New encumbrance norms - Short term pain for long term gain

In June earlier this year, SEBI made an amendment to its substantial acquisition of shares and takeovers regulations act that tweaked the definition of encumbrance (read as a mortgage or other claim on property or assets) of shares by promoters to include indirect pledge on shares. It also required promoters to disclose the reason for creation of lien on their shares in a company to the stock exchanges if such encumbered shares exceeded 50% of their holding in the company or 20% of the company's share capital. This was made effective from 1st October, 2019 and required all promoters to disclose within two working days any existing indirect encumbrance on their shares.

Result in the first 15 days due to disclosure and subsequent action have been mind boggling, caused panic selling in many stock counters and much to the chagrin of many investors and portfolio managers.

First, Disclosure by promoters of Zee Entertainment Ltd. showed that they effectively only ~2.2% despite have 22% stake in the company as a disclosure by VTB Capital Plc showed it had lien on 10.7% promoters stake in the company as part of collateral for a loan taken in September 2017. There are media reports that VTB now wants to sell the stake which is causing jitters among the lenders of Zee including some prominent MFs.

Promoters of Torrent Pharmaceuticals disclosed that lenders have lien on 26% of their stake in the company, which was undisclosed to investors. However, this was quickly clarified that the company's lenders do not have a charge on the equity and have lien merely to ensure that promoter stake in the company does not fall below 26%. The panic in this case was contained as market quickly realized "non-stress" financial position of the company.

Promoters of JSW group companies - JSW steel Ltd. and JSW energy have repaid debt worth 1200 crore to release the pledged shares worth 2500 crore which is 2.9% of paid-up capital of JSW Steel and 7.2% of JSW Energy. This is in addition to the 1150 crore pledge released last month to manage debt.

Bajaj Consumer sold 22% stake worth 700 crore yesterday to pay the bank and remove the pledge on stakes from the banks. With this transaction, the promoters’ stake will fall to 38 per cent and their pledged stake will come down to zero from 63 per cent. Plans for Bajaj Energy IPO next year has added to the haste in selling the stake by promoters.

For minority shareholders, this comes with a double edge sword - the promoters who were keeping this in dark on how much of their stake was "under control" of someone else now stands exposed. On the other hand, it substantially reduces information arbitrage for investors and managing risk will be easier in future. But in the interim, there will be short term pain for many of the debt-ridden names. Regulator intervention has ensured that the extremely complex web of corporate structure need to be entangled to make life easy for investors. Now investment strategy need to be aligned to avoid such names or keep allocation not more than 5% of the total portfolio. These are extraordinary times and the clean up would ensure we have a market which is stronger and ready to take off in few months.

The author may have positions in the stocks as mentioned in the article above, please assume us to be biased. This is not a recommendation to buy or sell securities. This is purely information about the company mentioned.  Equity investing contain risks and please consult your financial adviser for any buy and sell securities!


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