Stock prices have, in recent times, seen enough volatility to keep hopeful issuers away from raising money from the capital markets. The last few months have seen no listings on the main board of the Indian stock exchanges, despite the fact that over Rs. 600 billion worth of IPOs have already received clearance from the market regulator, SEBI. The qualified institutions placements, as a route to raise capital for listed entities, have been no different with very little activity during recent times. With many companies trading in the red, and very little activity in the primary markets, action has certainly picked up in share buybacks. Companies seem to be taking advantage of the situation to boost their valuation by improving return ratios, while also signaling to the market that their business is undervalued. During the year 2018, 66 companies announced buyback of their shares, which is almost a 20% jump when compared to the last year.

The regulations governing buybacks by listed companies have witnessed a recent overhaul - the Securities and Exchange Board of India (Buy-Back of Securities) Regulations, 2018 (Buyback Regulations) have substituted the erstwhile regulations of 1998. The new regulations were introduced with a view to eliminate redundant provisions and inconsistencies and to align the regulations with the Companies Act, 2013 and other SEBI regulations.

A buyback, put simply, is a mechanism allowing a company to purchase its securities from existing security holders. A company reduces the number of its existing securities, and as a result, increases the proportion of securities owned by its security holders. For companies undertaking a buyback, the primary motive is to reward its existing shareholders/ promoters either by cash pay-outs for their participation in the buyback, or a resultant increase in the holding of the existing security-holders from staying invested. Buybacks are also considered to be more tax efficient when compared to dividends. In case of PSUs, buybacks are also influenced by the fiscal targets of the government, as it enables divestment of a part of the existing shareholding for financing the socio-economic welfare schemes.

A buyback can be carried out in one of two ways, either through a tender offer, where the security-holders have the option to present, all or a portion of their securities to the company in the buyback offer; or through open market, on the stock exchanges. In the open market process, the company places the buy order for its securities and the seller (existing security-holder) places the sell order, the trades are executed by order matching mechanism, similar to secondary market trades. For open market buybacks, companies can also opt for the book building process, which is not commonly used in India, where orders are collected on an indicative price range, and the final price is ascertained based on the collective demand, similar to the IPO pricing process. In tender offers, eligible security-holders (i.e., security-holders as on a record date fixed by the company) receive a letter of offer which contains information pertaining to the buyback offer. In case of open market buybacks, however, companies only issue a public announcement which contains the buyback related information.

Earlier, buybacks also involved purchase of securities from the odd lot holders (i.e., where the lot of securities of a listed company, is smaller than the marketable lot specified by the stock exchanges), however, due to dematerialization, the concept of odd lots has become less relevant. In tender offers, buyback price is usually higher than current market price, and the investor looking for exit can take benefit of the difference. In open market buybacks through stock exchange mechanism, the shares are bought back usually at the prevailing market price, subject to the maximum price fixed by the company.

Buyback has a potential to influence the market price of a company's securities or cause prejudice to the interest of creditors, given that it involves reduction of capital/ floating stock. The regulatory framework therefore has put certain restrictions on means to fund and conduct a buyback. For example, a buyback can be funded only out of free reserves, securities premium account or proceeds of earlier issue of different kind of securities. There is also restrictions on further capital raising by companies undertaking a buyback. Also, to safeguard the interest of small shareholders, the Buyback Regulations require companies to reserve 15% of the buyback for small shareholders who hold securities of market value of up to rupees two lakhs.

Despite best intentions of the regulator, certain anomalies have emanated under the new framework. For instance, while the Buyback Regulations allow the buyback of physical securities, SEBI has recently mandated that, with effect from April 1, 2019, transfers of securities cannot be processed unless held in the dematerialized form. This issue, which companies will face from April 1, 2019, is yet to be resolved. Additionally, the Buyback Regulations have extended the restriction on dealing in shares during the buyback period to the 'associates'. The definition of the term 'associates' is unclear and accordingly its interpretation unsettled.

Given the relevance of buybacks in the current market conditions, the regulator should ensure that the issues around the new regulations are resolved at the earliest.

Authored by Manshoor Nazki, Partner and Abhyuday Bhotika, Senior Associate at L&L Partners (Formerly, Luthra & Luthra Law Offices).

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