35% Minimum Public Shareholding: Dear SEBI, Please Tread Carefully
Dilution routes, timelines, incentives - the ball is now in SEBI’s court to achieve 35% MPS without large-scale disruption.
This is the third in a series of columns on the fundamental considerations for the Budget proposal to increase minimum public shareholding in listed companies from 25 to 35 percent.
The ball is now in SEBI’s court to come up with the right framework for the effective implementation of the increased minimum public shareholding norm of 35 percent, as proposed in Budget 2019. It will need to consider interests of various stakeholders, keeping in view policy goals sought to be achieved, reality check of the market appetite (such as potential absorption of stock valued in excess of Rs 3 lakh crore) as well as collateral impact assessment, including on “ease of doing business” and comparison against global minimum public shareholding norms.
With increasingly sophisticated markets and the pressures of the spiralling economy, the ‘one size fits all’ approach would not work if the underlying aim is to make this MPS revision drive maximum impact.
Therefore, the regulator may need to consider a course alteration for ‘round two’ as compared to the norms that applied to ‘round one’ (i.e. the MPS requirement of 25 percent mandated in 2010 and effective from 2013).
Who Goes First
With more than 1,100 companies having less than 35 percent public shareholding, instead of having a blanket requirement of all listed companies having to comply with the 35 percent MPS norm, the regulator may consider providing for a ‘reasonable classification’ based on certain thresholds/criteria for applicability. Such classification may be based on market capitalisation, passage of time since the IPO/change of control, frequent/infrequent trading of shares, or other relevant considerations (including a combination of these). Most intuitive of these will be the market capitalisation-based classification – in this context it may be interesting to note that the top 10 non-PSU companies that have promoter holding in excess of 65 percent, alone constitute approximately one third of the total expected dilution value (i.e. more than Rs 1 lakh crore).
Timelines
Another important consideration for SEBI would be the time-period for compliance – both for already listed companies as well as those going for listing. There is bound to be a dilution overhang on the stock in case of a time-bound prescription. In round one, several companies subject to MPS-related dilution, experienced high price volatility in their stocks, and multiple attempts for MPS compliance also led to lowering of stock price (including by way of reduction of floor price in offer for sales due to inadequate demand) for a few.
While SEBI provided a three year time period in round one for compliance, it must re-consider the timeframe for compliance with 35 percent minimum public shareholding norm based on past experience and impact on the stock market.
With regard to companies proposing to list, currently, companies with post-issue capital of less than or equal to Rs 1,600 crore are required to undertake an initial public offering of 25 percent, companies with post-issue capital of more than Rs 1,600 crore and less than Rs 4,000 crore are required to undertake an IPO of at least Rs 400 crore, whereas companies with post issue capital of Rs 4,000 crore or more are required to undertake an IPO of only 10 percent.
These thresholds and time periods for compliance may be re-considered by SEBI in context of incentives/ disincentives for companies to list, especially if it continues to have a category of companies that will need 35 percent public float from day one of listing.
Dilution Methods
So far, SEBI has mandated companies to undertake dilution for minimum public shareholding compliance through specified methods only. These are primarily split into two categories:
- company action - which are issuance of shares by way of a follow-on offer (FPO), institutional placement program (IPP), qualified institutional placement (QIP), and rights or bonus issue to only the public shareholders)
- or promoter action - which are offer for sale (OFS) by promoters through prospectus or secondary market, and sale of up to 2 percent shares by promoters in open market)
SEBI also has residual powers to allow other methods of dilution on a fact specific basis, upon an application being made. Given the size and impact of the 35 percent proposed MPS requirement, SEBI may consider allowing certain other methods for MPS compliance, such as preferential allotment, subject to requisite thresholds and conditionalities.
It may also consider tweaks to the existing methods, to provide flexibility and sufficient mechanisms to companies and promoters to comply with this requirement.
For instance, to increase viability of further public offerings through offer for sale by promoters, SEBI may consider providing exemption from the one-year prior holding requirement. This will help in instances where the promoter may have acquired shares recently, say via a restructuring. Also, under the open market sale route, the 2 percent threshold may be revised to a higher threshold on a pro-rata basis, given the proposed increase in MPS threshold.
In order to encourage the market to come up with more effective methods of dilution, SEBI may also consider exercising its residual powers more proactively to allow, on a case by case basis, methods formulated by companies/ promoters.
The regulator also needs to address the limitations on use of funds raised in a public issue (such as 25 percent ceiling on use for general corporate purpose and parking of funds during the interim period). In case of change in use of funds, shareholder approval requirements coupled with exit offer by promoters to dissenting shareholders, needs to be relooked at in this context.
Given that the capital raising to meet MPS requirement may in some instances be a “forced capital raise” and not a business requirement, SEBI and the Ministry of Corporate Affairs may consider providing flexibility on these regulatory requirements.
This will allow the regulator to be lenient with companies and promoters who are not able to meet the MPS requirement due to genuine concerns or reasons outside their control.
Attract Foreign Investors
Foreign portfolio investment in India’s equity markets has fallen from an inflow of Rs 51,252 crore in 2017 to an outflow of Rs 33,014 crore in 2018. So far this year, the inflow totals Rs 67,923 crore, according to NSDL data. But July has not been an encouraging month, with an outflow of over 10,000 crore rupees, mostly on account of a new tax imposition in Budget 2019.
For minimum public shareholding norms to be met by companies, it is important that a harmonised and hassle free investment experience is provided to investors, specifically FPIs.
It is for this reason that the Finance Minister in her Budget speech proposed to rationalise and streamline the existing Know Your Customer norms for FPIs to make them more investor friendly.
Also, to give impetus to FPI investments in companies, the Budget also proposes to increase the automatic statutory limit for FPI investment in a company from 24 percent (which can currently be increased with approval of shareholders by special majority) to the sectoral foreign investment limit, with an option available with the concerned company to provide a lower threshold.
The government may also consider relaxing sectoral foreign investment caps and conditions further. For instance, banking and insurance are sectors which constitute majority of companies, besides PSUs, in the top 20 MPS non-complaint list in BSE 500, and sectoral thresholds for these may be liberalised.
Implementation of these reforms along with the new MPS requirement is likely to facilitate an increase in foreign investment in companies looking to meet the MPS norms.
Tax Treatment
That said, some thought would also need to be spared by the government on the prevalent tax-related concerns. Due to the proposed increase in surcharge on ‘individuals’ in the income group of Rs 5 crore and above, the effective Long-Term Capital Gains tax and Short-Term Capital Gains tax would be 14.25 percent (from 12 percent) and 21.3 percent (from 18 percent), respectively.
Given their structure of association of persons/trusts, a majority of FPIs fall under this category. Pending clarity from the government, FPIs may not participate to the extent expected in the potential MPS related dilutions.
Accordingly, given the expected large scale impact and implications of the 35 percent MPS norm, it is critical that the government and regulators pay heed to various aspects, ranging from process to incentives, and concerns of all stakeholders, prior to effecting these new norms.
This will ensure that the structural and regulatory amendments achieve the broad objective sought to be achieved by bringing in this change - a deeper public equity market, widely-held shareholding structures and better governance. Or else, form may hurt the substance.
The first part in this series examined the costs of a 35 percent minimum public shareholding norm.
The second part in this series focused on the winners and losers that this process would create.
Cyril Shroff is the managing partner of Cyril Amarchand Mangaldas. Manita Doshi is a partner in Cyril Amarchand Mangaldas’ general corporate, mergers & acquisitions and governance practice.
The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.