what is pledging of shares

The concept of pledging of shares by promoters is not new to India but it caught the attention of investors only after the Satyam debacle. Promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution. Non-banking financial institutions are more active than banks in providing such loans.

Why do promoters opt for pledging shares of their company?
There can be several reasons. It can be for either personal needs or business expansion. Sometimes, promoters collateralize their shares for converting warrants into shares. For instance, recently KS Oil borrowed Rs 50 crore to raise money required for conversion of warrants into shares. Also, they might find share prices in the secondary market quite lucrative for fresh purchase and adopt this route for garnering funds for the consideration to be paid for open market purchase.

What are the disclosure norms?
In developed countries like the US, not just promoters but directors too are required to disclose their pledged shares. In the UK this is covered under insider trading regulation. But in India, until recently when Securities and Exchange Board of India made it compulsory for promoters to disclose their pledged shares, there were no disclosure norms. However, post Satyam debacle, Sebi has made it mandatory for promoters and promoter groups to disclose the details of pledging of shares of their listed entities. Under this guideline, apart from disclosing whenever shares are pledged, promoters are also supposed to disclose it periodically. Respective stock exchanges are to be informed about the details of share pledging.

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What is the risk to promoters?
Bankers or financiers give loan taking the shares as collateral. Hence, whenever the prices of shares come down to a certain level in the secondary market, the promoter is required to either make some payment or pledge more shares. If the promoter cannot do either, the lender keeps the right to sell pledged shares in the market. Apart from this, promoters always have the risk of a hostile takeover.

What cues does it send to investors?
If promoters raise the money for the betterment of the business, investors should take it positively but if the money is raised for any personal needs, it imparts negative signal. Even if the funds are raised for improving the business it indicates a liquidity problem.

What is the difference between pledging of shares by general shareholders and promoters?
Banks and financial institutions give loan against shares. To avail such loans any shareholder can pledge shares to the lender. But unlike promoters, small shareholders are not required to disclose. For taking a loan against shares, the investors have to collateralize the physical shares to the bank.