[Richa and Vanshika are students at National Law University Odisha.]
On 5 August 2024, the Securities and Exchange Board of India (SEBI) issued a consultation paper appropriately titled, “Streamlining the Process and Reduction in Timelines of Bonus Issue” focused on fostering uniformity in timelines for credit and trading of bonus shares from the record date ensuring the timely implementation of the same. It has also proposed streamlining the timings of bonus issues by enabling the T+2 trading of shares post-record date.
This article delves into the existing framework surrounding the trading of bonuses along with the changes proposed by SEBI. It also analyses the positive impacts that the proposed changes might have as well as the potential shortcomings.
Current Framework and the Proposed Changes
Under the current regulatory framework, the overall timeline has been prescribed by SEBI under Regulation 295(1) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations). As per Regulation 295(1) of the ICDR Regulations, bonus issues must be implemented within 15 days of board approval. SEBI defines the implementation date as when the trading of bonus issues commences. In a case where the issuance requires the approval of shareholders, the bonus issue is required to be implemented within 2 months from the date of the board meeting announcing the bonus issue subject to shareholder’s approval. While the current framework provides an overall timeline, it lacks specific provisions regarding the timeline for crediting and trading bonus shares from the record date of issue (T).
As per the current market practice, after a bonus issue is announced, the existing shares remain available for trading under the original International Securities Identification Number (ISIN), and the new bonus shares are credited to the ISIN within 2-7 working days from the record date. This lacks uniformity regarding the bonus issue and exposes the market to various risks like price swings, market volatility, etc. Therefore, SEBI proposes to establish timelines for crediting and trading of bonus shares post the record date. This would ensure prompt crediting and implementation of shares, reducing investors’ risk of market volatility.
SEBI’s proposal for a streamlined process requires companies to apply for approval from the stock exchange within 5 working days post the board meeting approving the bonus issue. Once the record date of issue is set, its allotment date must be recorded as the next working day after the record date. Post the receipt of notification from the stock exchange specifying the record date and the number of bonus shares to be issued, companies are required to furnish the necessary documents by the next working day to ensure the quick crediting of shares to shareholders’ accounts. This process will make bonus shares available for trading 2 days post the record date, eliminating uncertainty regarding the timelines for these shares.
Upsides of the Proposal
The introduction of the proposal for fast-track issuing of bonus shares presents a paradigm shift by expediting the trading process and reducing uncertainty among investors. Such predictability has certain positive impacts like boosting investors’ confidence by helping them align their trading activities with a definite knowledge of the timeframe available, equalization of market structure and the proposed changes’ compliance with the global standards.
Boosting the confidence of investors
The proposed changes provide the investors faster access to bonus shares as the shares will be credited to the shareholders’ accounts within a short span of 2 days. Owing to the reduction of the waiting period, the investors will be able to trade their shares almost immediately, encouraging a sense of uniformity and bolstering confidence among the investors while they navigate through the market with certainty.
Equalization of market structures
The proposal strives to shield investors from being exposed to market uncertainties. There have been instances wherein investors have speculated about profits that bonus shares have to offer by trading them as a consequence of not having a definite timeline to adhere to. Eventually, they are driven to the risks of erratic price movement due to market overreaction. The proposal assures to create a less volatile market by reducing impediments and oversights, benefitting all the concerned stakeholders like stock exchanges, depositories, registrars, etc.
Compliance with the global benchmarks
By adopting international norms like the T+2 trading standard, SEBI is poised to make the Indian market appealing to foreign investors. International investors seek reliability and proficiency, and by implementing these norms India can establish itself as a premier investment destination. For instance, it is often seen that foreign investors prioritize a lot on the markets that offer a wide range of efficiency. India’s adoption of the proposed standards depicts its commitment to ensuring expedited processing of transactions and reduction in settlement risks. Furthermore, this acts as an assurance to foreign investors that the Indian market is at par with other leading markets like the US and Europe which have adopted the same standards. Such balanced harmony encourages international investors to keep Indian assets in their portfolios as a result of hassle-free cross-border investments.
Shortcomings in the Proposal
While SEBI’s consultation paper promises smooth trading of bonus shares, there exist potential shortcomings that need to be considered before effectuating the proposed changes. The changes may lead to increased short-term volatility and liquidity concerns due to shorter crediting timelines.
Increased risk of short-term volatility
Volatility refers to the rate at which the price of a security fluctuates for a given set of returns. This implies that high volatility in the market leads to uncertainty with the risk of immediate price swings of securities. The T+2 days’ timeline for crediting of shares, intended to streamline the trading process will result in a sudden influx of bonus shares in the market, as the shares will be available in a short span of 2 days. This can result in high fluctuations in the price of shares as investors might rush to buy or sell their shares due to the large volume of additional shares injected into the market, potentially disrupting the usual trading pattern. For instance, if the investors intend to capitalize on the bonus issue, there will be a sudden drop in the price of shares due to a large number of sellers readily available to sell their shares in the market. However, if the investors rush to buy the shares, the prices will escalate quickly creating an imbalance of demand and supply in the market.
The short-term volatility will also make the market very unpredictable. The short-term investors will have greater risks associated with their returns as the market might move against their predictions in a short time. It can also be disadvantageous for long-term investors as they will have to face the increased risk of temporary losses if they start panic selling or buying in case of price fluctuations only to find the prices recovering later.
Concerns of liquidity crunch
SEBI defines liquidity as “the ease with which an investment can be converted into cash without causing a significant impact on its market value.” Higher liquidity enables quicker trading of shares at stable prices due to sufficient market participants, whereas low liquidity leads to trading difficulties, large price swings, and fewer market participants. In case of simultaneous issuance of bonus shares, it may be challenging to sell these shares as investors might lack the capital to absorb the influx causing share prices to drop, leading to a potential market saturation. There are also concerns about a liquidity crunch owing to the sudden surge in the volume of shares available for trading within a short period (T+2 days) as the market may not be able to accommodate the sudden increase in shares.
Conclusion
SEBI’s proposal to simplify the bonus issue process and allow a T+2 timeline for trading bonus shares is an appreciable move because it will cut down on delays in the market, making it more efficient. Nevertheless, if market participants respond unexpectedly, this move might increase short-term volatility. This means that SEBI should execute these changes in phases so that the market participants can have adequate time to adjust themselves. Additionally, SEBI must guide investors so that risks can be mitigated and they may understand their investment goals as per the time horizons. The existing market participants must update their investment strategies and infrastructure to adapt to the proposed changes. It is imperative to address these challenges so that the risks associated are not overlooked and the advantages are made available to all the market participants.
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