Price Discovery of Shares of Listed Investments Companies and Investment Holding Companies: SEBI Invites Public Comments

Posted On - 30 April, 2024 • By - King Stubb & Kasiva

Introduction

In the ever-evolving landscape of financial markets, ensuring fair and transparent price discovery is paramount to maintaining investor confidence and market integrity. However, concerns have arisen regarding the valuation of shares in certain listed Investment Companies (ICs) and Investment Holding Companies (IHCs), where market prices significantly lag behind their book values.

To address this disparity, SEBI has released a consultation paper seeking public comments on proposed measures to revamp the price discovery framework for these entities.[1] By introducing a special call-auction mechanism and reassessing existing provisions, SEBI aims to foster greater transparency, liquidity, and investor protection in the trading of ICs’ and IHCs’ shares.

This article aims to analyze the proposals and their impact in the following manner:

  • Background and Context
  • Key Proposals in the Consultation Paper
  • Analysis of Potential Implications

Background and Context

Background

  • Current Scenario:
    • Shares of certain listed ICs or IHCs are trading infrequently.
    • The market price is significantly lower than the book value disclosed in the last audited financial statements.
    • These companies have minimal day-to-day operations and primarily hold investments in various asset classes, including shares of other listed companies.
  • Investment Holdings:
    • In cases where investments are primarily in shares of other listed companies, there’s a significant variance between market value and book value.
    • Despite the high market value of investments held, the market price of ICs or IHCs remains low relative to book value.
  • Valuation Impact:
    • Growth in investments in shares of other listed companies suggests the potential for a high valuation of ICs or IHCs.
    • Market perception of variance between market price and book value adversely affects liquidity and fair price discovery.
  • Market Concerns:
    • Section of the market believes the variance hampers liquidity, fair price discovery, and overall investor interest.
    • The presence of circuit filters specified by SEBI further restricts price discovery, resulting in significant variance from book value with minimal liquidity.
  • SEBI Representations:
    • SEBI has received representations advocating for free price discovery in shares of such companies.
    • Circuit filters and market price limitations imposed by SEBI hinder shares from being priced closer to their investment value, resulting in large variances from book value and near-zero liquidity.

Existing Provisions: Price Discovery Mechanisms for Listed Companies’ Shares

  1. SEBI Provisions for Price Discovery:
  2. SEBI implements mechanisms for fair and transparent price discovery and to ensure liquidity in shares of listed companies.
  3. Price bands are established as risk management and surveillance measures to facilitate orderly trading, appropriate price discovery, and promote market integrity.
  4. SEBI Master Circular:
  5. Paragraph 17 of Chapter 1 of the SEBI Master Circular for Stock Exchanges and Clearing Corporations dated October 16, 2023[2], outlines:
    1. Call-auction session for IPOs or relisted companies.
    1. Pre-open session for listed companies.
    1. Periodic call-auction for illiquid shares, subject to conditions.
  6. Differential Price Bands:
  7. Differential price bands of 5%, 10%, and 20% are implemented based on various parameters such as surveillance, volatility, and risk management.
  8. These bands aim to reduce volatility and manipulation.
  9. Price bands for the first day of trading following IPOs, relisting, etc., in normal trading sessions are also prescribed.

Key Proposals in the Consultation Paper

Consultation

  • Consultation and Deliberations:
    • Discussions were conducted with Stock Exchanges and specific ICs or IHCs to understand the extent of the issue and methods to enhance effective price discovery.
    • Approximately 70 listed ICs or IHCs were reviewed during the deliberations.
  • Investment Distribution:
    • Among the reviewed companies, 28 have 25% or more of their assets invested in shares of other listed companies.
  • Price Discrepancy:
    • Out of these 28 companies, 16 companies had their six-month average VWAP (October 01, 2023, to March 31, 2024) at a discount to their book value (as of September 30, 2023).

These observations highlight the prevalence of the issue where a significant portion of assets is invested in shares of other listed companies, leading to a discrepancy between the average VWAP and book value for a notable number of ICs or IHCs.

Need for Review

  • Two distinct views have emerged regarding price determination:
  • Investor perspective: Price bands hinder fair price determination.
  • Company perspective: Market price is determined in the secondary market.
  • There is a substantial discount of market price to book value for certain ICs or IHCs.
  • To safeguard investor interests and ensure fair and transparent price discovery, a review of the existing framework is deemed necessary.

This highlights the divergent perspectives on price determination and the imperative need to reassess the current framework to facilitate fair and transparent price discovery, particularly for ICs or IHCs experiencing significant discounts in market price relative to book value.

Proposals

  1. Special Call-Auction Mechanism:
    • Enable a special call-auction mechanism without a price band for listed ICs and IHCs trading below a certain discount to their book value.
    • Coordinated implementation by Stock Exchanges to provide this mechanism for eligible companies.
  2. Criteria for Eligibility:
    • Companies may be identified based on:
    • Existing industry classification.
    • Listing and compliance with LODR Regulations for at least 1 year.
    • Total assets invested in shares of other listed companies being at least 50%.
    • 6-month VWAP of the security being less than 50% of the book value.
  3. Initiation Process:
    • Stock Exchanges to initiate the special call-auction process with a 7-day prior notice for identified companies.
    • Detailed information including overall book value, book value based on investments in other listed companies, investments in other listed companies, and last traded price to be disclosed by Stock Exchanges.
  4. Conduct of Special Call-Auction:
    • The special call-auction session is deemed successful only if at least 5 unique buyers and sellers participate.
    • If not successful on day 1, the auction continues on the next day until a price is discovered.
    • Aspects such as session duration, risk management, and equilibrium price to align with pre-open call auction norms for IPOs and relisted shares.
  5. Frequency and Limitation:
    • The special call-auction mechanism may be provided for ICs or IHCs only once a year.

Analysis of Potential Implications

  • Improved Price Discovery: Removing price bands for discounted ICs and IHCs could lead to a market-driven price reflecting their underlying asset value.
  • Increased Liquidity: A dedicated auction might attract more buyers and sellers, improving trading activity for these companies.
  • Reduced Discount to Book Value: By facilitating fairer pricing, the discount between market price and book value for ICs/IHCs could narrow.
  • Operational Burden for Exchanges: Implementing a separate auction mechanism might increase operational costs for stock exchanges.
  • Volatility Risk: The absence of price bands could lead to increased price fluctuations during the auction.
  • Limited Impact: The annual frequency might not address persistent undervaluation for some companies.
  • Success Relies on Participation: The minimum participation threshold (5 unique buyers and sellers) could affect the effectiveness of the auction.

Conclusion

The proposals outlined in the consultation paper aim to address the persistent challenge of undervaluation faced by certain listed Investment Companies (ICs) or Investment Holding Companies (IHCs). By introducing a special call-auction mechanism and revisiting existing price discovery frameworks, regulators seek to enhance transparency, reduce market distortions, and protect investor interests. However, the success of these measures will depend on active market participation, effective implementation, and ongoing monitoring to ensure fair and efficient trading conditions for all stakeholders. To assess the point of view of the industry stakeholders, SEBI has invited public comments on these proposals.

[1] https://www.sebi.gov.in/reports-and-statistics/reports/apr-2024/consultation-paper-on-framework-for-price-discovery-of-shares-of-listed-investment-companies-and-listed-investment-holding-companies_82945.html.

[2] https://www.sebi.gov.in/legal/master-circular-for-stock-exchanges-and-clearing-corporations_78047.html.

King Stubb & Kasiva,
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