Panic selling by financiers holding stocks as collateral behind recent stock price crash; experts call for transparency.
The off-market margin funding deals of promoters and high net worth traders have come under a scanner. Stock brokers and analysts say panic selling by financiers, who extend huge funds by accepting stocks as collateral, was the main reason for the crash in several small and mid-cap stocks in the past three-four trading sessions.
There was panic among large financiers because of confusion and fear, after talk of India’s double taxation avoidance treaty with Mauritius coming under review resurfaced. The hue and cry was louder this time because of the recent corruption scandals.
Shares which crashed badly included Global Tele Ltd (GTL), GTL Infra, S Kumars, K S Oil and Orchid Chemicals, among others. These shares fell 20-70 per cent in just one or two trading sessions this week, even while the benchmark equity indices Sensex and Nifty were down just over two per cent on Monday and recovered some ground the next day.
Heavy selling in some of these counters came from funds domiciled in tax havens like Mauritius. These funds are said to be the ultimate financiers involved in margin funding deals.
Deven Choksey, managing director of one of the oldest Mumbai-based broking firms, K R Choksey Shares and Securities, issued a white paper today, criticising 'private' margin funding arrangements of promoters and traders.
Choksey, through the paper submitted to the Securities and Exchange Board of India (Sebi), demanded an alternative lending-borrowing mechanism be brought on the exchange platforms. This, he said, would keep even the smallest investor informed about the float of shares and bring down widespread manipulation.
“The reason for the recent crash in some of the mid and small-cap stocks was not fundamental but completely out of the box for retailers. Should an investor be asked to assume a risk which is other than the business risk?” asked Choksey.
He wrote to Sebi that margin funding deals be made more transparent. “Currently, it is a private arrangement between the borrower and lender. Only disclosure of pledged shares is not enough. Financiers liquidate shares kept as collateral under panic. The investor on the street is caught unawares. Wealth erosion of small investors is high under such hostile situations for no fundamental reason. This scares them away and liquidity dries up on the exchanges. Let margin funding happen on the exchange platform,” said Choksey.
Sandeep Parekh, former executive director at Sebi and legal advisor on capital market-related issues, said, "This is a system of shadow banking. Most NBFCs of brokers are not following any Sebi rules, as they are not bound to. The promoter and trader should be made to disclose who the ultimate pledger is."
Parekh is of the view there is not much difference in pledging of shares and margin funding. If the promoters or traders default, small investors have to pay for it, as large financiers flood the market with float.
Of late, the dynamics of the margin funding business have changed. Unlike earlier, when domestic stock brokers raised money through debt placement in their non-banking finance company to provide for margin funding, a few foreign funds are now the ultimate financiers.
Brokers negotiate the deal between the borrower and the lender, for which they charge a 0.5-1 per cent commission. Large foreign institutions extend funds at a substantial discount to the market price of the collateral.
In case of group 'A' stocks, where the quality of company and management is better, the haircut (margin or fee) charged by institutions is 10-20 per cent. In other stocks, the haircut is as high as 50 per cent.
The collateral shares lie in an escrow account under an agreement that they will be sold any time if the borrower is not able to deposit additional margin as an when required. The key issue is there is no information such positions held through margin funding.
This is what happened in the case of GTL group companies and S Kumars. While GTL fell 60 per cent, GTL Infra was down 40 per cent on Monday. S Kumars declined 28 per cent on Tuesday in a single session in intra-day trade. K S Oil too fell over 30 per cent on Monday. While GTL and S Kumars promoters denied that shares pledged by them were being sold in the market, experts say there should be a probe of all the major sellers as it seemed to be a coordinated effort.
In the case of GTL group companies, bulk deal data on exchanges showed seven private holding companies — Green Ridge Properties, Cosmo Advisory Services, Reckon Trading, Aerolite Advisory Services, Cross Link Trading, Plasma Advisory Services and Savyasachin Estates — together sold 5.6 million shares. This is roughly 40 per cent of the total delivery volume of 10.28 million shares traded on Monday.
Margin funding has been responsible for crashes in small and mid-cap stock prices in the past too. In December last year, investors were trapped in the counters of Ruchi Soya, K S Oil, Ackruti City, Karuturi Global, Glodyne Technoserve, Shree Ashtavinayak Cine Vision, Welspun Corp, Parekh Aluminex, Midfield Industries, Money Matter Financials, Comfort Intech and SVC Resources after brokers started offloading them. Some of these were kept as collateral by either promoters or large traders.
Brokers were closing these margin funding positions after police raids on Money Matter Financial and circulation of an Intelligence Bureau report naming several operators. This created a crisis of confidence and financiers feared being hauled up for manipulation, after which stock brokers stopped directly extending margin funds to big punters.
Domestic brokers are already under Sebi watch after the crackdown on operator Sanjay Dangi and promoters of companies like Ackruti City, Murli Industries, Welspun Corp and Brushman for their alleged involvement in price rigging. Use of leveraged money through funding deals was high in these counters then.
