India’s new securities rules may trigger a boom in share offerings, but have sparked fears over the liquidity of the market. They have also prompted mixed reactions from listed companies and their legal advisers
George W Russell reports
It’s being called India’s version of the Big Bang. On the evening of Friday 4 June, after equity markets had closed, the government announced that amendments to the Securities Contracts (Regulation) Rules, 1957, will require all listed companies to have at least 25% public shareholding.
India Inc was taken by surprise and within hours furious lobbying had begun.
Under the new rules, any company listing its securities on an Indian stock exchange will be required to have a public float of at least 25%. Listed companies with a public float of less than 25% must raise their public shareholding by a minimum of 5% every year until it reaches 25%. “A dispersed shareholding structure is essential for the sustenance of a continuous market for listed securities to provide liquidity to investors and to discover fair prices,” the Finance Ministry said in a statement announcing the change.
Rationale for change
Before 1993, section 19(2)(b) of the Securities Contracts Rules required a minimum public offer of 60% of the issued capital of a company in order to be listed on a recognized stock exchange. However, the central government could waive or relax the strict enforcement of this requirement. The level was set at 25% from 1993 to encourage the listing of a large number of companies to broaden the market, but again the government could waive or relax the rule.
In 2001 the Securities and Exchange Board of India (SEBI) directed stock exchanges to amend clause 40A of the Equity Listing Agreement to provide that companies must maintain, on a continuous basis, a minimum level of non-promoter holding no lower than at the time of listing.
However, the first inkling that implementation of more substantial rules was imminent was Finance Minister Pranab Mukherjee’s budget speech in February. The announcement of the amendments to the rules on 4 June followed consultation with SEBI.
The rule changes are seen as part of the government’s bid to improve corporate governance and transparency in listed companies. “The effort of the government is to see the listed companies having a wider investor base,” says Jagannadham Thunuguntla, head of equities at SMC Capitals in Mumbai. “This is to ensure that the corporate governance and decision-making in companies will be more broad-based and that the decision-making won’t remain entirely in the hands of the promoters.”
The authorities would also like to see more public participation in the markets. Thunuguntla points out that this year an average of 20 million mobile phone accounts have been added each month, but only an average of 200,000 investment banking accounts. Only about 17 million of India’s 1.1 billion-plus population own shares. “The main obstacle is tapping the investor,” says Lalit Bhasin, managing partner of Bhasin & Co in Delhi.
In addition, disinvestment is a major economic plank of the Manmohan Singh government. Delhi wants to raise Rs400 billion (US$8.6 billion) in the year ending 31 March 2011 by selling shares in public-sector undertakings (PSUs, or state-owned enterprises). In January the government said that selling shares in 60 companies would shrink its budget deficit.
“There are 79 listed PSUs,” says Deven Choksey, managing director of Kisan Ratilal Choksey Shares and Securities in Mumbai. “The government would collect about US$26 billion at current market prices if it divested its stake by 25% in these companies. This should help them reduce the deficit to 4.76% in 2011 and 3.8% in 2012.”
Benefits of a new threshold
However, public shareholdings have had a troubled history in India. The average public float in Indian listed companies is less than 15%. “This needs to be increased for a larger and diversified public participation,” says Manish Desai, the founding partner of Vidhii Partners in Mumbai. “The problem of over-pricing of public issues is also being addressed by way of increased public exposure.”
The 25% threshold will also integrate the Indian markets better with their global counterparts. “This move was overdue in comparison to the economically developed nations,” says Khyati Trivedi, an associate at Advani & Co in Mumbai. “The London Stock Exchange requires 25% minimum public holding, the Singapore and Hong Kong Stock Exchanges also stipulate public shareholding between 12% and 25% respectively.”
Cyril Shroff, managing partner of Amarchand Mangaldas in Mumbai, says the new rules are in keeping with global best practices. “Furthermore, under Indian company law, a greater than 75% voting threshold is required to approve special resolutions, which are a pre-condition to a number of major corporate actions such as mergers, buybacks and delisting. Ensuring that the shareholding of the promoters is not more than 75% would enable public shareholders to influence the working of the company in an effective way.”
Markets generally welcomed the change. “We believe this a positive move as it is in line with the best practices followed in the developed economies,” says Tarun Bhatia, director of capital markets at Crisil Research in Mumbai. “Further, the move will result in stocks being fairly priced with adequate liquidity, which is always good for the average investor.”
Srinivas Parthasarathy, a partner at Trilegal in Mumbai, believes the new rules, if they are actually enforced, will create greater liquidity in the stock markets, which will particularly benefit small investors. He suggests it will also check price manipulation. “The larger the number of shares and shareholders, the less is the scope for price manipulation,” he says.
Lawyers outside India are also upbeat about the changes. “While it appears the main reason for increased public shareholding is to increase liquidity, it will also make Indian markets attractive to foreign funds that allocate investible amount based on public float,” says Sakate Khaitan, a partner with ALMT Legal in London.
In search of clarity
But within hours of the 4 June announcement, market makers, especially public sector companies, sought clarity on the details of the rules’ implementation. Less than a week later, the government was on the defensive. “The Finance Ministry and disinvestment department are receiving representations or points of view from public-sector enterprises,” Finance Secretary Ashok Chawla told reporters in Delhi on 9 June. “If there is any need for modification, or correction, or amendment, or maybe an amplification, any of these could be done.’’
Indeed, some lawyers wonder if the pattern of exemption, waivers and non-compliance will simply be continued under the new regulations. “Given the previous track record on this issue, we would not be surprised if the norms are soon diluted and/or non-compliance for some years is condoned,” says H Jayesh, founder partner of Juris Corp in Mumbai.
At least 179 listed companies will be affected by the new rules, according to data from Crisil Research, a unit of the Mumbai-based Credit Rating and Information Services of India. “There are principally two mechanisms in which the companies are going to endeavour to meet this requirement,” says Yashojit Mitra, an associate partner with Economic Laws Practice in Mumbai. “[Companies will either] transfer shares from the promoters to the general public, or issue new shares and hence bring in liquidity and therefore dilute the promoter’s stake.”
Crisil Research says these companies could raise Rs1.6 trillion (about US$34.8 billion) if promoters sell existing shares and Rs2.1 trillion if the companies issue fresh shares. Some estimates put the figure at US$53 billion, which would account for more than the total amount that Indian companies have raised from equity issues in the past decade, according to Prithvi Haldea, of Prime Database, a Delhi market data supplier.
Lawyers see the secondary market as the preferred option for most companies. “Since the primary market issuance of securities involves a higher level of regulatory compliances, it is likely that many of the companies would prefer secondary market issuances,” says Himanshu Sinha, a partner at Associated Law Advisers in Delhi.
“It would be a tough task for Indian companies to meet the prescribed targets,” says Rajesh Begur, founding and managing partner of ARA Law in Mumbai. “The biggest challenge that the Indian companies are likely to face is the lack of depth of the Indian markets to absorb the stream of securities offerings.”
Liquidity could be a major issue. Dilip Kumar Niranjan, a partner at Singh & Associates in Delhi, warns that “the [level of] investment could put pressure on available liquidity at a time when the Reserve Bank of India is already grappling with high inflation.”
However, others expect the 5% a year target to ease the liquidity problem. “While there is concern in some quarters that the Indian markets might not have the capacity to absorb such a large volume of paper in a short period, it should be kept in mind that compliance is staggered, and companies are obligated to divest only 5% per year,” says Rajiv Luthra, managing partner of Luthra & Luthra in Delhi.
The new regulations are, in theory, backed up with enforcement provisions. Failure to comply could result in delisting and a fine of up to Rs10 million. In most cases, though, such punishments are unlikely. “We expect that most blue-chip listed companies will meet this target without action being taken against them by the government,” says Priyanka Dwadash-Shreni, an associate at Pasrich & Company in Delhi.
Indeed, some private companies expect the new limits will be fairly easily achieved in principle. Global information technology services firm Wipro is 79.52% owned by its chairman, Azim Premji – a frequent public champion of improved corporate governance and transparency. A sale of the excess 4.52% shareholding could net Premji about US$870 million at current prices. However, Wipro has no need for cash. “The surplus proceeds of cash so raised might not at all times be put to productive use,” says Preeti Mehta, senior partner at Kanga & Co in Mumbai. “This might lead to large cash resources lying idle over a period of time.”
A tougher test case will be Hindustan Copper, which is now 99.59% government owned. A proposed follow-on public offer (FPO) representing 185 million shares, or 20% of its current equity capital, received a cool response from banks and has been postponed several times. “PSU divestments have received lukewarm retail response,” observes Praveen Singh, a senior associate at FoxMandal Little in Delhi. “Another concern is
that such offers may ‘crowd out’ genuine issuers and absorb liquidity otherwise meant for the secondary markets.”
The government is already planning exemptions for major PSUs. Disinvestment Secretary Sumit Bose said that Indian Oil Corporation, India’s largest public enterprise and one in which the public holding is less than 25%, would not be affected by the new rules.
The pressure to reach and maintain the 25% listing could be a difficult task for companies to implement amid the current market volatility. “Small- and mid-cap companies could opt for delisting if they do not intend to dilute their equity, especially those that are relatively new,” says Suparna Sachar, a partner at OP Khaitan & Co in Delhi.
The rules are also likely to clash with other legislation. “Specific instances where obstacles will be faced are (a) by promoters of companies which have pledged their shares; and (b) sectors in which FDI is restricted, for example the insurance companies [FDI capped at 26%],” says Rabindra Jhunjhunwala, a partner at Khaitan & Co in Mumbai. “Unless the government allows an increase in overseas ownership limits, compliance will be difficult.”
There is no clear understanding of the effect the new rules will have on multinational corporations listed in India with a public shareholding of less than 25%. Some of the prominent companies that would be affected include the Indian units of Alfa Laval, AstraZeneca, Atlas Copco, BOC, Gillette and 3M. “This guideline may force them to delist,” says Thunuguntla. This could lead to an exodus of foreign companies from Indian exchanges, and many may follow in the path of Cadbury India, Reckitt Benckiser and Wartsila which have already bought out minority shareholders.
Whatever the result, analysts caution that the market should be braced for more changes. “If the government chooses either tactical or practical retreat from this guideline, it would be welcomed by the Indian capital markets, which are waiting with bated breath to see what’s in store,” says Thunuguntla. “Otherwise, we should get ready for about 184 public issues this year.”
Busy days ahead for lawyers
That could mean a capital markets boom for law firms. Ashish Ahuja, a partner at Wadia Ghandy & Co in Mumbai, says his firm is ramping up its capital markets team as a response and expects other firms are doing the same. “It is definitely going to be a lot of work for law firms,” he says.
Other firms agree. “We anticipate an increase in workflow for law firms with the relevant expertise as a result of the new regulation,” says Jyoti Sagar, founder partner of J Sagar Associates in Gurgaon. “We do expect that our colleagues in the capital markets and securities laws practice will be busier with clients who are faced with this regulatory requirement.”
The increase in legal work may be more than just a short-term phenomenon. “If companies undertake issues in a phased manner, law firms will have long-term engagements for the successful completion of the promoter dilution within the specified timelines,” notes Akil Hirani, managing partner of Majmudar & Co in Mumbai. “Also, the rush of public issues may render growth opportunities to small and medium-sized firms in the capital markets segment.”
International law firms are also taking an interest. Last year Allen & Overy moved Parthasarathy from its Singapore office to Trilegal, its Indian affiliate, to expressly build the firm’s Indian capital markets practice. “Law firms, especially those with a capital markets practice, are expected to get busier advising clients on compliance with the revised public shareholding norms and by acting on the expected new FPOs,” he says.
Legal fees may see an upswing, especially since the number of law firms possessing the expertise to handle such assignments is limited. “However, since Indian law firms are not permitted to charge fees based on a percentage of the deal size, the number of the issues will be pertinent,” notes Rupinder Singh Suri, a senior advocate with Suri & Company in Delhi. “Share issuance values will not have an impact.”
Other lawyers are more cautious about its likely effects. “The pressures on pricing that these offerings will face are likely to drive down pricing further for legal services which already often operate on wafer-thin margins,” says Vijay Sambamurthi founding partner of Lexygen in Bangalore.
Moreover, Indian law firms usually play second fiddle to merchant bankers, chartered accountants, cost accountants and company secretaries when it comes to share issues. “Law firms play a marginal role,” says Uttam Hathi, a partner at Brus Chambers in Mumbai. “The marginality of a lawyer’s role can be seen from the attitude of the Ministry of Corporate Affairs,” he adds. “I practise corporate commercial law, yet I cannot do a simple thing as incorporate a company for my client.”
What is certain is that given the lobbying after the Friday evening shock, the final form of the rules is yet to be announced. “Perhaps there may be more relaxation given to companies that are currently listed and not to companies that are seeking to list,” muses Juhi Singh of S&R Associates in Delhi. “It is uncertain right now whether any changes will be made.”