Friday, June 9, 2023

Revamping the Equity Market

The Securities Exchange Board of India has released a consultation paper to amend existing regulations on buyback of securities or shares from the open market to make such routes shareholder-friendly. The proposals send mixed signals to investors.

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By Shivanand Pandit

To rationalize and amend the regulations on buybacks of securities or shares from the open market to make such routes robust, proficient, crystal clear and shareholder-friendly, the capital market watchdog, the Securities Exchange Board of India (SEBI) released a consultation paper on November 16, 2022, on “Review of SEBI (Buyback of Securities) Regulations, 2018”. These suggestions came as SEBI has been receiving many recommendations and representations from market participants, asking for a review of several essential provisions related to buybacks of specified securities, buybacks through tender offers as well as from the open market through stock exchange mechanism.

The amendments advised are quite wide-ranging in nature and, if accepted, would bring about key changes in the governing framework for buybacks in India. Buybacks mainly happen under either of the two routes—through an open market, which can be through stock exchanges or book building, or tender offers. The amendments are being proposed for both the routes and the Consultation Paper deals separately with each route. SEBI has recommended changes regarding the maximum limit, quantum, and the time consumed to complete buybacks.

The suggested modifications come from the recommendations of a sub-group committee established by SEBI under the chairmanship of Keki Mistry, the vice-chairman and chief executive officer of Housing Development Finance Corporation. The committee submitted buyback proposals on October 30, 2022. This sub-group committee is supervised by SEBI’s Primary Market Advisory Committee.

A buyback is a method through which a listed company buys back shares from the stock market. A buyback can be executed in two ways—either via open market purchases or via the tender offer way. Under the open market method, the company buys back the shares from the secondary market while under the tender offer, shareholders can submit their shares during the buyback offer. Traditionally, many companies had chosen the open market channel.

Buybacks are usually done when a company has a substantial cash reserve and believes that the shares are not fairly valued at the current market price. Listed corporate entities may buy back shares to raise the amount of the remaining shares available, or to stop other shareholders from taking a commanding stake or involvement. Promoters also employ this method to strengthen their power on the entity.

Buyback rules were first notified on November 14, 1998. SEBI assessed the buyback mechanism through tender offers and open market purchases in two stages in 2012 and 2013, respectively. In 2018, the watchdog assessed the present Buyback of Securities Regulations, 1998, with an objective to streamline the language, eliminating unneeded provisions and updating references in the buyback regulations to the provisions of the new Companies Act, 2013. Although SEBI has been altering its buyback regulations ever since they were initially informed in 1998, including by bringing in a new set of regulations in 2018, there has never been any policy changes to the theme which has continued from 1998.

SEBI wants to introduce a glide path relating to the drop in the upper limit and the time for the conclusion of the buyback offer under the stock exchange mechanism. It has proposed reducing the threshold limit of buyback from the open market through the stock exchange to 10% from April 2023, 5% from April 2024, and ultimately 0% from April 2025. Presently, it should be less than 15% of the paid-up capital and free reserves of the company.

According to SEBI, the time for the buyback procedure can be lowered to 66 working days, commencing from April 2023 and further reduced to 22 working days from April 2024. Ultimately, the open market route can be closed down for buyback offers from April 2025. The buyback directives presently provide six months from the date of opening of the offer for the buyback offer to be closed. SEBI also mentioned that a separate window may be created for open market buyback.

SEBI has suggested that the buyback via stock exchanges can be done only in frequently-traded shares. The regulator has suggested that in the case of buybacks via stock exchanges, the company should use 75% of the amount assigned for the buyback compared to the present top limit of 50%. The company should guarantee that at least 40% of the amount assigned for the buyback is used within half of the duration stipulated as per the glide path.

SEBI has recommended that a company which is net debt-free, should be allowed to carry out up to two buybacks via tender offer in a single financial year. The difference between the two tender route buybacks has to be at least six months. The current rules restrict companies from undertaking more than one buyback in any 12 months. In a tender offer, the maximum limit can be 40% of paid-up capital and free reserves compared to the present limit of 25%. In one financial year, the maximum size cannot be above 40% of paid-up capital and free reserves.

To block circumstances where the trading price of the company’s shares is inflated by the buyback being undertaken, SEBI has proposed that the company shall not buy more than 25% of the average daily trading volume (in value) of its shares or other specified securities in the ten trading days preceding the day in which such purchases are made. SEBI has suggested that the company cannot participate in the first 30 minutes and last 30 minutes of the regular trading session. Moreover, it has also proposed that the buyback price cannot be more than the highest current independent published bid, and it cannot also be more than the last independent sale price reported. It has also recommended that the future escrow account can be opened within two days of an announcement of buyback than before the announcement of buyback.

SEBI suggested that buybacks should be taxable only in shareholders’ hands. Because if the company pays tax, the remaining shareholders bear the tax burden of the shareholders who are selling. From July 2019, buybacks are taxed in the listed company’s hands. Both listed and unlisted companies have to pay the tax at 20% plus a surcharge at 12% and a health and education cess of 4%, aggregating to 23.30% of the “distributed income”.

There is no doubt that these modifications will have the effect of rewriting the governing outline for buybacks. The Consultation Paper makes it clear that SEBI is trying to walk a tightrope when dealing with buybacks. It, of course, wishes to assure that buybacks are not utilized for market manipulations. It also desires to foster transparent methods of buyback avenues. These significant proposals, if approved eventually, can surely step up the quantum of buybacks and their success.

A more generous regime for buybacks is welcome as companies that do not have use for cash are better off returning it to their stakeholders. The proposals are mostly inclined towards providing a more efficient procedure for the buyback of securities of listed companies and doing away with the existing loopholes in the same. It seeks to provide convenience to the listed companies on one hand, while ensuring no compromise with the stakeholders, especially the public shareholders’ interests on the other. The actual market response can be known only after the notification rolls out, but the proposals prima facie seems to be acceptable with a welcoming approach.

Nevertheless, several impressive alterations will demand amendments to the Companies Act. From experience, changes to the Companies Act often come with a delay. Even though the changes under the Consultation Paper are sweeping and reflect many major policy shifts, one must keep in mind that these are still proposals, and the final changes could very well be a bit tame. The point on taxation, however, remains critical and may end up deciding the future of buybacks in India. The increase in limits of maximum buyback size will help many matured companies to distribute their surplus funds effectively to the existing shareholders and scale down appropriately. Therefore, the proposals provide mixed signals to the upcoming buyback regime in India, when looked at from the shareholders’ perspective. 

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

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