The risk on pledging of shares.
The recent order passed by the SEBI regarding declaration ordering the promoter group has to disclose the details to shareholders the corporate India might be spending some sleepless nights. At the primary market advisory committee meeting held , there was a consensus that irrespective of the quantity of the shares pledged, the promoter group has to disclose the details to shareholders and stock exchanges.
The pledging of shares takes place when the promoter has exhausted all other sources to raise funds, he pledges his holding in the company as a last resort. This kind of situation arises more when the corporate India is reeling under the pressure of raising laons other financial instruments. Indian financial markets is facing excessive pressure due to the substitution effect, subsequent to the drying up of alternative credit avenues during the current financial turmoil.
What is a Pledge?
Promoters simply pledged a part of their holdings in the company for a set term and interest rate. The tenure of the loan — mostly short-term — would vary between three months to two years, at an interest rate in the range of 20-30% per annum. With the borrowed money, promoters would fund working capital requirements, make open purchases from the market, subscribe to warrants, or make preferential allotments to themselves in order to boost the confidence of investors in the company. With equity markets in a bear grip and a rising interest rate scenario, many cash-rich Non-banking finance companies (NBFCs) have begun providing loans on pledged equities, to enable promoters meet their fund requirements. NBFC are increasingly financing promoters to meet working capital requirements, capex, investment and holding consolidation.
The risk arises when the promoters are unable to garner additional funds, NBFCs start selling the pledged shares to recover money. This starts a chain reaction, and therefore, it is best for investors to stay away from companies whose promoters are known to have pledged their shares. If a market related decline in the price of shares triggers a margin call — the lender asks the borrower to bring funds when the value of shares pledged as collateral against a loan collapses — as is the case now. If the borrower (promoter) is unable to meet the margin call following a default on the loan, the lender can sell the shares. Besides impacting share prices, in cases where promoter holding is small, such sales can destabilize companies as they would become vulnerable to takeovers. The promoters of not only mid- and small-cap companies, but also some large-cap companies, have been pledging shares to raise funds.
The sustained downturn in equities over the last one year has pushed promoters to the wall, as the value of collateral (shares) dipped with every fall in market. Globally, the pledging of shares by promoters as collateral for a loan is equivalent to a sale of the stock to the pledgee. Some of the recent instances where Indian promoters have pledged their shares to raise funds include Satyam Computer, Orchid Chemical and Great Offshore. Interest of minority shareholders, as they consider the extent of promoter stake as a crucial factor for their investment decision stands at a great risk.
The government is "working closely" with market regulator SEBI and other authorities to probe any violations related to pledging of shares by promoters in companies. The regulator is considering mandating promoters of listed companies to disclose pledged shares, as this can have an impact on market price of the company stock. The government is working with the SEBI to probe any violations related to pledging of shares by promoters in companies. The Ministry of Corporate affairs have also taken actions to mandate the disclosure norms of promoters on their holdings.