The devil of pledged shares actually lies in the details
In the last few weeks, we have seen a number of large companies getting hit by the sale of pledged shares. This is not the first time it has happened and has been seen before too. But the magnitude of pledged shares has really grown in the recent past. For example, the BSE data estimates that a total of 2942 companies have promoters pledging shares on behalf of the company totaling to Rs.2.15 trillion. Also, the top 100 borrowers have pledged more than 80% of promoter stake making them really vulnerable.
RCOM and Zee trigger a crisis
The real pledged shares crisis began with the Reliance ADAG group and the Zee group. In both cases, a large chunk of promoter holdings had been pledged. When RCOM announced its intent to go to NCLT for liquidation and when Zee announced a real corporate governance problem, the markets went berserk. Financers had no choice but to sell the shares as the promoters were in no position to bring in additional margins. In both cases, the problem was a combination of a high percentage of shares pledged and a liquidity crunch at the company. Essel group had made some bad investments in infrastructure and was paying the price. This led to selling across companies where there were corporate governance issues. But there are bigger issues that need to be looked at. Let us look at two critical issues that will matter for markets.
Better pledge disclosure
That is where most of the problems come up. There is a huge time lag between the financer sending a margin notice to the client and the client actually reporting the default. Pledged shares data is known only when the shareholding pattern is disclosed to the exchanges. It is this time lag of 3 months that is material. To begin, the onus to disclose any default by promoter should be on the financer. A margin call need not be communicated but the logic of reporting defaults immediately must be strictly adhered to. If the RBI is prepared with this data, then they can appropriately prevent the crisis from snowballing. Also, additional disclosure requirements must be made mandatory where pledge ratio crosses 50% of promoter holding.
Not all above board in pledging
The market reality is that even this pledge data can be quite misleading. There are many companies who effectively pledge their shares to brokers for cash-futures arbitrage. That is not disclosed to the exchange. Also, there are informal arrangements to fund based on mere Power of Attorney to sell without actually creating a pledge. These methods are commonly used to circumvent pledge reporting. SEBI needs to close the loop on these minor detailing so that pledged shares do not post a real systemic risk to markets!
