In the burgeoning stock markets, the secret to success lies in the proper understanding of various technical terms that hold the information hidden behind them. This is why it is necessary for traders and investors to gain as much knowledge they can about these terms so as to make the right move towards their investment. One such term is pledging of shares. If you have not heard it before, it’s time to decode it and learn more about it in this post. So, let’s get to know more.
What does pledging of shares mean?
When it comes to examining a number of stocks for investment, the pledging of shares is one of the many crucial factors to ponder upon, which is often unnoticed by many investors. A high pledging of shares can be a pain point for the shareholders.
In simple language, pledging of shares refers to obtaining loans against the shares that one possesses.
Shares are largely referred as assets. Pledging of shares is an option for the promoters of a company to seek loans to fulfill their business or personal requirements by putting their shares as collateral to lenders.
What is the reason behind pledging of shares?
According to the top 10 stock brokers in India, pledging of shares emerges as the last resort for the promoters to get money. It is moderately safer for the promoters to advance funds through equity funding or by obtaining debts. However, if the promoters are planning to pledge their shares. then it refers that all the other choices of raising funds have been exhausted. You can consult the best stock broker in India to gain more insights about the pledging of shares in Indian stock markets.
Why pledging is considered detrimental to shareholders?
Though in case of pledging of shares, the promoters employ their stake as collateral to get the secured loans. In case of a bull market scenario, pledging of shares may not present various concerns as the market is going upwards and the investors are hopeful. However, the problem emerges in the case of bear market or economic downtime.
When the price of stocks changes due to market fluctuations, the worth of the collateral also varies with the deflection in the share price. However, in a majority of scenarios, the promoters are supposed to upkeep the value of that collateral. If the price of the shares slumps, the value of the collateral will also corrode. In a bid to meet up the change in the collateral worth, the promoters have to refuge the shortfall by either giving extra cash or pledging more shares to the lender.
In the worst case scenario, if the promoters find themselves unable to make up for the difference, the lender can choose to sell the pledged shares in the open market to get back their money. This minimum collateral value is decided in the contract signed between the lenders and the promoters. Thus, it lends an authority to the lender to sell the pledged shares, if the value goes below the minimum value.
How pledging of shares affects the retail investors?
When a speculation is raised that a lender is selling his shares, the stock price tends to go down. This may cause an additional decline in the collateral value of the share due to the panic selling by the investors.
Besides, the selling of the pledged shares by the lenders may also trigger the change of the shareholding pattern of the business. This may influence the voting capability of the promoters as they possess fewer shares now. their ability to take important decisions is low.
Nonetheless, pledging of shares can cause a havoc if the share price ceases to fall further. This is because the promoters have to steadily pledge large number of shares to compensate the difference in the collateral value.
How you can determine the pledging of shares for Indian firms?
When it comes to finding the pledging of shares for Indian business, the following method can be opted
Find the percentage of the total holding shares on the BSE and NSE websites. Here are the precise steps to find the pledging of shares for the Indian public companies.
- Visit BSE India website.
- Search the company name in the search bar.
- Click on the ‘shareholding pattern’ tab on the left sidebar of the company page.
- Open the latest quarter report of the shareholding pattern.
Pledging of shares is usually noticed in the companies where the shareholding of the promoters is following upward trend. A general rule is that the pledging of shares beyond 50% can pose heavy risk for the promoters.
It is recommended to ignore companies with heavy pledging of shares to avert needless troubles. This is because pledging of shares is an indicator of poor cash flow, debt-ridden company, and incapability to fulfill the short-term requirements.
How does the pledging of shares work?
Promoters can pledge their shares to avert wiping out trade opportunities because of low cash margins. They can obtain a loan after haircut deduction. The collateral margin got from these pledged shares can be employed for equity trading, futures, and options writing.
What do you mean by haircut?
A haircut means a percent difference between an asset’s market value and the value that can be utilized as collateral.
Pledging of shares is typically the last resort for promoters to raise funds; if the promoters are pledging their shares. it means that there are no other way left for them to raise funds. It is reasonably safer to use equity or debt as collateral for the promoter. Pledging of shares is widely preferred in bull markets when the market is going up.
What are the new guidelines regarding pledging by SEBI?
SEBI has released fresh directive in regard to the pledging of stocks as collateral to receive margins for trading purposes. Earlier, one had to move the shares to the broker’s account from their demat account for the purpose of pledging. As per the new guidelines, shares will have to be pledged by following a process where the pledge is registered against the customer’s holdings in the records of the clearing corporation.