The double-edged MCX-SX warrants

Convertible warrants to meet shareholding norms seemed a great idea; but, these left Shah and others vulnerable, if other shareholders turned hostile

Jignesh Shah and his cherished dream of running an equity exchange in the country have been parted, at least for now. This week, he had to step down from the board of MCX Stock Exchange (MCX-SX), the bourse for which he and his men picked many a fight with regulators and rivals.

Whenever people on Dalal Street were asked how the new exchange would pull it off, one heard “Jignesh will manage.” Will the fledgling bourse be of any relevance without the man? Why did he give it up so easily? Can he wrest it back? Why could he not manage it this time?

The resignation followed an extraordinary general meeting convened following the directions of the market regulator, Securities and Exchange Board of India (Sebi). It asked the shareholders to decide on the constitution of the board, eligibility of key personnel, etc. It did not expressly spell out what these steps had to be.

It is obvious that Shah’s writ did not run at the EGM. There were no creative interpretations of the regulatory directives this time, nor any out-of–the-box solution.

In the takeover of the Satyam Computer board, the central government had to move the Company Law Board for permission to appoint directors under Section 408 of the Companies Act. The exit of Shah and his long term associate and chief executive officer, Joseph Massey, has been much smoother. It seems this was a shareholders’ move, with banks and other institutions acting in concert to push him over.

How was this possible? Did Shah not have enough control? Did he not have enough votes to block the move?

The questions take us three years back in time. In the summer of 2010, Shah and his disciples came up with an out-of-the-box solution to counter Sebi’s decision to set compliance with shareholding norms as a pre-condition for getting a licence to trade in equities. According to the norms, shareholders other than certain widely held institutions cannot hold more than five per cent stake in an exchange. At that point, the MCX-SX promoters, Financial Technologies (FTIL) and Multi-commodity Exchange (MCX), held a little over 70 per cent, with banks and institutions holding the rest. The promoters devised a share reduction plan to bring down the voting rights to 10 per cent. But they would hold warrants amounting to some 60 per cent of the undiluted capital.

According to its high court filing, the exchange issued 617.1 million warrants to MCX and 562.5 million warrants to FTIL. The plan was that the promoters would gradually sell the warrants when the markets were conducive and valuations are agreeable. When the warrants were converted into equity shares by outside shareholders, the company’s equity base would expand and the promoter’s stake fall below the five per cent limit, depending on the extent of conversion. The promoters could then convert warrants still in their possession into shares to keep their stake at five per cent. Banks and institutions which had 30 per cent stake before the restructure now had 88 per cent voting rights.

Shah’s bet was that these institutions, largely public sector lenders such as Punjab National Bank and entities such as IFCI, would not interfere in the daily management of the exchange. With friends in Delhi’s North Block ministry headquarters, it was almost a given.

The warrant plan seemed audacious when it first came to light. When Shah’s legal eagles managed to win favourable court orders, many thought it was brilliant. Shah could have the cake and eat it, too. Or, so it appeared for a while.

Shah’s strategists did not foresee an event where the institutional shareholders would turn active and throw him out. Even if they saw it, they put the probability as remote. What an incredible few weeks these have been!

MCX-SX had, in its annual report for the year ended March 2013, put in the following footnote under the head ‘Share capital’: “A total of 1,19,66,30,000 transferable warrants issued under the scheme of reduction-cum-arrangement which was sanctioned by the Hon’ble High Court of Bombay are presently held by two shareholders. The said warrants are to be disposed off within a period of three years from the date of notification of SECC Regulations i.e. by June 20, 2015.”

FTIL and MCX could still sell those warrants and salvage some cash. But, are there any buyers?