Pledging shares against debt is a sure recipe for disaster, especially in a falling market. Around 31% companies out of 1,214 listed ones have actually pledged shares of more than 50% of their paid-up capital

In the backdrop of inadequate disclosure levels on share pledging, investment in such companies exposes an investor to severe price volatility, in case a promoter is not able to meet payments, or provide additional collaterals in a falling market, said a research agency. According to a report by Crisil Research, promoters of 31% of the 1,214 listed companies and with a market capitalisation of Rs100 crore or more, have pledged substantial portion of their shareholding. The total pledge works out to Rs1.1 lakh crore worth of market capitalisation as on 18 November 2011.

Promoters have pledged substantial portion of the shares in several popular companies. Such companies include Gujarat Pipavav (in which promoters have 100% of their holding), Tata Coffee (100%), Ansal Properties (97.74%), Koutons (97.03%), GTL (96.38%), Dunlop (91.89%), Kingfisher (90.93%), Gati (89.83%), United Spirits (89.64%), Gujarat NRE Coke (88.35%), JSL Stainless (87.69%), Spice Jet (86.16%), Essar Oil (83.99%), Bilcare (83.05%), S Kumars (83.03%), Omaxe (81.61%), Era Infra (80.9%), Orchid Chemicals (77.14%), McDowell Holdings (74.14%), Parsvanath (71.24%), KS Oils (70.28%) and Suzlon Energy (69.41%).

“In 2011, the capital markets have been highly volatile due to looming concerns of high domestic inflation, rising interest rates and tepid global economic environment. These concerns have triggered a fall in stock prices, creating pressure on the promoters who have pledged shares to make good the loss in the value of the collateral. Investors, especially retail investors, are generally oblivious of such details, and eventually incur losses because of sharp fall in prices,” said Mukesh Agarwal, senior director, Crisil Research.

The equity markets have been under phenomenal pressure. Stocks across the board have been shivering under selling pressure amidst of gloomy market scenario. While the markets are under pressure, the companies in which the promoters have pledged substantial portion of their shares will come under tremendous pressure, as there is a risk of margins calls getting triggered from the lenders.

Jagannadham Thunuguntla, strategist and head of research at SMC Global Securities said, “Leverage is like fire. If you know how to handle it, you can cook food. If you do not know how to handle, you can burn your fingers. The promoters of mid-cap and small-cap companies will need to find the solution to this problem very quickly, before things move out of hand.”

While the motive for pledging shares is very difficult to ascertain, promoters of larger corporates may able to withstand the margin pressures associated with pledged shares. Tarun Bhatia, director, Capital Markets, said, “Other than the Securities and Exchange Board of India’s (SEBI) current guideline, which require companies to disclose percentage of promoter holdings pledged, there are no regulations that make it mandatory for promoters to disclose other crucial details like purpose of funds raised through pledging of shares, price at which the initial pledging is made and the conditions under which the margin call will be triggered.”

Crisil Research said it believes that the critical information on promoter share pledging other than the percentage holding should be made available on a quarterly basis to provide greater transparency and information to investors. “The information provided should include purpose of fund raising, amount of funds raised through shares pledged, entity with which the shares are pledged, stock prices and the conditions when the margin calls will be triggered,” added Mr Bhatia.

The concept of pledging of shares by promoters is not new to India but it caught the attention of regulators and investors only after the Satyam debacle (now, Mahindra Satyam). Promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution. Non-banking financial companies (NBFCs) are more active than banks in providing such loans.

In developed countries like the US, not just promoters but directors too are required to disclose their pledged shares. In UK, this is covered under insider trading regulation. But in India, until recently when SEBI made it compulsory for promoters to disclose their pledged shares, there were no disclosure norms. However, post-Satyam debacle, SEBI in January 2009 made it mandatory for promoters and promoter groups to disclose the details of pledging of shares of their listed entities. Under this guideline, apart from disclosing whenever shares are pledged, promoters are also expected to disclose it periodically. Respective stock exchanges are to be informed about the details of share pledging.

In today’s market conditions, with the Sensex slipping, promoters do not have the cash to meet margin calls. When the pledged shares are sold in a weak market, the share price falls further. Apart from this, promoters always have the risk of a hostile takeover.

Crisil Research’s analysis also reveals that of the listed companies, which have reported pledging, in 183 companies, 25% or more of promoter holding is pledged; this includes 107 companies with 50%+ of promoter’s holding being pledged. In as many as 14 companies, promoters have pledged 90%+ plus of their holding, thereby exposing the companies to the risk of losing promoter control and also higher share price volatility if the prices fall from their current levels. Sector-wise, power generation, IT and ITeS, infrastructure, and pharma and healthcare companies have seen higher levels of pledging.