The FIIs may be replaying their act of 2008. Buying stocks in emerging markets, particularly India, lock stock and barrel. The latest data pegs FII investment in Indian stocks at US$ 18 bn in 2010. Reports of the Finance Ministry showing confidence on GDP growth and disinvestment targets could only accelerate the fund flows. But besides the FII frenzy there was another trend that drew momentum during the market peak of 2008. That of promoters pledging their shares to raise funds. The banks offered these loans against shares based on the expectations of rising markets. What followed suit, however, was a game changer altogether. Fearing such instances this time as well, the banking regulator has tightened its noose on the entities.
The recent reports about promoters of real estate majors pledging a lion's share of their stock holding in the companies seems to have miffed the RBI. It has tightened norms for banks extending loans to promoters against shares. Infact such restrictions would also be applicable if the promoter wishes to raise money on the pretext of overseas buyouts. The only exception to the rule is pledging of shares to buy stakes in Indian PSUs.
The cases of share pledging, initial public offering and qualified placement of shares are all benign to the extent that they do not repel interest of other stakeholders. The promoters are certainly the ones to make money out of these initiatives. However, the minority shareholders too need to be kept in the loop. Nevertheless, the greed to cash in when the sentiments are good has often led the promoters to sacrifice the minorities' interest. Especially in times when markets are near peaks, cases of expensive equity dilution or share pledging are seen gathering steam. These often end up putting the company's fortunes in trouble. Particularly when the economic cycle turns. The instances of companies issuing FCCBs and failing to convert or redeem them are also fitting examples to cite.
This directive by the RBI is in fact in the interest of promoters as well. It could stop them from getting greedy and in the bargain lose control of the company. There are many ways in which a company promoter loses control of his company. But nothing could be worse than losing it for being unable to cough up margin money on pledged shares. And this has already happened recently with the promoter of Great Offshore. Other promoters seemed to have taken note of this rather seriously. A leading business daily reported in early 2010 that nearly half of the 1,000 odd companies analyzed by it had released their pledged shares, either fully or partly, from the clutches of financiers.
Thus investor agony over promoters pledging their shares for fund raising could soon be a thing of the past. However, investors need to still watch out for companies where the promoters try to fleece them on the basis of lofty promises.