Pledging shares by promoters increases risks

Last  year, shares of Bhushan Steel took a beating after its lenders invoked nearly 14 million pledged shares held by the company's promoters.

Pledging of shares by promoters can be a cause for concern especially when the market is going through uncertain times. 

According to a report from Prime Database, the value of pledged shares moved up to Rs 1.94 lakh-crore in 2014-15 against Rs 1.52 lakh-crore the previous financial year. Companies such as Cairn India alone (Rs 15,801 crore), Adani Enterprises (Rs 8,000 crore) and Tata Consultancy (Rs 7,300 crore) were among the ones with a high value of shares pledged. 

Share pledging is typically done by promoters to raise funds, either in the same company or for financing other projects.

According to investment analyst Arvind Kejriwal, if the promoters have pledged shares as a collateral to enhance the borrowing limit for business needs, then it can be a positive. For example, if a telecom company needs cash to make an upfront payment to buy spectrum and the promoters pledge shares, investors can ignore the pledging to some extent, he said. 

He added that investors should get worried if the number of pledged share rises significantly or if the pledging is done to fund the promoter’s personal needs, including buying property or the company’s shares. The rising markets may also prompt promoters to pledge shares. “Pledging can be an indirect way to cash out without sending the wrong signals to the market. The rising market can be a good time for promoters to get more money for their shares,” he said. 

If the pledging has been done with a non-banking financing company (NBFC), a correction in stock prices could immediately trigger margin calls which in turn could mean pledging more shares. If the share prices fall below a threshold limit and the promoter doesn’t have additional shares to offer as margin, the lender may even offload the shares, as was the case in Bhushan Steel. 

The need to pledge shares is higher for capital-intensive businesses such as realty and infrastructure as gestation periods for the projects in these sectors are longer.  

In February 2009, market regulator Securities and Exchange Board of India (Sebi) tightened pledging norms, making it compulsory for firms to give details of pledged shares every quarter. According to Sebi rule, firms have to divulge details of pledged shares if it exceeds 25,000 shares in a quarter or 1% of the total shareholding or voting rights of the company, whichever is lower.