The 25% Challenge?
By June 2013, promoters of all listed companies in this country have to reduce their stakes to 75%. Various counts indicate at least 200 companies, including several government-owned ones, are far away from meeting the 25% minimum public shareholding mandate. The challenge is 3 fold – time is short but SEBI seems to be in no mood to relent and unless the government changes its mind, June 2013 is a hard limit.
The second challenge is the market environment – nobody can fix that. And the third issue is the lack of suitable dilution methods. Companies, their lawyers and bankers complain that by restricting the dilution routes to 3 acronyms – FPO, OFS and IPP- SEBI is being too prescriptive or restrictive.
SEBI Chairman UK Sinha told me this in response:
"People who are raising these issues they do not have their heart on diluting. I am levelling this allegation that if there are so many options available why can’t you as a promoter reduce by 1%. Show me your intention, why is that intention not being shown? Just imagine there are 30 companies who are less than 10% and this rule has been in place since 2001. In last 11 years you didn’t find any opportunity to dilute and you are as low as 2% how ill you reach 25%? Please show your intent, don’t expect everything from SEBI. I am giving an assurance that we are willing but where is the action from your side, please do that. You will find us very responsive. If I find that companies are very keen and they are serious about diluting their stake then the manner in which they can divest or not divest that will not come in the way. We are looking at the entire thing in a fresh manner. Just because the avenues are limited that will not come in the way, we will provide them all the legitimate avenues."
So what are the additional avenues that India Inc wants in order to meet the 25% challenge. Joining me with their lists are Sanjay Sharma of Deutsche Bank, Somasekhar Sundaresan of JSA and Manan Lahoty of Luthra.
Doshi: Tell me why these three routes that SEBI has prescribed are not enough because if you look at it, the OFS is a lot like the block deal except that you are selling to a wider set of investors and there is no scope for negotiation or negotiated deals, which is exactly what SEBI wanted. The Institutional Placement Process (IPP) is like QIP except that the minimum number of investors has to be 10, not 2 or 5 and that meets SEBI’s criteria of broad based shareholding. The third offer, the follow-on offer has existed right from the time this notification came into force, so why these three routes are not enough?
Sharma: Firstly, I am not saying that there are any shortcomings in these three routes.
Doshi: Why are they not enough?
Sharma: I think they are not enough because like any product, each product has its pros and cons and there are limitations and super impose on that the two conditions in terms of lack of time and the market being challenging.
Doshi: Lack of time is not the SEBI or the government’s fault; the companies have pushed it to this point.
Sharma: If you are looking at it from now on there is about one year left.
Doshi: But if you looked at it from February 2013, or March or April 2013, no route would be good enough.
Sharma: Right, fair point. That is what I am saying it is not that these three are not enough or there are any shortcomings. Couple of points - because of the market being such, follow-on public offer (FPOs) make sense only for large issuance of say USD 100 million plus because it entails that much of effort. IIP as you mentioned the limitation of 10 investors- some times for smaller issues maybe a constraint but otherwise broadly speaking these three are not that they are not sufficient.
Doshi: If I can open this up and also argue the point that FPO, in this market condition you are saying would work only for certain size of issue in terms of the time, the cost etc but as Mr UK Sinha has pointed out there are several companies where the public shareholding is 10, so for them it would make sense to do a follow-on offer.
Sharma: If you look at some numbers, at least top 10 companies would raise about USD 4 billion to get this to 25%.
Doshi: So for them follow on offer would not work?
Sharma: For them follow-on offer works in terms of size but in a follow-on offer there is a time limit from the time you finalize the price- till listing it is still about 3-4 weeks and given the current volatile markets it wouldn’t work. So that is why OFS came in.
Doshi: The other point you raised about IPP being minimum 10 investors and that it could be restrictive, but the purpose of this exercise is to broad base shareholders. So if you have a problem with finding 10 investors then you have problem with the whole spirit of this exercise.
Sharma: You also need to look at the type of companies which are there right now which are non-compliant. These are companies which by the mere logic are not very liquid, do not have too much of institutional holding, have less of research coverage- in that context to try and sell it to a broad base becomes challenging.
Doshi: Som, what do we need to add to the list then?
Sundaresan: I think you don’t need to be fixated on a list. You need to focus on the quality of public shareholding rather than the quantity of public shareholding. These statistics that we are looking at also has compliant companies where an LIC or a GIC may hold 14-15% for decades and never traded (interrupted…).
Doshi: And you are saying that doesn’t meet the spirit of broad base?
Sundaresan: Exactly, the spirit of requiring a minimum public shareholding is you need to have enough float, which enables you to have a high quality price discovery in the secondary market- that’s the intent of having a minimum public shareholding. You can draw the line anywhere 10-25-30% as you will.
Doshi: It is drawn at 25%?
Sundaresan: It is drawn at 25%, but the policy focus needs to focus on the quality of public shareholding rather than the quantity and you can’t treat a company with public shareholding of 20% on the same terms as a company with public share holding of less than 10%. Those three routes can’t be applied to a company which has to divest 2% and to a company which has to divest 15%, you can’t apply the same three routes and say these are the only three routes. Let me give an example, the Indian constitution actually, before I give an example, says something that’s not prohibited is permitted. Reasonable restrictions by law can be imposed. So if you want to impose restriction by law you need to have a good reason to impose that restriction. So if you are talking about what is good policy, I see no reason where say for example a promoter owns some shares he has every right to sell them in the market. (interrupted…).
Doshi: The problem is, you will note in SEBI’s own board meeting notes that SEBI has raised, is that block deals nowadays have been noted not to be the standard anonymous trades that they are meant to be, but instead negotiated off exchange and then carried out on exchange and they have a fundamental issue with that; that doesn’t meet their transparency criteria. They have laid out two criteria on the basis of which this entire exercise of dilution or sell down needs to happen, broad basing of share ownership and transparency, the block deal doesn’t meet transparency.
Sundaresan: The best of objectives cannot justify the worst of policies. Assume you do an OFS or an IPP, you do one of the three methods, are you then going to regulate who can buy those shares in what quantity?
Doshi: Those processes are designed to reach out to a larger number of investors.
Sundaresan: It is a misplaced focus on a design because you are saying I will allow one of three designs to reach it because I think these are laudable. Come closing date, there is no other restriction in law or in fact people are going to be able to trade. So you are not going to say I am not going to let anyone buy more than X% of shares- that’s a rationing mindset from which it has come. I think we are writing regulation just because we have the power to write regulation. If someone holds 75% or 76%, what’s the harm if he sells in the anonymous screen-based trading system. If you don’t want block deals, ban block deals.
Sharma: I agree with the quality concept of broadbasing, which is being talked about. Broadbasing cannot be looked at from a perspective that you need 10 investors.
Doshi: That’s a beginning; they are not restricting it to that.
Sharma: Let’s take an example, there is a company with 85% holding, gives 5% to one domestic mutual fund, isn’t it broad basing? Mutual fund on the back of it has 100s of investors. What we are saying is don’t give preferential allotment to a promoter entity or an individual, but at least to QIBs, there is no harm.
Doshi: So let’s create a negative list, if not a positive list. Let’s create a negative list, maybe preferential allotments is out of the list, maybe let’s create a negative list, maybe that’s more useful?
Sundaresan: But why should even a preferential allotment shouldn’t be ban? There is a QIB route in the ICDR, a private placement of new shares to qualified institutional buyers.
Doshi: The QIP?
Sundaresan: Yes that's right. So when you wrote the QIP law, you wrote a provision saying to be eligible to do a QIP you ought to be compliant with listing requirements. You wrote that law, it is a subordinate law. You have every right to say a QIP shall be a valid means to achieve minimum public share holding; what’s the logical rationale to not recognize it as a...(interrupted)
Doshi: Because the QIP, from what I understand, requires only a minimum of 2 or 5 investors based on the size of the issue whereas they want to broad base, which is why they have ignored QIB and created an offshoot QIP, which is the IPP....(interrupted)
Sundaresan: Yes, it is a bit of an existential argument; that’s exactly my problem.
Doshi: So whether you create a positive list or a negative list, the need of the hour is to suggest SEBI more avenues via which promoters can sell.
Sundaresan: Yes open it up.
Doshi: To everybody?
Sundaresan: Just open it up to everybody. If there is something that you feel is market abuse you have the FUTP regulations to act for. If something you believe is undesirable, prohibit that. Let the rest be (interrupted…).
Doshi: It is not market abuse. If you do a preferential allotment let’s say to one or two investors (interrupted…)?
Sundaresan: If as Sanjay says if those are – if that’s UTI, let’s say it is LIC.
Doshi: If it is LIC it is fine, but what if it is not LIC and it is a private equity fund that’s not widely held in which case it doesn’t meet your broad basing criteria.
Sundaresan: What if it is a private sector mutual fund, is that okay, is that not?
Doshi: Mutual fund, I am saying okay. So, I am saying create a negative list or create a positive list, but... (interrupted)
Sundaresan: If it is a QIB, which you recognise as a QIB under your securities law of the country, it shouldn’t matter whether you give it to one or two or 10.
Doshi: Manan, you are very silent on all of this. A negative list, positive list, what do you want and can you tell me what new routes need to be added to the existing ones so that promoters stop complaining about not being able to meet this deadline?
Lahoty: I think the point that both Som and Sanjay were talking about – quality is a very important criteria, but it is more subjective. I think the regulator has taken a view here that probably quantity is going to take care of the quality aspects so long as there is a reasonable threshold and for them it is 25%. So, I think it is slightly easier to monitor over a period of time and I think globally this is how it is done, so draw line somewhere.
Doshi: You are broadly in agreement with what they are trying to tell?
Lahoty: If that is the policy. I think yes. Probably the next step really we have to think about is what are the possible ways, which SEBI hasn’t probably already thought about, but maybe they can still think a little bit more about it.
Doshi: Let's go through those.
Lahoty: Say for example, they obviously allow IIP, which is like you said an offshoot of QIP. One of the additional routes they can think about is modified rights issue, which broadly means the rights issue has to be given by company to every single shareholder, but if promoters don’t participate they could be essentially diluted.
Doshi: So they renounce their rights and let their rights lapse. But they don’t renounce in favour of somebody else, they renounce?
Lahoty: The question is you can have sort of four formulations here. In the first formulation, you can have promoter cannot renounce for example because the moment they renounce the question is who is going to come in and whether it will be renounced in favour of one or it is going to be renounced in favour of many. The first formulation is promoter does not participate at all and does not have a right to renounce either.
Doshi: And that seems to be the most ideal one because then he can’t give them up in favour of friends and family?
Lahoty: Yes actually in a way yes. But I think you probably would have some challenges about minimum subscription amount because typically for rights issue you still need to get 90% buyers. We are talking about situations where maybe 80% is held by the promoter. So, actually you are expecting 20% public shareholders to buy 100% of the rights issue, which I am sure Sanjay will probably have a view on that.
Doshi: So not everybody will be able to use the rights issue but some of them could.
Lahoty: Probably yes or you could even think of maybe having some underwriting element there or maybe you think of bringing down the sufficient requirement.
Doshi: So a modified rights issue is one route, so what else do you have on your list that you should think SEBI should consider?
Lahoty: Maybe An employee stock ownership plan (ESOP) maybe Employees Share purchase Scheme (ESPS) more than ESOPs because you don’t have so much time now to do ESOPs unless and until you were to allow ESOPs through a welfare trust route. So typically in that situation what you would do is you would allot all the shares to a trust straight away and trust would give out those options and shares over a period of time.But what you would end up doing in the next one year is parking those shares with the trust, which may not be a great idea. So what you could think of doing is ESPS, which is you give out shares straightaway to employees without giving out options first and then the shares.
Doshi: I think several people have mentioned the selective bonus or a bonus in which the promoter does not participate. Is that something that would be amenable?
Lahoty: Sure, companies who have capital reserves and who are thinking of giving out bonuses as one of the possible route- they can have an Article in their Articles saying that if a shareholder does not want to take shares under bonus, they may write to the company. So that is the way you could think of doing a selective bonus issue as well.
Doshi: Do you want to add to the list?
Sharma: This is fine but the only challenge would be if you look at modified rights issue and as Lahoty mentioned we are talking of companies where promoters own 75% or more and how do you get the balance 75% subscribed? But looking at the two, one is the modification of the current IPP guideline. Just for example there is a company which has to do only USD 20 million worth of selling for meeting the requirement. As per IPP, if he wants to do the IPP route, he can only do USD 20 million. Now why not allow the same process to somebody who can raise USD 100 million; USD 20 million to meet that requirement and the balance USD 80 million is used for the companies operations. A company wants money to run the business but you are constrained by using IPP route to come down to 75% and then after a gap ……
Doshi: But I thought the IPP guidelines allowed for ……
Sharma: Only upto 75%, if you want to go below 75%- so suppose from 76% I want to come down to 60%, I cannot use IPP. You need to come first from 76% to 75% and then do another offering. So that is one thing. The second if you look at from today’s scenario lot of companies have promoters shareholding pledged to some of the finances. Now if there is a market trigger which basically triggers the NBFC or the banks to sell those shares that is not eligible because it does not form a part of one of these three.
Doshi: But wouldn't that apply to a very few number of companies in the non compliant list?
Sundaresan: Actually Sanjay is raising a very important point; I would modify it slightly and put it differently. It is not even a method to achieve compliance. It is the evolution of facts that will mean you are compliant. I asked myself, if there is a company with promoter shareholding that 77%, lenders invoke the pledge and sell 5%, the promoters stake has come down to 72%. I want to see SEBI issue a Show Cause Notice to say, you are not compliant although you are at 72% because you came down to 75% in a route other than those three routes.
Doshi: I don’t think they are trying to be unreasonable..
Sundaresan: Exactly, so if they can’t act in that case they shouldn’t be able to act in any case where someone comes to below 75% in a legitimate manner. The Chairman used the word we are open to looking at any legitimate manner. A legitimate manner is, I own a property; I have a right to sell that property that is legitimate
Doshi: So I am not going to get a list from you.
Sundaresean: I don’t think you need a list.
Doshi: So if these additional routes are put on the table, are we likely to see higher compliance by those 200-250 companies that have yet to meet that 25% norm?
Sharma: I wouldn’t say a clear yes. If, as Chairman himself mentioned, if somebody wants to really comply with the regulations, most of the companies will be able to comply with these three guidelines. I think the point is on a case to case basis, if Sundaresan’s suggestion of blanket is not acceptable- which I think has its own merits- on a case-to-case basis, there should be allowance that if it is legitimate, if it is sold out to investors. Whether 2 or 5, I don’t think that number should be what people should look at but what type of investor the share has gone t.
Lahoty: I think discussing that point about someone just being just slightly higher than 75%, I think we probably need to be more sympathetic towards that promoter. Maybe doing and OFS, maybe doing an IPP, maybe doing an FPO is really not for him (CHK if he is saving really not for him).
Doshi: So sell on the secondary market is what you are saying?
Lahoty: That is right.