The Securities and Exchange Board of India (Sebi) has done well to soften its stand on the rules for companies buying back their own shares. In a discussion paper released early this year, the regulator had proposed cutting the duration of an open market buyback to three months, from the existing period of 12 months. It had also said that after each buyback, companies will have to wait for two years before raising any capital, much higher than the current waiting period of six months.

Sebi announced on Tuesday that the buyback duration has been reduced to six months and that the restriction on raising capital is for a period of one year. The regulator’s main recommendation of a mandatory minimum buyback of 50% of the targeted amount stays.

Sebi’s decision to tighten the buyback process is welcome. Even though there haven’t been clearly laid out rules on a mandatory minimum buyback amount, the regulator has already been instructing companies to commit to a minimum buyback of 25% of the total targeted amount. According to the discussion paper released in January, this has produced the desired results. On an average, companies have ended up buying about 50% of the targeted amount after Sebi started giving these instructions. Earlier, some companies had buybacks open for a period of a year but didn’t actually buy any shares. Buyback announcements, in such cases, were used as effective tools to manage a company’s share price.

The new rules will deal a blow to this. Having said that, Sebi must be mindful of cases where the traded price of the company’s shares is close to or above the announced maximum buyback price. In such a case, it will become difficult for the company to complete the mandatory minimum buyback, and the rules should be applied carefully.

With the above-mentioned rules in place, investors should be able to breathe easy that buyback announcements will not be used for price manipulation. But Sebi has gone a step ahead and asked companies buying back shares to create an escrow account as a security for performance, with an amount of at least 25% of the targeted buyback amount. This is an unnecessary burden, especially given the mandatory minimum buyback rule.

Sebi’s rules also suggest a preference for buybacks made through tender offers, as they are generally at a premium to the market price. But this is a decision best left to the company and its investors.

While Sebi has done well to tighten buyback rules, it has also gone a bit too far. It must be noted here that an open market buyback is the most tax-efficient way to return surplus cash to shareholders under current tax rules, and one hopes that the new rules don’t cause some companies to consider other methods of returning cash that are tax-unfriendly to investors.

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