Stock prices have, in recent times,seen enough volatility to keep issuers away from raising money from the capital markets. The last few months have not seen any listing on the main board of the Indian stock exchanges, despite the fact that over ₹60,000 crore worth of IPOs have already received clearance from the market regulator. QIPs have been no different with very little activity in recent times.
With many firms trading in the red, and very little activity in the primary markets, action has certainly picked up in buybacks. Firms seem to be taking advantage of the situation to boost their valuation and improving return ratios, while signalling to the market that their business is undervalued. In 2018, 66 firms had announced buybacks of shares, which is almost a 20% jump compared to 2017
The regulations governing buybacks by listed companies have witnessed a recent overhaul—the Securities and Exchange Board of India (Buy-Back of Securities) Regulations, 2018, (Buyback Regulations) have substituted the erstwhile regulations of 1998. The new regulations were introduced to eliminate redundant provisions and inconsistencies, and to align the regulations with the Companies Act, 2013, and other regulations by the Sebi. Buybacks are considered to be tax-efficient when compared to dividends.
Buybacks also have the potential to influence the market price of a company’s securities or cause prejudice to the interest of creditors, given that it involves reduction of capital/floating stock. The regulatory framework, therefore, has put certain restrictions on the means to fund and conduct a buyback. For example, a buyback can be funded only out of free reserves, securities premium account or proceeds of earlier issue of different kind of securities. There are also restrictions on further capital-raising by firms undertaking a buyback. Also, to safeguard the interest of small shareholders, the buyback regulations require companies undertaking tender offer buy backs to reserve 15% of the buyback size for small shareholders who hold securities of market value of up to ₹2 lakh.
Sebi’s rejection of L&T’s ₹9,000 crore buyback highlights that companies are required to ensure a debt-to-equity ratio, which is within 2:1, consequent to the buyback. The legal framework is silent on whether this ratio is to be computed on a standalone or consolidated basis. Even though L&T satisfied this requirement on a standalone basis, Sebi took a view that the ratio should be computed on a consolidated basis and as a consequence, rejected L&T’s proposal.
While the Buyback Regulations allow the buyback of physical securities, Sebi has recently mandated that, with effect from 1 April, transfers of securities cannot be processed unless held in the dematerialized form. This issue, which companies will face is yet to be resolved. Additionally, the Buyback Regulations have extended the restriction on dealing in shares during the buyback period to the ‘associates’. The definition of the term ‘associates’ is unclear and accordingly its interpretation unsettled. As is evident from the L&T’s case, lack of clarity in the regulatory framework can adversely impact companies and the market. Also, given the relevance of buybacks in the current market conditions, the regulator should ensure that the issues around the new regulations are resolved at the earliest.
Manshoor Nazki is Partner and Abhyuday Bhotika is senior Associate at L&L Partners (Formerly, Luthra & Luthra Law Offices). The views expressed here are for general information purposes and are not a substitute for legal advice.