35% Minimum Public Shareholding: Understanding The Costs
A forced capital raise may have the unintended consequence of inefficient hoarding of capital by corporations, warns Cyril Shroff.
This is the first in a series of columns by on the fundamental considerations for the Budget proposal to increase minimum public shareholding in listed companies from 25 to 35 percent.
In January 1974, India introduced the Foreign Exchange Regulation Act, which required multinational corporations to reduce their equity shareholding in Indian subsidiaries to 40 percent. This led to the mass exit of many large MNCs from the country in the seventies, including Coca Cola, IBM, and Kodak (with as many as 54 companies reported to have applied to the Reserve Bank of India to exit from India at that time). The nexus between regulatory changes to the limits on shareholding patterns and correspondingly, commercial decisions on investment is, therefore, a lesson in history that we as a country have already learnt.
Needless to say, there can, and have, been compelling reasons for the government to mandate rules on shareholding limits when driving a larger macro-economic or social policy. Last week, we saw the Finance Minister set out the government’s position that “It is (the) right time to consider increasing minimum public shareholding in the listed companies. I have asked SEBI to consider raising the current threshold of 25 percent to 35 percent”.
While the budget speech itself did not go into much detail about the proposed change including the objectives sought to be achieved from such a change, we do expect that the Securities and Exchange Board of India will delve into this issue with careful consideration. In this series, we outline the considerations that may be borne in mind while reviewing this proposal at close range.
First, it is imperative to identify the policy goal sought to be achieved through this change. The concept of ‘minimum public shareholding’ for listed companies is well embedded. Levels of public float have been prescribed by law with the objective of ensuring that a minimum volume of shares is made available to the public to ensure adequate liquidity and depth for effective price discovery. There is also a significant corporate governance angle to the MPS norms that seek to establish principles of democracy, fairness, and transparency.
Globally, the MPS requirements vary between 10 percent and 25 percent. In India, over a series of regulatory iterations, we have seen the public float norms vary from 10 percent to 25 percent depending upon certain threshold criteria prescribed. With effect from June 4, 2010, the MPS requirement was made uniform at 25 percent for all listed companies, with specific rules and timelines on how non-compliant companies were to come into compliance. The 25 percent threshold prescribed was in line with the requirements of many international markets on liquidity, and also aligned with the Indian corporate law protections that become effective at this threshold.
Specifically, a range of corporate actions that are considered material in nature for minority interest protection, are subject to the requirement of a special resolution of shareholders. Special resolutions can be blocked by 25 percent of the shareholding voting against the proposal.
What Changes From 25 Percent To 35 Percent?
The fundamental premise that supports a 25 percent MPS is therefore well-rooted and widely understood. From a corporate law perspective, there is no change in rights or remedies that would be effected by the increase in the threshold to 35 percent. Similarly, an argument that a higher public float will ensure greater diversification of the shareholding pattern which in itself will derive the benefit of higher governance standards, will face strong resistance in light of recent experience. This would include the several ‘governance issues’ that have been raised in the context of companies with very diverse shareholding patterns, and also the international concerns surrounding diverse shareholding bases that have driven companies to extreme short-termism in decision making and laxity in governance priorities.
An alternative motivation may be that an increase in MPS to 35 percent will contribute towards the Indian aspiration to become a $5 trillion economy in the next few years. This argument may not hold up. An increase in public shareholding can essentially be achieved through a secondary sale of shares by the promoters, or a fresh issuance of capital by the listed company to public, in each case in the manner approved by SEBI.
In a secondary sale by promoters, ‘investment’ by one investor is substituted by ‘investment’ by another investor – with no net change in investment from a macroeconomic standpoint.
Similarly, where the fresh issuance by the listed company is driven by the regulatory requirement of achieving a certain breakup in the shareholding pattern and not for commercial objectives arising from the growth plans or opportunity of the company, it is not necessary that the objective of investment for economic growth will be met. Such a capital raise by the listed company would need to be further reviewed in the light of:
- the various SEBI limitations on the use of funds raised in a public issue and shareholder approval requirements for the change in the use of funds; and
- the international currents of shareholder activism focussed on companies distributing surplus capital back to investors.
These issues become more acute for companies which are already sitting on surplus cash reserves but are faced with the obligation of ensuring MPS.
Effectively, a forced capital raise, for regulatory requirements and not a business requirement, may have the unintended consequence of inefficient hoarding of capital by corporations.
Such a consequence would better be avoided to allow for capital to flow towards fundamental growth of the economy and not to bridge the regulatory arbitrage.
The Cascading Impact
There is also the psychological impact of changing the goal post that should be factored in. The 25 percent threshold for MPS has been in the realm of expectation for corporate India for several decades. The specific rules on MPS set out the 25 percent threshold. Further, the restated Takeover Regulations of 2011 also allowed for promoters to consolidate their shareholding to 75 percent under the creeping acquisition route of 5 percent per annum. This led to a number of promoters, including MNCs, investing calculated capital towards consolidating their shareholding towards the 75 percent threshold. The current proposal by the government may raise compelling reasons for promoters to opt for delisting the company rather than continue to risk the implications of continued losses arising from regulatory predictability.
A wholesale move of well-performing companies delisting their shares may hurt investor sentiment at the macro level – a concern which should be carefully weighed.
In conclusion, regulatory requirements of public float can be costly for listed companies, promoters, and also more generally to the markets and enforcement. As per the SEBI order of June 4, 2013, interim orders were passed against 105 non-compliant companies for freezing of voting rights and corporate benefits, prohibiting promoters / promoter group from buying, selling or otherwise dealing in securities of their respective companies and restraining directors from holding any new position as a director in any listed company. Similarly, the SEBI circular of October 10, 2017, issued directions to stock exchanges to come down heavily on listed entities (and their promoters and directors) which were in breach of the MPS norms. Despite these efforts, for a variety of reasons, the number of non-compliant companies stands at approximately 37 out of the BSE top 500 companies even today. If the proposed increase to 35 percent is given effect to, it is expected that upward of 1100 listed companies will need to devise a go-to-market strategy. Given this large scale impact, we believe that it is imperative that the objective sought to be achieved is clearly defined and that the structural and regulatory amendments required are then tracked to the stated goals.
To be continued. In Part 2 and 3 of this series, we will review the impact on the various stakeholders and analyse the regulatory amendments that may be considered while reviewing the proposal for an increase in the rules of minimum public float.
Cyril Shroff is the managing partner of Cyril Amarchand Mangaldas. Amita Gupta Katragadda is a partner in the firm’s disputes, governance, and policy practice.
The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.