Reverse Book Building Process in the Delisting Regulations - A Critique
Arvind Kumar Tiwari, second year student at National Law University, Delhi.
The COVID-19 has created an environment of unpredictability and perturbing volatility which has adversely impacted stock trading. Consequently, a number of companies, like Vedanta, Adani Power and Hexaware Technologies, have triggered the process of voluntary delisting. Stock trading is occurring at multi-year lows for several industries due to which other companies may also resort to voluntary delisting. In India, delisting is governed by SEBI (Delisting of Equity Shares) Regulations, 2009.
Companies tend to delist during the times of economic slump based on the justification that the share price does not correctly reflect the true worth of the company. Indian scenario in this regard presents an irony, the market price which does not reflect the true worth of the company becomes the yardstick to determine the offer price at which the company buys back shares from public shareholders. The offer price is determined through the Reverse Book Building process and the procedure for the same is spelt out in Schedule II of SEBI Delisting Regulations. Interestingly, India is the only country which has adopted the Reverse Book Building process for delisting shares of a company.
As per delisting regulations, the promoter is required to nominate a Merchant Banker and a Trading Member to carry out this process. The delisting process commences when the company makes a public announcement about delisting following which, it must send a letter of offer and bidding form to the public shareholders. These aforementioned documents are to be filed without delay with the concerned stock exchange and such stock exchange shall update its website to inform the shareholders about the commencement of the delisting process.
Then a floor price is fixed as per Regulation 15 of Delisting Regulations and the Reverse Book Building process commences after the fixation of the floor price. The public shareholders start entering their bids in the bidding period during this process. After the bids are audited, the final offer price is determined, which is the price at which the maximum number of public shareholders have offered shares to the promoters. The company enjoys the right to accept/reject the offer price. If accepted, the merchant banker shall announce the final price and the promoter’s acceptance. Any remaining shareholders may tender shares to the company at the final price within one year from the date of delisting according to Regulation 21.
At a cursory glance, these regulations may seem good as the public shareholders enjoy the power to decide upon the final offer price in the delisting process but this mechanism is prone to certain inadequacies. Reverse Book Building process is complicated and it requires all the stakeholders to have a high level of information and knowledge. Usually, public shareholders are not as well-versed with the intricacies of this process as promoters and this information asymmetry shrinks the prospect of appropriate price discovery.
Furthermore, a floor price is fixed to carry out reverse book building but no price ceiling is prescribed and the final price is completely dependent upon the wisdom of the public shareholders. This opens up the possibility of bids being entered at a price level which the company may not find acceptable and accordingly, it may reject the offer price, leaving the shares listed. Another factor which can potentially discourage the promoter from undertaking the delisting process is opportunistic behaviour by arbitrageurs who may manipulate price discovery by deliberately entering bids at a level which is not in the interest of various stakeholders in the delisting process. Such arbitrageurs purchase shares about to be delisted to influence the final price in a manner which profits themselves.
The SEBI’s July 2018 Discussion Paper on Delisting Regulations has acknowledged these concerns and further pointed out that even promoters may indulge in unscrupulous behaviour by selling stakes to “friendly shareholders” who would then bid at a price level which unduly favours the promoters in the reverse book building process. The promoters may also announce delisting at a point in time when the market price of the shares is significantly lower than the actual value of the company and ultimately take undue advantage of the minority shareholders. Another issue with this process is that it does not consider book value during computation of floor price and this may lead to share being delisted at a price which is substantially lower than the book value of the company.
In 2018, Securities and Exchange Board of India enforced SEBI (Delisting of Equity Shares) (Second Amendment) Regulations, 2018 pursuant to the aforementioned Discussion Paper and it added a provision which allowed the public shareholders to make a counteroffer if they are not satisfied with the price discovered in Reverse Book Building Process. Shareholders willing to exercise this option must make their counter offer within two working days from the discovery of price and such price must be more than the book value of the company. The counter-offer is required to be accepted by the promoters to successfully conclude the delisting process.
SEBI should consider the possibility of making book value the benchmark to determine floor price at the time of the original offer as it allows a more reasonable and fair price discovery at the initial stage itself. This would also be a more efficient way to go about delisting and it safeguards shareholders’ interest as well. The contingent price mechanism is yet another way go about delisting which sufficiently preserves the interest of minority shareholders. This method could help in nullifying the adverse effect of the promoters’ opportunistic behaviour as the public shareholders can enjoy proportionate benefits if the value of the company rises significantly as a result of delisting.
In the wake of COVID-19, more companies are expected to delist and this is a time to evaluate how effective the existing delisting regulations are to smoothly conclude a delisting transaction. Considering the loopholes in the current delisting procedure, there seems to be an emerging need to revamp the existing delisting mechanism and replace the complex reverse book building process to fix the final offer price.
The opinions expressed herein are those of the author in their personal capacity and are not intended to be construed as legal, financial or investment advice.