The divestment will be in the larger public interest but it will be practical only if there is an enabling environment for the capital market to gain depth and function efficiently.
CFO, TATA Capital Ltd
The move facilitates greater price discovery and will dampen market volatility, providing incentives for more retail participants to enter the market
The public listing of a company is perhaps its most significant rite of passage. It symbolises the willingness of its owners to allow others to participate in their journey of entrepreneurship, at a price. By accepting public money, a company binds itself to a governance code. One cannot make the argument that divesting just a smaller shareholding allows one to somehow operate within a more lax code of governance or to treat minority shareholders differently. Unfortunately, even with good intentions, minority public shareholders currently have virtually no say in the management of a large number of companies, as promoters who hold between 75 per cent and 90 per cent of the shares can effectively operate the company as they choose. It is in this light that the recent guidelines of the finance ministry which require companies to achieve a 25 per cent free float over a three-year timeframe should be viewed. There is now a greater likelihood that the majority promoters will operate within certain bounds of acceptable corporate behaviour. One is not suggesting that with 74 per cent, promoters will become lily-white overnight, but, undoubtedly, a 25 per cent public stake will be materially more influential than a 10 per cent public stake. This regulatory change, therefore, serves the cause of good governance.
In addition to the customary commercial arguments for increasing depth in the equity market, there is an overriding moral consideration that needs to be kept in mind for a more liquid equity market. India is moving to a phase where there is a general desire to enable consumption and investment as opposed to saving, something that is now reflected in a general desire to keep interest rates low. As a result, many people, especially pensioners, are now having to eschew fixed-income investments and look elsewhere for returns. While investors need to be willing to accept market risks, they need to be partly insulated from unnecessary risks caused by illiquid and shallow capital markets as is the case with many stocks today. The new rule provides greater price discovery and will dampen market volatility, thereby providing incentive for more retail participants to enter the market. This can only be beneficial to companies and investors.
One can argue that the government has been reasonable by providing three years to promoters to reduce the percentage of their shareholding. It is not easy to support the claim that by forcing promoters to dilutes their stakes, one is somehow depriving them of fair value. At some point over this period, the markets will presumably provide a reasonable valuation. What is perhaps true is that wealth created by means of an artificial scarcity in a stock will disappear. This will perhaps reduce the super-normal profits of the past, but it seems illogical to believe that in a savings-rich country, investors will turn away opportunities to make a 12-15 per cent equity return over a three-four year period, when fixed income instruments earn less than 8 per cent. The increased price discovery caused by a greater free float will mean that those seeking to make quick profits based on manipulation or scarcity will have to work harder to get the same. This cannot be a significant disadvantage when the converse is the creation of liquidity and better price discovery. Increasing the free float in three stages will reinforce the need to perform well. The second and third tranches of divestment will naturally take place at prices that reflect the performance of the first tranche. This is excellent from a governance perspective as it will induce discipline in the company’s operations. If a share is originally over-priced, the public will have an opportunity in the near term to invest at a fair price.
In the light of all these benefits, the proposal would have to be hugely impractical. This is far from the case. Practicality can be questioned if the market does not have enough depth to pick up the newly created shares. This is a circular argument because one can only create depth in the market by having a substantial float available for people to acquire. While it may appear that the market may not be able to absorb all Rs 1,60,000 crore of offerings, what will really happen is that investors will divert their investments from the least attractive ones to better ones. The men will be separated from the boys, and that cannot be bad for the markets per se.
No doubt, like any regulatory change, this will also require various qualifications and perhaps some fine-tuning. However, for a country that is deeply starved of capital and is at the cusp of growth, any measure that improves liquidity, price discovery, depth in the market and governance can only be seen as highly desirable.
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Executive Director, Corporate Finance, KPMG India
The move will work only if the right fiscal infrastructure is in place. Unless certain enabling conditions are present, the rule is impractical
Public listings have been a good avenue to raise capital, given the value discovery and liquidity that they bring, subject to certain enabling conditions. This would require listed companies to have diversified shareholdings through a higher public float as it would enhance transparency and accountability, enable value discovery and provide good exit options to investors. However, one needs to understand the kind of fiscal infrastructure needed to make this happen.
The government’s move to raise public shareholding (rightly excluding American Depository Receipts) to 25 per cent for new issues and a gradual target of 25 per cent for listed companies should be seen from this perspective. But some introspection is necessary.
Indians basically invest most of their savings in bank deposits. But, given the capital market exposure norms of banks and life insurance companies, the amount that flows into the stock market is very low. For example, the cumulative deposit base (savings and term) of banks is around Rs 35,00,000 crore while the capital market exposure of all banks is a fraction of this: approximately Rs 21,000 crore in equities and Rs 42,000 crore in debentures. Life insurance companies have a cumulative premium income of Rs 2,22,000 crore. LIC, the largest insurer and the collector of the maximum renewal premiums (incremental investments), invests only Rs 55,000 crore of this in listed equities. Other insurance firms invest Rs 39,000 crore although the Insurance Regulatory and Development Authority allows 60 per cent to be invested in equities. Mutual funds have an assets under management (AUM) of approximately Rs 74,000 crore, of which exposure to equities would be around Rs 40,000 crore, assuming that 60 per cent of premium is invested in equities. Accordingly, of the total savings of Rs 38,00,000 crore, only Rs 1,55,000 crore hits the equity markets. Most of the money available with public (or M3) is invested in corporate government debt.
The total market captialisation of the National Stock Exchange is approximately Rs 62,00,000 crore. Let’s assume the Indian public float today is over 20 per cent and Rs 2,00,000 crore to Rs 3,00,000 crore is required just to fund existing listed companies at current capitalisation. In that case, we would need our capital market allocations to grow five times to be able to meet the exit norms along with incremental equity raising. By no means can we achieve that. An increase in banks’ capital markets exposure may not help much but could prove risky for the banking system.
Mutual funds are struggling to garner AUM because of lack of incentives at the broker level and it may take some time before this situation improves. Foreign institutional investors, which dominate our markets, may not be the best way for incremental capital given that any global turmoil would impact our equity markets significantly as in 2008.
The need of the hour is to innovate to attract investors to equity markets through M3 allocations. We do not have to follow foreign regulation as our issues are different.
Mutual funds need a different outlook. A higher capital requirement for mutual funds would help give the requisite confidence to investors to attract funds. We should also consider bank deposits where funds are swiped into mutual funds daily or for fixed tenures. Such deposits should only use banks as agencies and hence not be part of banks capital market exposures (more like default swaps where banks maintain capital to protect investors).
Life insurance should be allowed to mature as an industry in order to get the much-needed long-term funds into the market. This, however, needs to be regularised through a pension rider.
Setting up of a sovereign fund to partly fund overseas and domestic businesses is important. Sovereign bonds to fund private sector equities would also be a good long-term source of capital. It needs to be run independently on commercial terms. This would provide the necessary capital for infrastructure as well as overseas growth for Indian companies.
Therefore, the 25 per cent public float move is not practical unless these measures are introduced. A series of regulatory initiatives is also necessary.
The author is also the head of financial services, KPMG India