Focus on capital formation policy

The economic impact of the response to Covid-19 begins to hurt. This is when the securities market regulator has a fantastic opportunity to dust off the entire framework for capital raising and look at requirements that have outlived their purpose and improve the ease of raising capital without compromising the objective of investor protection.

Each of these labels is easy to agree on. It is in the detail of what constitutes inconvenience in capital raising and what constitutes leaving an investor vulnerable that policymakers can differ until the cows come home. For starters, the Securities and Exchange Board of India (Sebi) has indeed started on the right track with its latest initiatives on making rights issues easier and making fast-track issuances easier. The key is to keep the focus on the wider objective and spread the net wider to examine which provisions are now musty and rusted, deserving to be thrown out or to be polished.
 

This financial year (and perhaps the next) will entail multiple companies fighting to stay alive — to retire debt, to meet obligations to employees, and simply to stay liquid. The banking sector was in a crisis even before Covid-19 and it would not be easy to expect a lot of new money on the debt side. Bankers who lacked confidence to lend when Covid-19 was yet to strike are not suddenly going to be spurred on to lend to borrowers further hit by the crisis. The money then has to come from the equity markets — investors who think it makes sense to invest risk money into the company to keep it alive, would do so at an acceptable price.

Therefore, care must be taken to consider pricing restrictions for listed companies. There is no pricing regulation for new listings and rights issues, and the hurdle there really is the time taken to process an offer document and the disclosure of a lot of information. This is an apt time to read every line of disclosure requirements and bring them to a logical position of having to only disclose truly material information. Requirements to make disclosures about associates, group companies and promoter group of the issuer company provide fertile ground for sifting through every single piece of information to see if it is really relevant for an informed decision on subscribing to an issue.

Disclosures for a rights issue is truly a corollary to how effective the disclosure obligations are on companies that are already listed. If a company’s securities are already listed, the regulations governing ongoing disclosures of all material developments are considered adequate for an informed price discovery in the secondary market. If this were true, an existing listed company should not have to work too hard to write a disclosure document for a rights issue. Whether rights issues should need a heavy offer document at all is an existential question that is usually unattractive to think about. Truly, if every company’s annual report or an annual securities regulatory return were to contain prospectus-type information, there should be nothing new to write in an offer document for a rights issue except to explain the purposes for which the money is being raised.  

After this week’s reform, the threshold of fund-raising through a rights issue below which no offer document is required is a mere Rs 25 crore. It is time to take this to a bold level of, say, Rs 100 crore, with close scrutiny of the conduct of the company being done to ensure that while money is raised more easily, its deployment is true to the word.

The Sebi has made perfectly valid moves in making it easier for “fast track” rights issues to be conducted — lowering the market capitalisation requirement to Rs 100 crore (from Rs 250 crore) and reforming the ban on eligibility if proceedings were pending. This is a good start but the ideal goal should be to ensure that all rights issues by all listed companies can be “fast track” by rethinking how we approach rights offerings.

Price regulation comes in where there is a new issue of capital that is not issued as a matter of right to existing shareholders or to the general public but to specific pre-identified investors. The regulation of pricing of such “preferential” issuances by a listed company essentially entails a floor price to protect existing shareholders whose ownership percentage and interests get diluted by the incoming shareholder. The Sebi has floated a consultative paper to make it easier for stressed companies to raise new money through the issuance of equity and this needs to be worked on and taken to its logical end.

Likewise, when new money is brought in by existing institutional investors, any limits applicable to such investors must also be studied carefully. For example, an alternative investment fund has a requirement to ensure the absence of concentration in individual investments and exposure to one investment is capped at 25 per cent of the corpus. Forbearance in breaching that cap for say, a year, by a reasonable margin, would be a measure to think of.  

This financial year would need a policy focus on capital formation. It is vital to ensure that the clamour for suspending bankruptcy laws does not translate into reality. For the economy to remain viable, both entry and exit must be unhindered.

The author is an advocate and an independent counsel; Tweets @somasekharS