Mint Explainer | Inside the Shriram–MUFG deal: Why proxy firms are pushing back

Touted as India's largest cross-border deal in the financial sector, the $4.4 billion transaction has been given a thumbs up by credit rating agencies such as Care Ratings, Icra, and Moody's Ratings, putting the NBFC in a favourable position to secure cheap borrowing.

However, the deal has faced scrutiny from two prominent proxy advisors. Mint delves deeper into the deal and its implications for shareholders.

What rating agencies say

Following the deal announcement, Care Ratings was the first to upgrade the domestic lender to its 'AAA; stable' from 'AA+; stable'. The rating agency also reaffirmed the 'A1+' rating for the company’s commercial paper.

Icra, too, placed its AA+ rated lending instruments on watch with positive implications. It said that the transaction will significantly improve Shriram Finance's capitalization profile, providing a sizeable buffer for growth and for managing volatility in its asset quality, given the target borrower profile. “This, in turn, shall strengthen its credit risk profile, leading to an improvement in its financial flexibility and earnings performance," the agency said.

Moody's, the latest of the rating agencies, upgraded the company's outlook to positive from stable on 9 January, while affirming its Ba1 long-term corporate family rating. It said the proposed investment by MUFG will provide a stronger capital base, access to global expertise and funding channels, and improve Shriram's funding diversity and risk management practices over time.

"The positive outlook reflects our expectation that SFL's business and financial profile will strengthen, supported by a strong strategic shareholder and a significant capital increase," the rating rationale read.

Brokerage firms, too, have been making bull calls on Shriram's stock since the deal was announced. Jefferies, Nomura and CLSA came out with fresh notes on Shriram Finance in December. Nomura hiked its target price on the scrip by 5%, and Jefferies upped its target by 8%. CLSA has maintained an 'outperform' rating with a target price of ₹1,030.

What proxy advisors say?

Despite all the upsides, two prominent proxy advisors have flagged resolutions Shriram Finance seeks to pass.

The NBFC is seeking shareholder nod for three resolutions:

• Issuance of 47.1 crore shares worth ₹39,618 crore to MUFG by way of preferential issue on a private placement basis.
• Granting certain controlling rights to MUFG Bank.
• A one-time, non-recurring $200 million payout by MUFG to promoter Shriram Ownership Trust, for non-compete and non-solicit obligations.

Governance research firm Stakeholders Empowerment Services (SES) has opposed all three proposals, and Institutional Investor Advisory Services has opposed the third one. InGovern Research Services has supported all resolutions to clear the deal.

The resolutions will be up for shareholder approval at an extraordinary general meeting on 14 January. E-voting for the same began on 11 January.

What is SES's argument?

SES claimed that the Japanese banking giant is seeking de-facto control of Shriram Finance that should have triggered a mandatory open offer. The proxy advisory challenged the first two resolutions, arguing that despite the massive capital infusion, minority investors are being denied an exit opportunity usually required when control shifts.

While the deal falls below the 25% threshold mandated by India’s takeover regulation, SES contended that the arrangement bypasses the spirit of the law by placing MUFG in the "driving seat jointly with the promoter".

The first resolution is being opposed by SES basis the rationale that "preferential issue should be followed by open offer, which is not presently envisaged." The second resolution is being opposed as "controlling rights (are) being acquired without open offer; special treatment being provided to the Investor (MUFG); unfair for the existing investors."

The firm argued that MUFG is acquiring influence through board seats and additional rights that exceed those of the original promoters. In its note, SES said "commercial reality" often outweighs literal legal text, citing precedents from the markets regulator and the judiciary.

“Commercial reality allows the regulator to lift the corporate and contractual veil when governance rights are structured to replicate control while avoiding an open-offer obligation," Raheel Patel, partner, Gandhi Law Associates, told Mint. The “commercial reality" doctrine invoked by SES resonates with the current Securities and Exchange Board of India (Sebi) regime.

Shriram Finance, in a response to SES, rejected the advisory's claims, maintaining that no control, legal or practical, has shifted.

The company argued that the rights granted, including two board nominations and secondment rights for key appointments, are "protective and reactive" rather than "proactive." It emphasized that these measures are intended solely to preserve MUFG's proportionate holding and offer no preferential voting or economic advantages.

However, SES in an addendum dated 7 January argued that while a literal reading might suggest compliance, a "holistic approach" reveals that the bundled contractual rights vest MUFG with material influence.

IiAS flags non-compete premium

IiAS backed the first two resolutions but joined SES in opposing the third resolution for a non-compete fee in favour of the company's current promoters. Both advisories have flagged the payment, intended to bar promoters from launching a rival lending entity, as a significant governance concern suffering from weak transparency.

The scepticism centres on the deal's optics: the Shriram Group is retaining management control and a 20% equity stake post-investment. Furthermore, the Shriram Ownership Trust, the recipient of the payout, is overseen by the group’s own current and former leadership. IiAS believes there is little clarity on the size and beneficiaries of the Shriram Ownership Trust.

“The absence of clarity on ultimate beneficiaries and allocation mechanisms creates information asymmetry between insiders and public shareholders," warned Supreme Court lawyer B. Shravanth Shanker.

IiAS also questioned as to why a non-compete premium is required for a promoter group that isn't actually exiting. The firm questioned why this financial windfall is concentrated in a specific trust rather than being integrated into broader deal terms for all shareholders.

Shriram Finance defended the arrangement as a strategic safeguard for its investor base. The company, in a response to IiAS, argued that the fee serves to ring-fence the value of its lending and credit business. By legally restricting the promoter group from exploiting its deep industry expertise to build a competing platform, the company claims the move protects the long-term interests of all stakeholders.

However, IiAS contended that as long as the promoters remain at the helm and retain a significant stake, their interests should already be aligned with the firm's success. It argued that unless a promoter is fully divested, paying a premium to prevent them from competing against their own company lacks commercial logic and appears unnecessary.

"It is unclear why such protection is required," SES observed. "If Shriram were to start a competing business, it would harm its own economic interest as much as MUFG’s, given their comparable shareholding."

IiAS also said there is no clarity on the incremental businesses that the Shriram group is likely to set up, which will compete with Shriram Finance.

"The company has stated that the group plans to enter the digital lending space," IiAS said. "In its conference call, the company has stated that it plans to leverage MUFG’s digital play to develop its platform." Thus, it is unlikely that the group will develop a digital lending platform outside of Shriram Finance.

What should shareholders do?

While the transaction may be commercially prudent and significant in scale, advisories do not assess resolutions solely on commercial considerations. Their evaluation is anchored in broader concerns like governance standards and legal compliance.

“Governance issues are mostly based on the perspectives of individual advisories and they can almost always be ironed out," Kranthi Bathini, equity strategist at WealthMills Securities said.

“Fundamentally, a shareholder with a long-term perspective needs to understand that Shriram Finance is a legacy business with strong fundamentals," he said. MUFG coming in as an investor will give the company more visibility and a stronger outlook, both of which will ultimately benefit the minority shareholders, he said.