35% Minimum Public Shareholding: Winners And Losers

This is the second 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.

Indian markets are at the cusp of an evolutionary curve – given the tightening of the governance framework, pro-active regulatory enforcements, increasing institutional ownership, and higher relevance and impact of proxy advisory firms, significant impetus has also been provided to ‘active ownership’ by public shareholders. The growth of digital and social media have helped as well. We may, therefore, be at the brink of seeing ‘market-led’ governance reforms after two decades of a regulatory push.

In this backdrop, a proposal to increase the minimum public shareholding threshold to 35 percent, depending on the terms, form and timelines for implementation, has the potential to turn this evolution into a revolution (borrowing from the SEBI committee report on corporate governance, issued under the chairmanship of Uday Kotak, that preferred to follow the approach of evolution than a revolution).

The impact will be felt across stakeholders, with potentially conflicting interests to be balanced and tradeoffs made.

The Antagonists

The key stakeholder in the process will be the ‘listed company’, which has the primary obligation to comply with the MPS requirement and may be subject to penalties in case of non-compliance. However, the boards of such companies may struggle with the singular option available to them - of issuing new shares, either at a price or as a bonus.

Both, a capital raise (at a price) or reserve depletion (bonus) will have a significant impact on the company’s strategic and commercial objectives. That the decision has to be made simply to comply with a mandated dilution, may not be in its best interests. There’s also the dilution overhang on the prevailing stock price.

Another equally important and ‘invested’ stakeholder in this process will be the ‘promoters’, given the double whammy they could be subject to due to non-compliance. As the majority/largest shareholder they bear the biggest brunt of monetary penalties imposed on the company. They may also face a freeze on shareholding, restrictions on new directorships and restraints on dealing in shares of the company.

Ironically, compliance itself may come at varied costs to the promoter – these could include economic loss linked to valuation/timing/structure/ terms of divestment and ‘dilution’ of control - such as reduced ability to swing special resolutions or ‘significant’ minority position in the stock due to increased public holding.

Given that the price discovery process for delistings is tilted in favour of public shareholders, (the discovered price is often rejected by promoters), it may not result in the exit of a large number of companies from the market, but it is bound to incentivise delisting attempts. These may result in considerable volatility in the market.

Such disinclination for the markets may be shared by promoters proposing to list their companies - they may reconsider their plans to go public. Especially smaller companies who may have to fulfill the 35 percent minimum public float condition from day one of listing. For instance, currently, companies with a post-issue capital of less than or equal to Rs 1,600 crore are required to undertake an IPO of 25 percent, whereas larger companies have more time to meet the threshold.

Another set of stakeholders who may find resonance with the promoter perspective and dissonance with the increased MPS requirement will be acquirers seeking controlling stakes in listed companies.

The current threshold requirement of making a mandatory tender offer of at least 26 percent for acquisition of control, even if such acquisition were to push the acquirer holding to above the MPS requirement thereby triggering the sell down obligation to reach minimum float threshold within a period of one year, can often make acquisitions cost-inefficient.

In such an instance, the acquirer is bound to prefer delisting, However, if the current delisting threshold of 90 percent is left unchanged the commercial challenges to successful delistings will stand compounded as the discovered price pursuant to the reverse book built process will need to paid for a minimum 25 percent stake as opposed to the current 15 percent to reach the minimum threshold of 90 percent. Such factors may have an impact on commercial viability of control deals involving listed companies.

While in an ideal economy, free-market forces would find a solution to such disconnects in valuations and costs, it needs to be considered whether the current economic environment, with the high number of stressed assets in the listed company space itself, will be able to afford such increase in costs of M&A and bridge the commercial disconnects without impinging on commercial viability.

The Cheerleaders

The markets and public shareholders will, of course, in the long term, benefit from better price discovery due to increased liquidity. This assumes markets absorbing the dilutions in a stable manner, resulting in true diversification in holdings. Further, in the short term, the dilution overhang may create opportunities for public shareholders to enter the markets at competitive valuations. The higher public float requirement is also expected to improve India’s score/weight in the MSCI indices, which could result in a boost to foreign investments.

This may also be an opportunity for the government and the regulators to practice “less government, more governance” by allowing markets to prompt governance reforms through active ownership and activism. The legal framework now provides multiple avenues for the shareholders to hold companies accountable. These range from e-voting to filing class-action suits.

Further, increased public holding may result in institutional shareholding increasing at a higher rate – this has been observed in the west, with Blackrock, Vanguard and State Street holding approximately 20 percent of the S&P 500 companies.

The government, being the initiator of the proposal, is the main cheerleader. That the proposal was introduced in the union budget speech suggests a tax purpose as well - of higher tax collections through long term capital gains tax that will be apply to the impending divestments. As a government official pointed out - the higher MPS requirement may also serve as a catalyst for more government divestment across public sector units.

SEBI will play a key role in coming up with the framework for achieving the new threshold. It does have the benefit of hindsight and may apply the experience from the past six years of enforcement actions to come up with a new framework that will allow for more value-accretive dilutions and diversely held markets.

In conclusion, the framework of implementation and enforcement of the higher public float requirement will be a key determinant for impact assessment across stakeholders. That said, this undoubtedly points to a greater political will for a more sophisticated and globally relevant capital market through increased foreign investment and higher governance standards.

Therefore, it’s a move which has its heart in the right place but will require nuanced understanding and appreciation of various interests and incentives/disincentives to ensure that there are no unintended consequences.

The first part in this series examined the costs of a 35 percent minimum public shareholding norm. In part three we will analyse the regulatory amendments that may be considered.

Cyril Shroff is the managing partner of Cyril Amarchand Mangaldas. Anchal Dhir is a partner in the Firm’s general corporate, M&A 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.