All markets need information to function. The financial crisis and now Satyam have injured expectations of transparency. On Wednesday, the Securities and Exchange Board of India (Sebi) helped market transparency by announcing that it would require promoters to disclose shares pledged with banks.
The practice of pledging shares as collateral in exchange for loans has come into the limelight, thanks to the economic slowdown. With prices falling, there is a danger of defaulting on loans. This triggers margin calls at the lenders’ end which, if unmet, can lead to banks seizing shares and even selling them. As reported by Mint on 19 January, these loans pledged against shares worth $15 billion (Rs73,650 crore) by 35 company promoters are raising eyebrows.
Illustration: Jayachandran / Mint
It’s not hard to see why. Thanks to a bank’s liquidation of stock, a small fall in share price can end up becoming a large downward push on the stock, as happened to Satyam in December over the Maytas controversy. More importantly, any dilution in the promoter’s equity stake prompts doubts of company ownership. Yet, when the promoter ends up forfeiting equity, shareholders are left in the dark. So far, this has been legal. After all, every investor uses shares as collateral for loans without disclosures— then why hold up promoters?
Investors care more about the company boss than the ordinary portfolio investor for a combination of reasons. First, the nature and volume of the stock pledged—and potentially dumped by the lender—invites dangers of a price fall or, worse, a takeover. Second, where an ordinary investor operates publicly, the promoter possesses insider knowledge. Risking equity for capital is sometimes a last-ditch effort.
To be sure, promoters can risk their equity for increasing leverage even when the company isn’t in trouble. Whatever the reason, this disclosure allows investors to quiz the promoter, who can still defend a rightful leverage. Such a disclosure can be simply added to existing requirements on buying and selling shares at minimal cost.
This announcement is only a first step. Sebi now has to stay firm on enforcement. For one, chairman C.B. Bhave’s decision to only mandate disclosure for listed companies obscures unlisted subsidiaries continuing the practice.
Though regulators should not overreact post-Satyam, this is one Sebi requirement that can help rectify a legal lapse. Investors across the country can now make sounder decisions.
Should promoters be required to disclose shares pledged? Tell us at firstname.lastname@example.org