remaining portion.
Back Stops as Insurance
A backstop is not an insurance policy but it works as a form of insurance in securities offering for the unsubscribed portion of shares. A backstop offers guarantee that an underwriter or investment bank who provides a back stop will purchase a portion of an unsold shares from the investor who holds the backstop. For example, if Company A wishes to raise a capital of $500 through the sales of a number of shares in the open market but is able to raise only $300, the underwriter who provided the backstop will purchase the remaining number of shares so that Company A would realize the desired $500. Also, the underwriter or investment bank that provides a backstop is liable for all the risks associated with the shares.
Any number of shares purchased by an underwriting organization or an investment banking firm under a backstop contract is owned and managed by the firm. The treatment meted out to other shares purchased in the nirmal market are applicable to shares purchased under a backstop contract.
Once an underwriter, or investment banking organization purchases the remainder shares unsold on the open market, the issuing company no longer has claim to the ownership of the shares. The treatment of the shares or how they are traded can also not be determined by the issuing company, instead, the underwriting company or investment banking firm take charge of the shares.
Reference for “Back Stop”
Academics research on “Back Stop”
Fine-tuning the use of bail-in to promote a stronger EU financial system, Micossi, S., Bruzzone, G., & Cassella, M. (2016). Fine-tuning the use of bail-in to promote a stronger EU financial system. CEPS Special Report, (136). This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law.
Shadow money and the public money supply: the impact of the 2007–2009 financial crisis on the monetary system, Murau, S. (2017). Shadow money and the public money supply: the impact of the 2007–2009 financial crisis on the monetary system. Review of International Political Economy, 24(5), 802-838. This article explores the effects of the political reactions to the 2007–2009 financial crisis on the monetary system. It chimes in with the view that shadow banks create ‘shadow money’, i.e. private substitutes for bank deposits. The article analyses how the three main forms of shadow money – money market fund shares, overnight repurchase agreements and asset-backed commercial papers – were affected by the short-term government intervention and medium-term regulation during and after the 2007–2009 financial crisis in the United States. The analysis reveals that the measures taken between 2007 and 2014 integrated some shadow money forms in the public money supply. In the year after the Lehman collapse, the initially private shadow money supply was either publicly backstopped or de-monetised as it had broken par to bank deposits. The public backstops took on the form of emergency facilities established by the Federal Reserve and guarantees proclaimed by the Treasury. Those backstops imply that the public institutional framework to protect bank deposits was extended to some forms of shadow money during the crisis. This tendency has continued in post-crisis regulation. Accordingly, the 2007–2009 financial crisis has triggered a paradigmatic change in the monetary system, attributable to the political decisions of US authorities.
The use and abuse of special-purpose entities in public finance, Schwarcz, S. L. (2012). The use and abuse of special-purpose entities in public finance. Minn. L. Rev., 97, 369.
Financial risks in the low-growth, low-interest rate environment, Nassr, I. K., Wehinger, G., & Yokoi-Arai, M. (2015). Financial risks in the low-growth, low-interest rate environment. OECD Journal: Financial Market Trends, 2, 63-90.
Spotlight: Mexico Development Bank lending rises following financial reforms, Perez, M. (2015). Spotlight: Mexico Development Bank lending rises following financial reforms. Southwest Economy, 11(Q4), 15-15.