What is a pledged Share?
Pledging of shares is a loan raising system, where promoters raise money from lenders using the shares held as a collateral. These promoters raise finance from financial institutions and Non-banking financial companies against their holding in the company. Ideally, the amount lent by these financial institutions and NBFCs are less than the market value of these shares. The margin acts as a security for these lenders. In any case, if the company goes through a bad face and the stock prices fall, these banks ask for extra cash or shares so that the margin could be maintained. In case the company is not able to provide extra cash or shares, banks are allowed to revoke their rights and sell their shares in the open market.
This sale of shares in open market by the lenders can be a huge risk for retail investors, as the supply of shares increases and the prices fall incurring a loss to shareholders.
Sale of shares by NBFCs
A similar situation has been witnessed in case of Reliance Group. Several NBFCs including Edelweiss’s group and L & T finance had granted loan in return of pledged shares as a collateral to reliance ADAG group. These NBFCs invoked pledge of listed shares and sold the share in the open market. The shares, which were worth Rs 400 crore, were sold in a short time frame between February 4th to February 8th . This move by the NBFCs eroded Reliance group’s market valuation by approximately Rs 13,000 Crore.
Anil Ambani led Reliance group has quoted this move as “Illegal, motivated and completely unjustified”. This sort of open market sales is violating the regulations and is in charge of several illegal activities such as insider trading, price manipulation and market abuse said the company. There are a lot of counter arguments by the NBFCs, defending their action.
L & T finance has claimed that they provided credit facilities in return of these pledged shares and that the Reliance group repeatedly failed to provide funds to top up the collateral and maintain the margins even after various notice and reminders. As a result, L & T Finance was forced to invoke the right and sell the pledged share to the extent of outstanding amount with proper law and as per the contract.
Similar statements were made by Edelweiss group complaining that the company was incapable of providing any fund to improve the fall in collateral valuation and also breached contractual obligation. On February 4 there was sudden fall in the share value, further reducing the collateral value. Edelweiss group claimed that it intimated Reliance group several times to address these concerns but due to no response from the group, Edelweiss was forced to liquidate the shares as per the contract terms.
Invocation of pledge on Reliance group shares weighed down the stake of promoters by 1-4%. Promoter’s stake in Reliance Capital and Reliance communications fell below 50%
What led to this fall in value of shares?
The estimations says that Reliance Communications has a debt burden of around Rs 46,000 crore. Strategic Debt resolution plans were invoked on 17th June 2017 to address company’s debt resolution plans, and when those plans were reviewed in January by the Board of Directors of Reliance Communications, it was said that despite the passage of 18 months, lenders haven’t received any payment and the asset monetization plan is not making any changes in the system. Plan to sell spectrum to Mukesh Ambani’s reliance Jio also did not materialize. As a result, Reliance Communications opted for insolvency proceedings on 1st February 2019. The result of this action was a steep fall in share value and as a result sent lenders into a state of panic.
Other controversial aspect of this story is the debt of Swedish telecom giant Ericsson, which Rcom was not able to pay back. Ericsson is one of Rcom’s vendors and had signed a deal with RCom to operate its nationwide telecom network. The Swedish telecom company has dragged RCom to Supreme court, for failing to clear its dues of Rs 550 crore. SC in his decision has warned Anil Ambani and held him guilty of contempt for not paying the dues. However, RCom still has 4 weeks time to pay back the dues, failing which, Anil Ambani may have to face 3 months jail.
Standstill Agreement with lenders
Anil Ambani has reached to a standstill agreement with more than 90% of its lendors to not issue security and sell the pledged shares of the promoters till September 2019. Also it has promised to pay back the amount of loan along with interest on the due dates as per the contract.
Sources: CNBC TV 18, Business Today, Business Insider, Economic Times
Image source: asianage.com, economictimes.com