It’s time to return to some issues in the securities market

Many traders have provided margin to investors through Adani’s underlying shares. Because the margin is market-linked, traders have additional margin requirements. Therefore, in order to provide additional margin, derivatives traders had to bet on their best performing stocks in order to meet such requirements. In short, these stocks spelled doom for other stocks due to selling pressure. Margin calls, which can happen with any script, result in investors losing a significant amount of money. CG Power, companies of the Zee group are some of the other companies that have faced such margin calls.

The Adani-Hindenburg saga also drew attention to the free-floating of the various listed organizations. Patanjali Foods recently came under scrutiny for violating a “free float” condition. Free-float refers to shares of institutional investors (FPI, mutual funds, insurance companies) and retail investors that are available for trading on the stock market. This does not include promoters or other blocked promotions. According to existing rules, at least 25% of the company’s shares must be compulsorily owned by the public. This is an important criterion because it reduces manipulation, promotes price discovery, and leads to increased liquidity in the market.

We analyzed the top 500 companies in India and found that 94% of them met this minimum threshold. It is time to set a higher limit of 35-40% so that companies can reduce the share of promoters and have a diverse set of shareholders. This would ensure that the promoters would not interfere in the ownership of the company due to their whims and fantasies. In addition, global indices also prefer to include those companies in their indices if the number of shares in free float is higher, as this reduces the likelihood of share price manipulation by any one group of investors.

Here’s what stock exchanges and market regulators can do to stop the mayhem in the markets whenever there is a margin call. They may revise the criteria for granting a share margin benefit if the promoter’s margin exceeds a certain threshold. Exchanges can come up with a stronger surveillance mechanism that kicks in whenever promoters pledge their share. They may prescribe a nudge mechanism through brokerage houses by which an investor can be warned before investing in companies in which the promoter’s stock collateral exceeds a certain threshold. Several brokerages already provide such a nudge tool to alert investors to companies facing a period of injunction, or heading to the National Companies Court, or in the news for other serious issues.

As far as retail investors are concerned, they should carefully study the fundamentals of a company before making any investment decisions. They should avoid investing in shares of companies whose founders have pledged shares beyond a certain limit. They should check the circle of shareholders of the company (group of promoters, foreign portfolio investors, local institutional investors, etc.); the more diverse the shareholding scheme, the better.

Every crisis provides an opportunity to make amends for a better future. The current crises should also be used to explore and implement various measures that can make our securities markets more resilient and less exposed to systemic risks.

Kuldip Tareja, Mitu Bhardwaj and Rasmit Kohli are from the National Securities Market Institute.