It’s time to revisit some issues in the securities market
PremiumRetail investors must avoid companies that see a high level of promoter share pledges
The recent Adani-Hindenburg episode brings to the fore some regulatory and operational issues in the securities markets and reinforces the need to revisit these. Post the Hindenburg report, share prices of most Adani group companies saw a downward spiral. The reason for this fall, apart from the firm’s debt concerns, was the quantum of promoter holdings that the company had pledged with various financial lenders to secure loans. Primarily, this free fall was triggered by debt concerns and then exacerbated due to the margin calls for Adani group stocks. A margin call is defined as a demand by a broker that an investor deposit further cash or securities to cover possible losses.
Many traders had provided margins to investors through the underlying Adani stocks. Since the margins are marked to market, the traders received top-up margin calls. Consequently, for providing additional margins, the derivative traders had to bet on their best performing stocks to fulfil such requirements. In short, these stocks spelled doom for other performing stocks due to the selling pressure. Margin calls, which can happen with any scrip, result in investors losing s significant amount of money. CG Power, Zee group companies are some of the other stocks that have faced such margin calls.
The Adani-Hindenburg saga also put the spotlight on the free float status of various listed entities. Recently, Patanjali Foods came under the scanner for flouting the ‘free float’ condition. Free-float refers to the shares of institutional investors (FPIs, mutual funds, insurance companies) and retail investors that are available for trading in the stock market. It does not include promoter or other locked-in shares. As per extant regulations, at least 25% of shares of a company should be compulsorily held by the public. This is an important criterion as it lessens the scope of manipulation, fosters price discovery and results in higher liquidity in the market.
We analysed India’s top 500 companies and found that 94% of them comply with this minimum threshold limit. It is now time to mandate a higher limit of 35-40% so that companies can reduce promoter ownership and have a set of diverse shareholders. This would ensure that the promoters do not fiddle with the ownership of a company based on their whims and fancies. Further, global indices also prefer to include those companies in their indices if the free float is higher as it reduces the probability of manipulation in stock prices by any one group of investors.
Here is what stock exchanges and the market regulator can do to stop the mayhem in the markets whenever there is a margin call. They may revisit the criteria for providing margin facility on stocks wherein the promotor pledge is beyond a certain threshold. The exchanges can come up with a stronger surveillance mechanism that is triggered whenever promoters pledge their stake. They may mandate a nudge facility through brokerages by which an investor may be forewarned before making investment in companies where the promoter share pledge is beyond a certain threshold. A few brokerage houses are already providing such nudge facility to forewarn investors about companies that are facing a ban period or are headed to the National Company Law Tribunal or are in the news for other serious issues.
As for retail investors, they should properly study the fundamentals of a company before making any investment decisions. They should avoid investment in shares of companies whose promoters have pledged stock beyond a certain limit. They should check the company’s universe of shareholders (promoter group, foreign portfolio investors,domestic institutional investors, etc.); the more diverse the shareholding pattern, the better it is.
Every crises provides an opportunity to make amends for a better future. The present crises should also be used to learn and implement various measures that can make our securities markets more robust and less prone to systemic risks.
Kuldeep Thareja, Mitu Bhardwaj and Rasmeet Kohli are working with the National Institute of Securities Market.
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