This article has been written by Agnelo Marques pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction

A public limited company is one that is listed on a stock exchange, where the general public can acquire its shares as investments through the secondary market. Another way by which the company’s share can be acquired is during the initial public offering (IPO), made by the company selling its shares directly to the general public. This mechanism of acquiring shares through the primary market via an IPO or through the secondary market from trading activity necessitates that there are enough shares available in this pool for the required purpose. However, depending on the situation, there could sometimes be a problem that prevents the general public from acquiring the company’s shares. This happens when the promoters of the company hold a very large portion of the shares compared to the non-promoter population, thereby defeating the purpose of a publicly traded company. Despite 5000+ companies listed on the Indian stock exchange, it was observed that the liquidity of shares was very low. This is where, in India, the minimum public shareholding (MPS) rule comes into play; a rule that not only ensures liquidity but also enhances corporate governance and positively impacts price discovery. 

Download Now

What is Minimum Public Shareholding (MPS)

MPS or minimum public shareholding, is a regulatory norm that all listed companies in India need to comply with. The MPS rule states that a prescribed percentage of the total outstanding shares should be made available to the general public, thereby restricting promoters to a maximum limit beyond which they cannot own shares in their own company. Currently, in India, the Securities Contract Regulation Rule (SCRR) regulates the minimum public shareholding; it prescribes that all listed companies should have a minimum of 25% of the total outstanding shares available to the public. Certain Public Sector Undertakings (PSUs) owned by central and state governments are exempted from this rule and they can hold a higher percentage based on the situation from time to time. In such cases, the minimum public shareholding is prescribed to be 10%, and every attempt is being made for it to be standardised to 25%.

The Securities Contract Regulation Act (SCRA), enacted by the Indian Parliament in 1956, serves as a crucial law regulating the Indian capital markets. Its primary objective is to control securities trading contracts and the functioning of stock exchanges in India to prevent undesirable transactions and maintain market integrity.

Key provisions of the SCRA:

  1. Definition of contracts: The SCRA defines what constitutes a “contract” in the context of securities trading. It encompasses transactions involving the buying, selling, or dealing in securities, including stocks, bonds, debentures, and other financial instruments. This definition provides clarity and uniformity in understanding what activities fall under the purview of the law.
  2. Recognition of stock exchanges: The SCRA empowers the Central Government of India to recognise stock exchanges in the country. It establishes a formal process for stock exchanges to obtain recognition and operate legally. Recognised stock exchanges must comply with the provisions of the SCRA and adhere to the regulations set forth by the government.
  3. Regulation of trading activities: The SCRA regulates various aspects of trading activities on recognised stock exchanges. It outlines the types of contracts permitted, such as spot contracts, forward contracts, and options contracts. It also specifies the conditions under which these contracts can be entered into and executed, ensuring fairness and transparency in trading practices.
  4. Listing of securities: The SCRA governs the listing of securities on recognised stock exchanges. Companies seeking to list their securities must meet certain criteria and requirements as prescribed by the law. This process helps ensure that only credible and financially sound companies can access the capital markets, providing investors with confidence in the listed securities.
  5. Investor protection: The SCRA aims to protect the interests of investors by prohibiting fraudulent and manipulative practices in the securities market. It empowers regulatory authorities to investigate and take action against individuals or entities engaged in such activities, safeguarding the rights of investors and upholding market integrity.
  6. Jurisdiction of the Central Government: The SCRA grants the Central Government of India jurisdiction over various matters related to stock exchange recognition, types of contracts permitted, and the securities listed on exchanges. This centralised authority allows for consistent regulation and policy implementation, ensuring a level playing field for all participants in the securities market.

The SCRA has played a significant role in shaping the Indian capital markets by providing a robust regulatory framework for securities trading and stock exchange operations. It has contributed to the growth and development of the Indian capital markets, attracting domestic and foreign investments and fostering economic prosperity.

Additionally, SEBI (Securities and Exchange Board of India) has the power to regulate and continuously supervise the exchanges and the functioning of the participants associated with securities contract trading. SCRA plays an important role in the minimum public shareholding regulation with a set of rules framed by the SCRR.

Securities Contract Regulation Rule (SCRR)

The SCRA legislation provides a broad legal framework that helps regulate the recognised stock exchanges and the securities listed on them. SCRR are detailed rules formulated under the act that further detail the specific regulations that actually help implement the provisions in the SCRA. In a sense, SCRR helps operationalize the SCR Act. To simplify this further, we can look at a realistic example: SCRA makes provisions for penalties against those that violate the act and/or provisions stated in SCRA; to this effect, SCRR will define rules that clearly indicate the quantum of penalty for that specific violation. In a similar manner SCRR will quantify the penalties where required for each of the provisions and will clearly specify the enforcement mechanism to deal with the violation or non-compliance.

All about Minimum Public Shareholding (MPS) 

Free float, another term for minimum public shareholding, means the total number of shares freely available for the public to acquire and participate in the market. Making available a large free float is the primary goal of MPS. 

Liquidity

A larger free float enables a larger number of shareholders, which increases liquidity to begin with. Since the distribution is very large, it prevents the concentration of shares in the hands of a particular group and/or the promoter group. It enables keeping a check on such groups and reducing their dominance, thereby positively impacting fair price discovery. 

Corporate governance

Corporate governance improves because a higher number of non-promoter shareholders reduces the dominance of promoters, enabling public shareholders to participate and influence corporate decisions, which enables a better focus on minority shareholder interests and aligns with their objectives.

Other benefits

The free float is created by rules prescribed in SCRR under the authority of SCRA. This free float is responsible not only for liquidity, corporate governance, and price discovery, but also prevents price manipulation, helps maintain market integrity, and creates a level playing field for promoters and non-promoters in wealth generation.   

A timeline of MPS

Here is a quick timeline of how public shareholding norms have progressed and its status:

  • Before 1993, the required public shareholding was 60% 
  • After September 1993, public shareholding prescribed as 25% with flexibility for certain industries and PSUs
  • June 2010 SCR Rules amended and standardised to 25% MPS for all companies for listing and continued listing
    • For new listings, a company with post listing capital of more than 4000 crores can list with 10% MPS but eventually meet the 25% requirement by increasing MPS by 5% annually 
    • Already listed companies with less than 25% MPS to meet the requirement by increasing a minimum of 5% annually. Less than 5% is allowed only if such a percentage reaches the level of 25%
    • Listing conditions to apply for a continuous listing too and all companies must maintain a 25% MPS level at all times to stay listed on an Indian stock exchange. 
  • On a check conducted in 2013, it was found that 105 companies had not yet complied with the MPS requirements, and notices were sent out accordingly.
  • August 2018: was the date by which companies were required to adhere to the MPS norms 
  • Feb 2019 Union Budget: The government proposed increasing the MPS limit from 25% to 35% but later pulled back due to the market outcry.  

Notice that prior to 1993, the requirement to list on a stock exchange in India was 60% public shareholding. To encourage companies to list and broaden the markets, the percentage of public shareholding was brought down to 25% in September 1993 and the rules were amended accordingly. Also note that the government’s proposal in the 2019 Union Budget to increase the MPS limit from 25% to 35% was later pulled back considering market sentiments.

What we can observe is that the government and the regulator are making every attempt to create a balance between promoters and non-promoters. For example, before 1993, it was obvious why promoters of companies hesitated to list their companies on the stock exchange. Or how, based on market feedback in 2019, the proposal to increase the limit to 35% was pulled back. Clearly, an additional 10% float would have generated more supply than there was demand, thereby negatively impacting the price of the security. It is also important to keep in mind the promoters/entrepreneurs interests. If they are forced to give up too much of their share, they might not see an incentive for them to continue. That said, it is also important to note that the promoter holding in India is one of the highest in the world. This, to some extent, also impacts foreign investments due to a lack of liquidity. 

SEBI’s role

SEBI (Securities and Exchange Board of India) plays a crucial role in the Indian capital markets. It serves as the regulator, overseeing and enforcing compliance with securities laws and regulations to protect investors and ensure fair and transparent trading practices.

One of SEBI’s primary responsibilities is to ensure that companies comply with the Minimum Public Shareholding (MPS) norms. MPS norms mandate that listed companies maintain a minimum percentage of their shares in public hands to promote liquidity and prevent concentration of ownership. SEBI has the authority to take appropriate action against non-compliant companies, including imposing penalties, barring participation in the securities market, or even delisting from stock exchanges.

However, SEBI’s role goes beyond enforcement. It also offers support and guidance to companies to help them comply with MPS requirements. SEBI recognises that achieving MPS compliance can be challenging, particularly for small and medium-sized enterprises (SMEs). To facilitate compliance, SEBI provides various avenues for companies to raise capital, such as through initial public offerings (IPOs), follow-on public offerings (FPOs), and rights issues.

SEBI also has the power to make exceptions to MPS norms in certain cases. For example, it may grant exemptions to government-owned companies or public sector undertakings (PSUs) based on specific considerations. Additionally, SEBI may consider exceptions for companies facing genuine difficulties in meeting MPS requirements due to factors beyond their control.

SEBI’s role is critical to maintaining the integrity and efficiency of the Indian capital markets. By enforcing compliance with MPS norms, SEBI helps protect investors and promotes fair and transparent trading practices. At the same time, its supportive approach and willingness to consider exceptions demonstrate SEBI’s commitment to fostering a conducive environment for companies to grow and thrive.

Actions against non-compliance 

The Securities and Exchange Board of India (SEBI), as mentioned earlier, has taken a proactive stance in penalising companies that fail to comply with the Minimum Public Shareholding (MPS) requirements within the specified timeframe. In one notable instance, SEBI initiated regulatory action against Orchid Pharma for its persistent non-compliance with the MPS norms.

In May 2023, SEBI pulled up Orchid Pharma for failing to meet the MPS requirement of 25% for an extended period. At the time, the promoter holding in the company remained significantly high, close to 90%. This substantial promoter holding was a cause for concern, as it could potentially hinder the participation of public shareholders and limit the liquidity of the company’s shares in the market.

As part of its disciplinary action, SEBI froze the stock of the promoters, effectively restricting their ability to trade their shares. Additionally, the directors of Orchid Pharma were barred from taking up new director appointments at other listed companies. These measures were implemented to discourage similar non-compliance by other companies and to emphasise the importance of adhering to SEBI regulations.

In July 2023, Orchid Pharma undertook a significant step to address its MPS non-compliance issue. The company successfully raised funds through the Qualified Institutional Placement (QIP) route, which enabled it to bring down the promoters’ shareholding from the previous 89.96% to 72.40%. This move demonstrated the company’s commitment to meeting regulatory requirements and enhancing public participation in its shareholding structure.

SEBI’s actions in the case of Orchid Pharma serve as a reminder to all listed companies of the importance of complying with MPS regulations. The regulator’s firm stance underscores its determination to ensure that companies maintain a healthy balance between promoter and public shareholding, thereby fostering transparency, liquidity, and investor confidence in the Indian capital markets.

Exception to the MPS norms

SEBI, the Securities and Exchange Board of India, holds the authority to modify or grant exceptions to regulatory norms when deemed necessary. A notable example of this power in action is the case of listing Information Technology (IT) companies on the stock market.

The value of IT companies is often substantial, and requiring them to offer 25% of their shares to the public through an initial public offering (IPO) could result in a large amount of capital that the companies may not immediately require. Additionally, there was a risk that IT companies would seek alternative avenues for listing, such as overseas markets, if the listing requirements were too stringent.

Recognising these concerns, SEBI made the decision to reduce the minimum public shareholding (MPS) requirement for IT companies to 10%, along with implementing other provisions aimed at facilitating their listing. This move aimed to strike a balance between protecting investor interests and promoting the growth and competitiveness of the IT industry in India.

The success of SEBI’s intervention in the IT sector led to the adoption of similar specific waivers and exceptions for a few other industries. By tailoring the listing requirements to the unique characteristics and needs of these industries, SEBI demonstrated its commitment to fostering a vibrant and inclusive capital market in India.

The exercise of SEBI’s power to relax or make exceptions to the norms highlights the importance of regulatory flexibility in responding to evolving market conditions and industry dynamics. It enables SEBI to strike an appropriate balance between adhering to established principles and adapting to emerging challenges, ultimately contributing to the overall health and efficiency of the Indian securities market.

SEBI’s role in enabling compliance

The Securities and Exchange Board of India (SEBI), the regulatory body for the Indian securities market, plays a crucial role in ensuring that companies comply with the Minimum Public Shareholding (MPS) rules. To facilitate compliance, SEBI periodically introduces new methods and amends existing rules. In February 2023, SEBI introduced two additional methods through a circular: the ESOP route and the ETF route.

The ESOP (Employee Stock Option Plan) route allows companies to offer stock options to their employees as a reward for their services or for other reasons. Most companies maintain an ESOP pool through which they allocate stock options to eligible employees. SEBI now permits companies to use ESOPs to dilute promoter holdings and meet MPS norms, provided that such ESOPs do not exceed 2% of the paid-up equity share capital. This method offers companies a flexible and cost-effective way to comply with MPS requirements while incentivizing their employees through stock ownership.

The ETF (Exchange-Traded Fund) route is another method introduced by SEBI. ETFs are investment funds that track a specific index or a basket of securities and are traded on stock exchanges like regular stocks. SEBI allows companies to issue ETFs that track their shares and use these ETFs to meet MPS norms. By issuing ETFs, companies can increase the public shareholding without diluting the promoter’s stake directly. This method provides companies with an alternative avenue to comply with MPS requirements while maintaining control over their shareholding structure.

SEBI’s introduction of the ESOP and ETF routes demonstrates its commitment to providing companies with practical and flexible options to comply with MPS rules. These methods not only facilitate compliance but also align with the broader objectives of promoting employee ownership and enhancing market liquidity. SEBI’s proactive approach to regulation ensures that companies can navigate the complexities of corporate governance effectively while aligning with investor protection and market integrity goals.

In the second method, SEBI will allow promoters to transfer their shares to an ETF (exchange traded fund), which is managed by a SEBI approved mutual fund. Such a transfer can be done to a maximum of 5% of the paid up equity share capital of the listed entity. 

Conclusion

We’ve seen that the primary goal of the regulation is to make sure there is sufficient free float in the market. This free float drives liquidity, better corporate governance, a larger distribution, prevents price manipulation, and ensures investor protection. This in turn enables wealth generation opportunity, foreign investment, strong market integrity and making the Indian markets robust. Looking at the evolution of MPS rules, it is clear that the regulators also favour promoters by keeping the dilution at the right level and making sure that there is enough incentive for promoters and entrepreneurs. And finally, the ability of the regulators to punish errant players, facilitate the compliance of the norms, and at the same time make the required exceptions and relaxations where necessary indicates their intent for a positive and progressive business environment.

References

RELATED ARTICLESMORE FROM AUTHOR

LEAVE A REPLY

Please enter your comment!
Please enter your name here