India’s free float flexibility is fraught with danger
The Indian government has given itself another year to meet free float requirements on listed state-owned firms, despite having had since 2014 to wind down its positions. The move illustrates a lax attitude in both the public and private sectors around liquidity and public shareholding levels — an issue that must be remedied.
A three year grace period was apparently not enough. Earlier this month, India amended the Securities Contracts (Regulation) Rules, 1957, to give government-controlled enterprises until August 2018 to comply with the minimum 25% free float.
Reports in the local press suggested that the finance ministry had asked the Securities and Exchange Board of India to be flexible on the original August 2017 deadline, with the central bank also understood to be in agreement.
The problem is a longstanding one in India. Listed firms — state-owned or not — have to abide by the 25% public shareholding requirement. But this is one rule everyone has flouted. It is normal practice for issuers to float a smaller percentage as a kind of stepping stone to a listed status, after which companies have a leeway of three years to regularise their shareholding spreads.
For example, InterGlobe Aviation, the owner of Indian low cost airline IndiGo, is looking to sell some Rp48bn ($746m) of shares to increase its public float from 14% to 25%.
The practice causes no major hiccups for issuers, and banks have no incentive to get it changed as they can charge the client for multiple equity raises.
Yet it flies in the face of best market practices and India’s own reform agenda. It is time the regulators put their foot down.
The benefits of a bigger public float are well established. More freely tradeable shares means more liquidity, better price discovery and smaller bid/offer spreads. It also addresses one of the classic bugbears of equity investors in Asia — low trading volumes.
So India’s lack of compliance is problematic on a number of fronts. It raises questions about why government-owned firms deserve special treatment when compared with the private sector, which is generally a bad precedent for any economy.
Moreover, it is a drag on reform. The free float rule was extended to state-owned firms in an effort to diversify the investor base and give a fillip to the government’s divestment plans, while also reducing the heavy hand of the state in companies.
To be fair, the Indian government has not been sitting on its hands.
Over the past year it has offloaded around $1.3bn of shares in ITC and Larsen & Toubro. The state has also completed an IPO for Housing and Urban Development Corp and a divestment in National Aluminium Co. Next week, Cochin Shipyard is launching an IPO that will see the government’s holdings diluted to 75%.
But in extending the public float deadline to next year, India has reasoned that hitting the market with what some estimate to be Rp200bn in share sales would be difficult to pull off all at once. It also does not help that officials are averse to be seen selling state assets on the cheap, even though they left it until the last minute.
State-owned banks have their own problems. The government, instead of paring its stake, has been pumping in equity to keep them afloat as external investors have steered clear of the sector amid persistent asset quality woes.
But this kick the can down the road mentality will do little to solve these issues — other than set a bad example.
The government has had three years to comply, so if a more nuanced solution or a more realistic deadline is required, then regulators should band together to find one, rather than procrastinate. The same goes for the flexibility granted to private sector firms, which raises the question of what shareholder value is being created by paying banks to do the same thing twice.
And for issuers, the grace period is a crutch they don’t need, especially if the market takes a turn for the worse. Not everyone will be as lucky as InterGlobe, which has enjoyed post-listing gains of over 60%.
To be sure, the issue of free floats has not stopped institutional money from piling into Indian equities this year. But if left to fester, there will be implications in the long term.
India has been on a winning streak thanks to its willingness to take the hard steps toward reform. That ethos should be carried through to its equity capital market too.