A hybrid security, also called hybrid instrument, is a security that has characteristics of both debt and equity, so it cannot be regarded as pure debt or pure equity.
Examples of hybrid securities include preference shares and convertible bonds. Although preference shares are legally shares, they provide a fixed return like bonds do. Similarly convertible debt is debt, unless it is converted.
Reasons for issuing hybrid securities include:
- Increasing capital without overly diluting existing equity. An example is the issue of hybrids that qualify as tier I capital for bank's capital adequacy, but do not share in profits as ordinary shares do.
- To give investors a wider choice of risk, return and tax treatment combinations. A good example is the issue of multiple classes of securities by split capital investment trusts.
- To reduce control risk for either the borrower or the issuer.
Issue of hybrid securities has become more popular in recent years as issuers, issuers and regulators have adopted more sophisticated approaches to managing risk.