What are pledged shares?
Promoters of companies sometimes pledge their shares as collateral to raise funds, which they can use to invest in new ventures, increase their holding in companies or tide over a cash crunch. This is like loans-against-shares that some banks offer, except that it’s on a much bigger scale. By pledging shares, promoters are leveraging their holdings in a company to borrow money.
How do they raise funds?
Promoters approach finance companies, mostly NBFCs. The number of shares to be pledged varies depending on a company’s market cap, liquidity in the counter, profile of the borrower, repayment terms, and additional security. For a company with Rs 4,000 crore market cap, a lender may ask for shares 2 times in value of the size of the loan; for a company with Rs 2,000 crore market cap, the lender could ask for a margin 4 times the size of the loan. Given the bear market, the lender also seeks additional security like a residential property.
What’s the loan size, coupon?
The loan size varies widely from Rs 5 crore to Rs 500-700 crore. Satyam once had a market cap of $4 billion or Rs 16,000 crore. Its promoter Ramalinga Raju had pledged his family’s 8.23 per cent stake, which was then valued at Rs 1323 crore. Many lenders would have been comfortable lending him Rs 700 crore with two times margin. The tenure of such loans varies between 12-36 months but most promoters prepay the loan. The interest rate varies between 12-24 per cent, depending on the profile of the borrower but typically it’s around 18 per cent.
How do they work?
Some promoters insist on keeping the shares with a trustee like IDBI Trusteeship but many lenders keep shares with themselves. When a promoter pays back, the shares are returned to him. But if a company’s share price (whose shares are pledged) falls sharply, the lender seeks additional security—a top-up of shares or asks the promoter to repay the loan. If the promoter fails to provide the additional security, the lender sells the pledged shares as it happened in case of Satyam.
What’s the new rule?
The stock market regulator Sebi has asked promoters to disclose the details of pledged shares if the same exceeds 25,000 shares in a quarter or one per cent of the total shareholding or voting rights of the company, whichever is lower. The promoters must inform his company within seven days of pledging his shares, or in case the lender invokes his shares. The company, in turn, must inform stock exchanges within seven days of such disclosures made by the promoter.
What was the trigger?
Satyam. Here, the shareholding had changed hands without anyone coming to know about it. Satyam’s promoter Ramalinga Raju had pledged his shareholding with lenders. When Satyam’s share price fell following the aborted Maytas deal and Raju failed to top-up the margins, lenders sold its shares by invoking shares pledged with them. So, there’s concern on pledged shares and regulators want the same to be disclosed in a methodical manner.
How big is the problem?
It’s huge. In a bull market, many promoters leveraged their holdings to grow their businesses, invest in new ventures, or increase their holdings in their companies. Some estimate that 200 companies’ promoters have raised finances by pledging their shares; others estimate the size of NBFC’s loan book (loans to promoters) at Rs 90,000 crore. But the NBFCs are not worried as they believe this (lending against shares) is one of the safest products as these are good-quality papers, and much better than personal loans. Worst-case, they can sell the shares.