The Companies (Acquisition of Own Shares) (treasury shares) Regulation 2003 came into force on 1 December 2003.

These allow companies whose shares are listed on the Official List, traded on AIM or a regulated EEA market to buy, hold and resell their own shares.

Katie Paxton-Doggett looks into what are known as treasury shares

Previously, a UK-listed company wishing to buy its own shares could do so, but was required immediately to cancel them.

A company can now hold up to 10% of their issued share capital indefinitely in treasury.

Should they wish to sell those shares at a later date to raise additional capital, they can do so without having to issue new shares.

Shares lose the benefit of the majority of rights attaching to that class of share while in treasury.

Thus, they carry no voting rights and no rights to dividends.

Pre-emption rights are suspended, although treasury shares attract bonus issues of shares that would be converted into treasury shares.

Treasury shares do not participate in any capital distribution on winding up.

However, shares continue to be listed or traded on AIM, as appropriate.

The purchase of treasury shares must be approved in advance by shareholders, since they must be paid for out of distributable profits that impacts directly on their dividends.

It is common practice among many companies to provide for a general authority to buy back shares that is renewed annually; it is expected that companies will extend this to cover treasury shares.

A company may hold up to 10% of its issued share capital or 10% of each class of shares.

If that limit is exceeded, the company must dispose of the shares or cancel them within 12 months.

Care must be taken to ensure that the limit is not exceeded inadvertently, for example, through a bonus issue, as the company officers could be liable to a fine.

If the shares cease to be qualifying shares, for example, listed on the Official List, they must be cancelled immediately.

A company may decide later to sell the treasury shares, in which case they are treated in the same way as an allotment of new shares.

The company must ensure that any pre-emption rights are disapplied.

Again, companies are likely to achieve this through an annual disapplication approved by a special resolution at the annual general meeting.

One of the major impacts of treasury shares will be the ease with which shares can be held and transferred for the purposes of employee share schemes.

A company can use treasury shares to satisfy employee share incentive requirements, where previously they may have needed to place shares in an all-employee share option plan.

Amendments have been made to the listing rules.

In particular, treasury shares will be subject to the model code so that transactions cannot take place during a close period.

This means that the shares cannot be dealt with during the two months prior to the announcement of the company's annual results, the two months prior to the announcement of the company's interim results, or at any time when the directors were aware of unpublished price sensitive information.

Therefore, the usefulness of holding treasury shares may be significantly restricted since they may be dealt with for less than eight months in any year.

The listing rules have also been amended to prevent listed companies from selling shares out of treasury at more than 10% discount unless the company is in severe financial difficulty or if a dispensation is granted by the UK Listing Authority.

Interestingly, the London Stock Exchange has made no changes to the AIM rules and regulation will largely be governed by the changes to the Companies Act.

This gives AIM-listed companies greater flexibility in dealing with treasury shares, particularly as no upper or lower limits have been set on the premium or discount at which they are traded.

In relation to takeovers and the City code on takeovers and mergers, a company cannot sell treasury shares during an offer period to frustrate a takeover offer without the consent of shareholders.

However, this still leaves a company potentially with the ability to distort markets and take advantage in a takeover situation where it obtains such consent.

Treasury shares are also excluded from the various thresholds, including the provisions whereby a successful bidder who has achieved 90% acceptance can compulsorily acquire the remaining shares.

One area that remains unclear is the definition of 'issued share capital'.

The regulations are inconsistent so that it is not certain whether treasury shares should be included or excluded.

This confusion could lead to problems in connection with disclosure requirements.

Section 198 of the Companies Act requires notification of interests of more than 3% of the issued share capital.

The section has been amended so that the company itself does not need to notify of any purchases it makes over this limit.

However, a minority shareholder may unknowingly go over the threshold in a situation where the company buys treasury shares that are then excluded from the definition of issued share capital.

The definition clearly needs clarification, and companies should take care to ensure adequate methods for informing their minority shareholders.

Treasury shares promise a number of benefits to companies able to deal in them.

Companies will have the ability easily to adjust their share capital and move the debt to equity ratio on their balance sheet.

This means that they can achieve optimum financial gearing without the costs of cancelling and re-issuing new shares.

Commentators suggest that this could lead to a reduction in companies' overall cost of capital, and stimulate investment.

Whether trading in treasury shares will have significant cost savings is debatable.

Certainly reissue of treasury shares avoids the need for legal costs associated with a new issue.

However, many companies have the authority to issue new shares and regard the mode of obtaining listing as straightforward.

What is clear is that it will be possible to trade treasury shares rapidly.

Treasury shares can be sold directly through the company's broker, reacting immediately to detrimental market changes.

However, whether the regulations are too restrictive remains to be seen.

The US model is successfully used by many companies; the UK regulations do not offer the same level of flexibility.

Nevertheless, companies are likely to welcome the introduction of treasury shares as a useful device.

Katie Paxton-Doggett is a producer with the Law Channel, Einstein Network