Time has come to revisit some issues in the securities market

Many traders had provided margin to investors through the underlying Adani shares. Since the margin is marked to market, traders receive top-up margin calls. As a result, in order to provide additional margin, derivatives traders had to place bets on their best performing stocks to meet such requirements. In short, these stocks faced selling pressure causing mayhem for other performing stocks. Margin calls, which can happen with any scrip, result in investors losing huge amounts. CG Power, Zee group companies are some other stocks which have faced such margin calls.

The Adani-Hindenburg saga also threw light on the free float status of various listed entities. Recently, Patanjali Foods came under the scanner for violating the ‘free float’ condition. Free-float refers to the shares of institutional investors (FPIs, mutual funds, insurance companies) and retail investors that are available for trading in the stock market. It does not include promoter or other lock-in shares. As per the existing rules, at least 25% of the shares of a company must be mandatorily held by the public. This is an important parameter as it minimizes the scope for manipulation, promotes price discovery and results in high liquidity in the market.

We analyzed the top 500 companies in India and found that 94% of them comply with this minimum. Now the time has come to mandate a higher cap of 35-40% so that companies can dilute promoter ownership and have a diverse set of shareholders. This will ensure that the promoters do not tinker with the ownership of a company based on their whims and fancies. Furthermore, global indices also prefer to include those companies in their indices if the free float is high as it reduces the possibility of manipulation of stock prices by any single group of investors.

Here’s what stock exchanges and market regulators can do to prevent the turmoil in the markets when margin calls come in. They may relook at the criteria for providing margin facility on shares where promoter pledge is above a certain limit. Exchanges can come up with a robust monitoring mechanism that gets activated when promoters pledge their stake. They can mandate a nudge facility through brokerages by which an investor can be warned before investing in companies where promoter’s share pledge is beyond a certain limit. Some brokerage houses are already providing the facility to alert investors about companies that are facing ban period or are going towards National Company Law Tribunal or are in the news for other serious issues.

For retail investors, they must study the fundamentals of the company properly before taking any investment decision. They should avoid investing in shares of companies whose promoters have pledged shares above a certain limit. They should examine the universe of shareholders of the company (promoter group, foreign portfolio investors, domestic institutional investors, etc.); The more diversified the shareholding pattern, the better.

Every crisis provides an opportunity to atone for a better future. The current crisis should also be used to learn and implement various measures that can make our securities markets more robust and less prone to systemic risks.

Kuldeep Thareja, Mitu Bharadwaj and Rasmeet Kohli are working with the National Institute of Securities Markets.