Should there be a 25% mandatory public float?

DEBATE

While the idea of a larger public float was mooted to make markets deeper and to help reduce price manipulation, its impact needs to be thoroughly examined first

Rashesh Shah
Chairman,
Edelweiss Group

'There is a need for more floating stock to meet investor demand and this will help achieve that'

The move will ensure a sufficient float for investors as well as improve the quality of governance. In fact, the threshold may be increased to 25.1 per cent. As per the Companies Act, 25 per cent is a threshold for the approval of all special resolutions, so having a marginally higher than 25 per cent float will ensure that non-promoters can protect their interests. 25.1 per cent will ensure that though the promoters retain 'positive' control over the companies, 'negative' (or veto) control can rest with non-promoter owners.

The increased float will ensure that secondary market trading in scrips is transparent and orderly. One of the problems most investors in secondary markets face is that of floating stock. There are very few companies with significant floats which can satisfy the investment needs of public market investors "" both retail and institutional. The higher liquidity will also ensure that impact costs and trading costs reduce.

India has one of the more pronounced equity cultures in the world. This has been due to active retail participation as well as growing local institutional investor base. With the advent of insurance companies and the imminent entry of pension funds in the equity markets, there is need for greater availability of floating stock of companies which are already listed and have a trading and governance history. This move will add liquidity of many larger listed companies for these investors to buy into without significant impact cost.

However, the broad suggestion needs to be clarified and possibly modified in implementation. First, we need to clarify what constitutes a float. In the public markets, stocks change ownership from retail to institutional holders and vice-versa all the time. Therefore, it is practically difficult to have a 25 per cent retail holding on a consistent basis. Hence, the ideal suggestion would be to have 25 per cent as non-promoter holding. This can be retail, MF, insurance companies, FIIs, PE investors, and so on. ESOPs as well as employee holdings should also be counted towards public float.

The second is to allow IPOs with 10 per cent float, as is commonly allowed now, but have a 24-month requirement for companies to reduce the promoter holdings to 75 per cent. This can ensure that the current IPO rules are not tinkered with "" as too many structural changes will also harm the development of the IPO markets "" while still implementing the requirement for a 25 per cent float. This multi-stage process will ensure that there is no sudden IPO surge and also present an opportunity for companies to dilute in follow-on offerings to institutional investors who would like to increase their holding.

As the Indian corporate sector morphs from promoter-owned companies to professionally-owned/managed ones over the next 25 years, these moves will make the transition to the next generation more orderly.

One of the key inflexion points in the development of India's equity culture was when the government, in the 1970s, insisted on foreign companies being listed in this country. Whatever be the political stand one has on such diktats, it did ensure one thing "" some good quality stocks were made available to Indian investors. The mandatory 25 per cent threshold may end up doing something similar.

S Ramesh
COO,
Kotak Mahindra Capital

'A lower initial float allows promoters to dilute equity gradually while retaining control "" this is critical'

It's important to understand why, from a public offer of 60 per cent of share capital, this was reduced to 25 per cent in 1993 and finally to 10 per cent which resulted in a boom in public floats. The 10 per cent initial float allowed promoters to dilute equity gradually by raising capital post-listing, yet retaining reasonable control (say, 51 per cent and over). A float of 25 per cent initially will throw water on this. In situations like hostile takeovers, the level of shareholding is going to be critical.

Also, in the event promoters offer their shareholding at IPO stage as a part of this 25 per cent, one must keep in mind the tax implications for promoters, as this does not get the benefit of STT. While India has witnessed a strong bull run in the recent past, one must not forget the long spells of bear runs our capital markets have gone through. Imagine the size of IPO floats for, say, a Reliance Power, TCS, BSNL, NTPC, and others at 25 per cent (instead of 10 per cent) and the challenges that this size of fund raising will throw up.

In Indian IPOs, 60 per cent of the offer is made to institutional investors, 10 per cent to high net worth individuals and 30 per cent to retail investors. The 30 per cent retail investors do not participate in price discovery. It is the institutional investors who help price discovery. Therefore, whether the float at the IPO stage is 10 per cent or 25 per cent, retail investors would typically abstain from the price discovery process and so a 25 per cent IPO float would not make any difference on this count.

In stocks of most well-traded companies, post-listing analysis shows that retail shareholders sell their shareholding to FIIs/mutual funds. Even if a 25 per cent public float is envisaged, there is a good chance that retail shareholding in these companies would shrink in the event they sell shareholding to institutions.

Current IPO guidelines stipulate that companies need to offer a minimum of 10 per cent shareholding, two million shares and an issue size of Rs 100 crore. To facilitate greater liquidity in these shares, this minimum size of Rs 100 crore may be significantly enhanced to, say, Rs 300 crore or thereabouts. This would imply that companies that would not qualify for this threshold would either dilute a higher percentage or look at alternate markets like the proposed SME exchange for listing their shares. Insurance companies and banks, which are becoming important investors in the capital markets, should deemed to be part of 'public'.

It has been suggested that promoters/companies will be given three months to restore non-promoter shareholding to at least 25 per cent, which for many companies would imply doubling or more than doubling the current public float. This time is insufficient as promoters are dependent on the vagaries of the capital markets. Also there is a due process to be run and there can be no assurance that this would be completed in three months' time.

If the uniform requirement of 25 per cent public holding is to apply to existing companies, this would imply a Rs 1 trillion of supply of equity paper would come to the capital markets. Can this be absorbed? Is this in the interest of existing retail investors? Will this supply not dampen stock prices?