WILL THE 25% PUBLIC FLOAT WORK?
he public listing of
T a company is per-
haps its most sig-
nificant rite of pas-
sage. It symbolises
the willingness of its owners to
allow others to participate in
their journey of entrepreneur-
ship, at a price. By accepting
public money, a company binds
itself to a governance code. One
cannot make the argument that
divesting just a smaller share-
holding allows one to somehow
operate within a more lax code
of governance or to treat mi-
nority shareholders different-
ly. Unfortunately, even with
good intentions, minority pub-
lic shareholders currently have
virtually no say in the man-
agement of a large number of
companies, as promoters who
hold between 75 per cent and
90 per cent of the shares can
effectively operate the compa-
ny as they choose. It is in this
light that the recent guidelines
of the finance ministry which
require companies to achieve
a 25 per cent free float over a
three-year timeframe should
be viewed. There is now a
greater likelihood that the ma-
jority promoters will operate
within certain bounds of ac-
ceptable corporate behaviour.
One is not suggesting that with
74 per cent, promoters will be-
come lily-white overnight, but,
undoubtedly, a 25 per cent pub-
lic stake will be materially more
influential than a 10 per cent
public stake. This regulatory
change, therefore, serves the
cause of good governance.
In addition to the custom-
ary commercial arguments for
increasing depth in the equi-
ty market, there is an over-
riding moral consideration that
needs to be kept in mind for
a more liquid equity market.
India is moving to a phase
where there is a general desire
to enable consumption and in-
vestment as opposed to saving,
something that is now reflect-
ed in a general desire to keep
The divestment will be in the larger public interest but it will be practical only if there is an
enabling environment for the capital market to gain depth and function efficiently
interest rates low. As a result,
many people, especially pen-
sioners, are now having to es-
chew fixed-income investments
and look elsewhere for returns.
While investors need to be will-
ing to accept market risks, they
need to be partly insulated from
unnecessary risks caused by
illiquid and shallow capital mar-
kets as is the case with many
stocks today. The new rule pro-
vides greater price discovery
and will dampen market volatil-
ity, thereby providing incentive
for more retail participants
to enter the market. This can
only be beneficial to compa-
nies and investors.
One can argue that the gov-
ernment has been reasonable
by providing three years to pro-
moters to reduce the percent-
age of their shareholding. It is
not easy to support the claim
that by forcing promoters to di-
lutes their stakes, one is some-
how depriving them of fair val-
ue. At some point over this pe-
riod, the markets will presum-
ably provide a reasonable val-
uation. What is perhaps true
is that wealth created by means
of an artificial scarcity in a stock
will disappear. This will per-
haps reduce the super-normal
profits of the past, but it seems
illogical to believe that in a sav-
ings-rich country, investors will
turn away opportunities to make
a 12-15 per cent equity return
over a three-four year period,
when fixed income instruments
earn less than 8 per cent. The
GOVIND
SANKARANARAYANAN
CFO,
TATA Capital Ltd
The move facilitates
greater price discovery
and will dampen
market volatility,
providing incentives for
more retail participants
to enter the market
increased price discovery caused
by a greater free float will mean
that those seeking to make quick
profits based on manipulation
or scarcity will have to work
harder to get the same. This
cannot be a significant disad-
vantage when the converse is
the creation of liquidity and bet-
ter price discovery. Increasing
the free float in three stages will
reinforce the need to perform
well. The second and third
DEBATE
tranches of divestment will nat-
urally take place at prices that
reflect the performance of the
first tranche. This is excellent
from a governance perspective
as it will induce discipline in the
company’s operations. If a share
is originally over-priced, the
public will have an opportu-
nity in the near term to invest
at a fair price.
In the light of all these ben-
efits, the proposal would have
to be hugely impractical. This
is far from the case. Practi-
cality can be questioned if the
market does not have enough
depth to pick up the newly cre-
ated shares. This is a circular
argument because one can on-
ly create depth in the market
by having a substantial float
available for people to acquire.
While it may appear that the
market may not be able to ab-
sorb all Rs 1,60,000 crore of of-
ferings, what will really hap-
pen is that investors will divert
their investments from the least
attractive ones to better ones.
The men will be separated from
the boys, and that cannot be
bad for the markets per se.
No doubt, like any regula-
tory change, this will also re-
quire various qualifications and
perhaps some fine-tuning. How-
ever, for a country that is deeply
starved of capital and is at the
cusp of growth, any measure
that improves liquidity, price
discovery, depth in the mar-
ket and governance can only be
seen as highly desirable.
ublic listings have
P been a good av-
enue to raise cap-
ital, given the val-
ue discovery and
liquidity that they bring, sub-
ject to certain enabling con-
ditions. This would require
listed companies to have di-
versified shareholdings
through a higher public float
as it would enhance trans-
parency and accountability,
enable value discovery and
provide good exit options to
investors. However, one needs
to understand the kind of fis-
cal infrastructure needed to
make this happen.
The government’s move to
raise public shareholding
(rightly excluding American
Depository Receipts) to 25 per
cent for new issues and a grad-
ual target of 25 per cent for list-
ed companies should be seen
from this perspective. But some
introspection is necessary.
Indians basically invest
most of their savings in bank
deposits. But, given the cap-
ital market exposure norms
of banks and life insurance
companies, the amount that
flows into the stock market is
very low. For example, the cu-
mulative deposit base (sav-
ings and term) of banks is
around Rs 35,00,000 crore
while the capital market ex-
posure of all banks is a frac-
tion of this: approximately
Rs 21,000 crore in equities and
Rs 42,000 crore in debentures.
ABIZER
DIWANJI
Executive Director,
Corporate Finance, KPMG India
The move will work
only if the right fiscal
infrastructure is in
place. Unless
certain enabling
conditions are present,
the rule is impractical
Life insurance companies have
a cumulative premium income
of Rs 2,22,000 crore. LIC, the
largest insurer and the col-
lector of the maximum re-
newal premiums (incremen-
tal investments), invests only
Rs 55,000 crore of this in list-
ed equities. Other insurance
firms invest Rs 39,000 crore
although the Insurance Reg-
ulatory and Development Au-
thority allows 60 per cent to
inate our markets, may not be
be invested in equities. Mu-
tual funds have an assets un-
der management (AUM) of
approximately Rs 74,000
crore, of which exposure to
equities would be around
Rs 40,000 crore, assuming that
60 per cent of premium is in-
vested in equities. Accord-
ingly, of the total savings of
Rs 38,00,000 crore, only
Rs 1,55,000 crore hits the eq-
uity markets. Most of the
money available with public
(or M3) is invested in cor-
porate government debt.
The total market captial-
isation of the National Stock
Exchange is approximately
Rs 62,00,000 crore. Let’s as-
sume the Indian public float
today is over 20 per cent and
Rs 2,00,000 crore to Rs
3,00,000 crore is required just
to fund existing listed com-
panies at current capitalisa-
tion. In that case, we would
need our capital market allo-
cations to grow five times to
be able to meet the exit norms
along with incremental equi-
ty raising. By no means can
we achieve that. An increase
in banks’ capital markets ex-
posure may not help much but
could prove risky for the bank-
ing system.
Mutual funds are strug-
gling to garner AUM because
of lack of incentives at the
broker level and it may take
some time before this situa-
tion improves. Foreign insti-
tutional investors, which dom-
the best way for incremen-
tal capital given that any glob-
al turmoil would impact our
equity markets significantly
as in 2008.
The need of the hour is
to innovate to attract investors
to equity markets through M3
allocations. We do not have to
follow foreign regulation as
our issues are different.
Mutual funds need a dif-
ferent outlook. A higher cap-
ital requirement for mutual
funds would help give the
requisite confidence to in-
vestors to attract funds. We
should also consider bank de-
posits where funds are swiped
into mutual funds daily or for
fixed tenures. Such deposits
should only use banks as
agencies and hence not be
part of banks capital mar-
ket exposures (more like de-
fault swaps where banks
maintain capital to protect in-
vestors).
Life insurance should be
allowed to mature as an in-
dustry in order to get the
much-needed long-term funds
into the market. This, how-
ever, needs to be regularised
through a pension rider.
Setting up of a sovereign
fund to partly fund overseas
and domestic businesses is
important. Sovereign bonds
to fund private sector equities
would also be a good long-
term source of capital. It needs
to be run independently on
commercial terms. This would
provide the necessary capital
for infrastructure as well as
overseas growth for Indian
companies.
Therefore, the 25 per cent
public float move is not prac-
tical unless these measures
are introduced. A series of
regulatory initiatives is also
necessary.
The author is also the head
of financial services,
KPMG India