BackWhen markets turn volatile, pledged shares pose a risk to investors
In the event of a correction if promoters can't pledge additional shares, lenders may forcibly liquidate holdings, leading to loss for investors as prices would then correct sharply
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Promoters of companies are known to raise money by pledging their shares as collateral, to borrow money for various purposes.
But trouble starts to brew when the equity markets tank and the value of the pledged shares falls. The situation can lead to margin calls being triggered, forcing promoters to pledge more shares or otherwise make good the loss in value or sell shares to make good the loss in value. These moves often trigger a domino effect of sorts, sending the share price further down.
What impact could the decline in equities in August have on pledged shares?
An India Ratings’ analysis shows that, as on 3 August, promoters of 917 companies had pledged shares worth ₹ 185,800 crore. One concern is that the pledged volume is way above the daily traded volume of shares—true for 314 or about one-third of the total pledged number of companies.
In a market correction, especially if the stock price corrects by 20% downwards, the promoters would have to pledge additional shares. In the event they cannot, the lenders may forcibly liquidate the holding, which could lead to loss for investors as the stock price would correct sharply.
According to the report, only 96 firms have a market capitalization that is sizeable, with promoters having sufficient shares to top up the pledged quantity if the stock price falls by even 80%. And, in 59 cases with a total value of ₹ 31,700 crore, the chance of loss on liquidation is high as excessive number of shares have been pledged.
The chart shows the ratio of total pledged volume to the average daily traded volume of a stock. It tells how tough it is to liquidate stocks in any adversity. For example, only 108 stocks have a pledged volume which is less than 15 times the average daily traded volume of the stock.
What should investors do with this information? In the long run, company fundamentals matter more to valuations. But investors would do well to track details of promoter holdings and pledged shares, which are available on the stock exchange. In the short run, shares of companies where promoters have pledged a significant portion of their holdings could experience volatility, either when the markets turn volatile, such as now, or when the business takes an unpredictable turn.
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