Narrowing Down the Roads of Buyback to Achieve Excellence

In Depth

Narrowing Down the Roads of Buyback to Achieve Excellence

Jyotsna Chaturvedi | July 2013

The Securities and Exchange Board of India (SEBI) framed the SEBI (Buyback of Securities) Regulations way back in 1998 and also made various amendments in the same in 1999, 2001, 2004, 2006, 2007, 2008 and 2012 for streamlining the whole procedure. The latest amendments were brought into few days back in its meeting held on 25th June, 2013.

The regulator has made various amendments including changes in buyback norms, rationalisation of preferential issue norms, allowing SMEs to trade on institutional trading platform (ITP) without coming out with an IPO, norms with regard to angel investors and direct trading by AMCs.

India’s capital market regulator has narrowed down and tightened the share buyback norms so as to make the process more transparent and credible for its various stakeholders. The regulator has on the other hand, vide other amendments, have simplified foreign investment rules so as not to put these amendments harsh on the foreign investor. This move by SEBI is also motivated by the ideology in bringing back the money which left the equity markets in the past few weeks putting lot more pressure on the Indian currency. As per the reports, foreign institutional investors (FIIs) have taken out Rs. 10,551 crore in the last 11 trading sessions.

Talking about buyback, it is one of the methodological cancellations of share capital which leads to reduction in share capital of a company and bringing up the share price lead by increase in earnings per share. However, since the launch of these regulations, this method has been used as a tool by many companies to have a short term increase in their share price, never honouring the offer given. The given rules, which were unveiled earlier this month, are based on the recommendations of a panel headed by former cabinet secretary K M Chandrasekhar.

THE CHANGES

The authority has made it mandatory for the companies following the approach of buying back its shares to open an escrow account in relation to the said buyback with an amount of at least 25% of the total amount earmarked for the same. This approach would obviously slash down the number of frivolous buybacks as 25% of the value of such buybacks would be attached. The mandatory minimum threshold limit for such buyback has also been increased from existing 25% to 50%, making it compulsory for the companies announcing buyback schemes to achieve the 50% compulsory limit, failing which the amount held in the escrow account would be forfeited, subject to a maximum of 2.5% of the total amount earmarked.

The regulator has also slashed down the maximum completion time for a buyback process from 12 months to 6 months, though the Companies Act still provides a time period of 12 months for completion of buyback. On the other hand, the restriction for not raising further capital after the completion of the said buyback has been extended from 6 months to 12 months as against subsisting 6 months under section 77A (8) of the Companies Act, 1956. This move is mainly driven by the understanding that companies resorting to buyback have idle cash resources with no attractive investment opportunities in the foreseeable future.

To further curtail the fraudulent and frivolous buybacks backing promoter’s interest, SEBI has restricted the listed entities to come up with two buybacks only with a minimum gap of one year from the closure of the preceding buyback. The regulator has mandated companies if they are buying-back 15% or more of capital (paid-up capital and free reserves) the same should only be done by way of tender offer.

On the better side for the companies, SEBI has also relaxed extant requirement of newspaper publications by the companies offering a buyback scheme. The companies would be required to give disclosure of the bought back shares, only on their websites and to the stock exchange(s) only on a daily cumulative basis.

Opening out options for the procedure for the buyback of physical shares, the same has been modified by the regulator which includes creation of separate window in the trading system for tendering the shares which include requirement of verification documents. The promoters of the company have also been specifically prohibited to execute any transaction, either on-market or off-market during the buyback period.

THE EFFECTS

The whole lot of amendments in the regulations of buyback of securities is aimed at controlling the manipulative activities by the frivolous promoters under the disguise of buy backs. The stock price of the company often starts moving upwards when a buyback offer is announced. After a period, liquidity of the stock dries up, causing losses to the stakeholders. SEBI has tried to resolve this issue vide these amendments.

The data from a financial research company shows that 13 out of the 37 companies making open offers since January 2011 did not meet half their offer size. The compliance of opening an Escrow account having a minimum requirement would assist the regulator in curbing such frivolous and unorganised proposals of buyback.

However, the genuine proposals of buyback would also have to follow the stringent rules for the same. This step by the regulator would surely slash down the numbers of buyback as the proposing company has to have an eighteen month view for cash flow requirements in present volatile market conditions. Further, failure of the same would attract a penalty of 2.5% of the proposed buyback amount. The sigh of relief for the promoters is relaxation from issuing a public notice in the newspapers.

On the other side, SEBI has also made amendments so as to encourage foreign investment and have given its approval for creation of single category of overseas investors namely the foreign portfolio investor (FPI), which would include foreign institutional investors (FIIs) as well as qualified foreign investors (QFIs).

FPIs’ stake in the company should not be more than 10%. Purchases above that percentage will be regulated under the foreign direct investment rules. The industry as well as the various Stakeholders awaits positive results out of all the aforesaid amendments by SEBI.