What is the pledging of shares?
Pledging of shares is an arrangement in which the promoters of a company use their shares as collateral to fulfil their financial requirements. Pledging of shares is common for companies that have high shares owned by investors. The borrower of pledged shares retains ownership of the assets and continues to earn interests and capital gains on those shares.
The value of shares keeps changing – the value of the collateral changes with fluctuations in the market value of the pledged shares. The promoters must maintain the value of the collateral. The minimum collateral value is agreed in the contract. If the value of the pledged shares falls below the amount fixed in the agreement, the borrowers must provide additional shares or pay cash to make up for the shortfall of the collateral. Banks or lenders can also choose to sell the pledged shares in the open if the borrower is unable to repay the collateral value or make up for the difference in the values. The pledged shares are lost if they are sold in the open market, this reduces the promoters’ shareholding, and the value of the stock is decreased.
How does the pledging of shares work?
Promoters can pledge their shares to avoid losing trade opportunities due to low cash margins. They can get a loan after haircut deduction. The collateral margin received from these pledged shares can be used for equity trading, futures, and options writing.
What is a haircut?
A haircut refers to a percent difference between an asset’s market value and the value that can be used as collateral.
For instance, if the market value of the asset is Rs. 1000 and the collateral value is Rs. 500; the haircut deduction is 50 percent.
Pledging of shares is generally the last option for promoters to raise funds; if the promoters are pledging their shares, it means that there are no other options for raising funds. It is comparatively safer to use equity or debt as collateral for the promoter. Pledging of shares is favourable in bull markets when the market is moving upwards.
Share pledging has often seen as a bad sign as it implies a lack of capital in the company, poor cash flow patterns, and promoters’ inability to meet working capital requirements. Share pledging is a way of raising additional funds for companies. Promoters also pledge shares for personal needs.
How to pledge shares?
1. The promoter has to initiate a request for pledging shares using the trading terminal.
2. Once the request is received, the trading terminal sends the request to NSDL/CDSL for confirmation.
3. NSDL/CDSL authenticates the request using email/mobile authentication for PAN/BOID
4. Once approved, the collateral margin is available for trading to the promoters.
Promoters can also submit Margin Pledge Request Form signed by all holders and submit it to Angel Broking.