The Sebi board will widen the definition of encumbrance and heighten disclosures on encumbered shares, said two people with direct knowledge of the matter, requesting anonymity. Under the current takeover code, encumbrance includes a pledge of shares, lien or any such transaction. “This will be widened to include any restrictions on free and marketable shares of the promoter, which affects the tradability of the shares. It will also include negative lien and non-disposable undertakings," said the first person. “The idea is to cover all innovative structures and methods used by promoters."
This comes in the wake of the recent spotlight on mutual funds’ exposure to loan against share (LAS) schemes. These involve debt mutual funds investing in papers of little-known companies on the backing of promoter shares. The LAS schemes faced criticism following a collective decision by fund managers to not sell shares of the Essel Group.
Other instances include promoters pledging their shares to take debt in unlisted companies to fund other businesses, which increases the leverage of the entire group. But the overall debt position of promoters or promoter’s unlisted entities is not available to minority investors. Another such means is the so-called use of structured obligations. Promoters create special purpose vehicles (SPVs) with their shares committed to it and minority investors would not know the purpose and end use of the SPV. In January, the Essel Group companies, to which mutual funds had lent a combined ₹7,000 crore against debt securities, neared a payment default. The fund managers agreed not to sell the pledged promoter shares until end-September on a promoter’s guarantee. This standstill agreement affected the pay out of fixed maturity plans (FMPs) of Kotak Mahindra AMC and HDFC AMC.
Mutual funds have an exposure of over ₹51,000 crore to these LAS schemes or papers.
As a further tightening, the promoters, promoter group and persons acting in concert will need to disclose the reason for creating an encumbrance as soon as 20% of their share capital is leveraged.
“More often than not, in case of encumbered shares, the economic risks of share price fluctuation are passed on to the lender, whereas the political right or the voting right remains with the promoters. This is not to say share encumbrances are bad, as many times these are created for company expansion, meeting financial needs of the company. The problem arises when investors do not know the reason for encumbrances. The new amendments are meant to bridge this gap," said the second person.
As of 24 June, 38,531 million shares are pledged across 790 listed firms and about 46.03% of these are promoter pledges.
“While disclosures are always good, it is the enforcement which is lacking. Sebi should rather penalize some of the non-compliances to ensure that its rules are followed. To my mind, the definition of encumbrance currently is wide enough," said a securities lawyer, also requesting anonymity. Sebi will also ease buyback rules for parents of non-banking financial companies (NBFCs). For companies with NBFCs and housing finance companies (HFCs) as subsidiaries, it would consider stand-alone financial numbers to determine the ratio as a post-buyback ratio.
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