The government and its regulators have talked incessantly over the last decade about rebuilding investor confidence and increasing retail market participation; but the grim reality is that Indian retail investors are being systematically pushed out of the market.
We are not talking about the growing trend of companies going private and delisting their shares from stock exchanges. There is an even more sinister industry lobby working hard to find ways to bypass stringent disclosure laws and regulatory permissions that are required to raise capital in India.
This is aimed at giving issuer companies several advantages. First, low floating stock in the Indian market allows the price to be kept artificially high. This, in turn, influences the traded price of international instruments such as Global Depository Receipts (GDRs) and American Depository Receipts (ADRs).
GDRs especially can be issued abroad with minimal disclosures to shareholders. At the same time, they enjoy two-way fungibility, which means that the converted shares are ultimately sold to domestic investors or mutual funds by way of a quick conversion to underlying equity. And local liquidity can be mopped up by a reverse conversion. If industrialists and investment bankers had their way, companies would list barely 1 or 2 per cent of their capital on Indian exchanges while the rest would be listed abroad. Domestic trading would then be mainly speculative day trading or derivative transactions that are based on inadequate information.
These are not irrational fears. The rules regarding minimum public holding of listed companies was drastically diluted by the BJP-led government, which also permitted industrialists to increase their stake through creeping acquisition of shares or by reducing company capital through share buybacks.
The mandatory public holding requirement was as high as 60 per cent when listing rules were framed; it was then dropped to 40 per cent and later to 25 per cent in the last two decades. Under Sebi Chairman D.R. Mehta, it was diluted to a mere 10 per cent to benefit promoters of Information Technology companies during the dotcom mania and then extended to all large-cap companies.
Finally, when investor complaints began to mount, then Finance Minister Jaswant Singh assured the Rajya Sabha in December 2002 that ‘‘companies would be asked to offer a minimum 25 per cent of their capital to the public at the time of listing.’’ He also agreed with MPs who said a 10 per cent public offer requirement was far too low.
At that time, we wrote ‘‘the FM’s assurance to Parliament presents Sebi with a fait accompli and will force it to amend several of its regulations.’’ It wasn’t true. Three years later, the assurance remains unfulfilled. Instead, a string of media reports since January this year say Sebi will enforce continuous listing rules very strictly to ensure a minimum public holding of 25 per cent within a stipulated timeframe (or 10 per cent as is applicable).
Until then, Sebi has introduced some restriction on creeping acquisitions by promoters who already hold 55 per cent equity in a company.
Meanwhile, there has been a more dangerous development. The Videocon group has had some disagreement over the listing of some of its follow-on issues at the National Stock Exchange (NSE) and has approached the Securities Appellate Tribunal (SAT) against the bourse’s decision. Sebi is also a respondent in the case. For the purpose of this piece, we will focus only on one aspect of the issue and that is Videocon’s contention that its GDRs should also be included in the 25 per cent ‘public holding’ requirement under current capital market regulations.
Videocon is probably hoping that SAT can be made to decide a policy issue that has serious and wide-ranging repercussions for Indian investors. In the past, investment bankers have made the same argument as Videocon. In May 2003, this column wrote, ‘‘Investment bankers argue that if equity listed overseas (ADRs and GDRs) is now fungible with domestic equity, then the 10 per cent public offer should include the overseas offering. This means that if an unlisted company goes public for the first time by listing 8 per cent of its equity overseas, then it should be allowed to get listed on an Indian stock exchange with a mere 2 per cent offering. Such a move will only export the Indian IPO market abroad, and Sebi has wisely ignored this demand.’’
Later, investment bankers lobbied hard to achieve the same results by proposing a simultaneous issues in India and overseas, with the condition that the unsubscribed portion of one segment can be transferred to another. This was also shot down mainly because investor activists voiced the fear that it would be used to dilute the domestic listing requirement by manipulating public offers.
The difference this time is that Videocon has challenged the NSE’s refusal to accept GDRs under the public holding criteria and taken the matter to the appellate tribunal. A verdict in its favour would also weaken Indian bourses considerably. Already, FII studies say foreigners apparently control 75 per cent of the free-float in the domestic market. Two-way fungibility of GDRs/ADRs already gives foreign investors an unfair advantage and there are several anecdotal reports about how top industrialists control large chunks of capital in their companies through benami GDR holdings, that can be converted at will to underlying Indian equity.
If the listing rules are changed to include GDRs and ADRs under the free float requirement, the fungibility of these instruments will give foreigners full control over domestic liquidity. This is completely unfair to domestic investors because, in the absence of capital account convertibility, they will not have the same freedom to invest in overseas stock and commodity markets. Clearly, any change in the understanding of what constitutes the 25 per cent listing rules involves fundamental policy issues with wide ranging implications. Such change has to be debated and can only be decided by the government and the capital market regulator. It is not an issue of interpretation of the rules that can be decided by an appellate tribunal.