The new insider trading regulations could create some problems for promoters looking to pledge their shares to meet funding requirements.
The new norms on insider trading place restrictions on 'trading' in securities by any insider when in possession of unpublished price-sensitive information (UPSI). However, the regulations have been drafted in such a way that the definition of trading also includes 'dealing'. This would cover not only activities such as buying and selling, but also pledging of securities when in possession of price-sensitive information, which is not known to the public.
"Such a construction is intended to curb the activities based on unpublished price-sensitive information, which are strictly not buying, selling or subscribing, such as pledging, etc., when in possession of UPSI," said the Sebi guidelines on insider trading.
UPSI refers to any information, relating to a company or its securities, directly or indirectly, which is not publicly available and could have a material effect on the company scrips.
"The assumption seems to be that an insider may fake a pledge and a default on it to circumvent the prohibition on sale when in possession of inside information. But such abuse would be covered by Section 12A of the Sebi Act. On the other hand, prohibiting the provision of a pledge when in possession of inside information will hurt the lending market, and will inconvenience the majority for an extraneous fear of abuse that is in any case covered by law," said Somasekhar Sundaresan, who heads the securities law and financial sector regulatory practice at J Sagar Associates.
Promoters looking to pledge shares will also now have to disclose reasons for doing so under the new insider trading guidelines, which came into effect on May 15. Earlier, promoters were exempt from providing reasons for share-pledging, which most often is for the purpose of meeting any liquidity shortages.
Legal experts believe that such disclosure is unnecessary and could be counter-productive. "Pledging is used by promoters who need cash temporarily, simply for liquidity. Every time a pledge happens, does not mean the promoter is transferring his ownership. Disclosing the reason for such pledging...(may be)... unnecessary," said Ramesh K Vaidyanathan, founder and managing partner, Advaya Legal.
Typically, a promoter pledges shares to raise money from a lender or a private party for funding any liquidity needs. Such a pledge does not translate into a transfer in ownership of shares, unless the promoter defaults on the pledge. Pledging is a common method of fund-raising employed by promoters looking to bridge any short-term capital needs.
However, some lenders believe that the new norms would add greater transparency to the process. The new insider trading norms in conjecture with the Reserve Bank of India guidelines on loans against shares issued last year would help reduce the misuse of the share-pledge route.
"There is a need for transparency. Any lender would want to know for what purpose the loan is being used and any investor would want to know how much the promoter is backing his own company," said Balachandran M, senior vice-president in-charge of the NBFC and margin funding business at Geojit BNP Paribas Financial Services.
Experts worry that often promoters use the pledge route to exit their stake entirely by pledging all of their shares. Others misuse it to fraudulently shore-up additional shares, they said.
The new norms come into effect even as pledging has been on the rise. FY15 saw a 30 per cent rise in the value of pledged-shares by listed companies to Rs 1.94 lakh crore from Rs 1.52 lakh crore in the previous financial year.
About 43 per cent of promoter holding was used as security to raise capital in FY15 in companies with pledged shares. This is up from 42 per cent the year before, according to data from capital market-tracker Prime Database.
FOCUS ON 'INSIDER' PLEDGING
Sebi's new insider trading regime to have ramifications for pledged-share financing
The route has been used to raise capital worth Rs 1.94 lakh crore
The new norms place restrictions on such pledging by insiders
It also calls for disclosing reasons for pledging
- Experts say additional restrictions may hurt lending activities