New Delisting regulations of SEBI, 2024 - an important reform

I have a piece with Rashmi Birmole and Manas Dhagat in today's Financial Express on the newly introduced delisting regulations introduced by SEBI (not yet notified). These are long over-due and bring a 'right to exit' the public markets back into the Indian markets. Indian markets have long got the moniker of Hotel California - after the song, to mean that it's easy to list in India, nearly impossible to delist. Finally, reforms have arrived, which should not just make exits easier but also encourage more people to enter the markets. After all, how many would enter a room if the leaving the room were made into a maze? The full piece is produced below:  

Going public and getting listed on an exchange is, for the most part, considered a significant milestone for a company. However, due to factors beyond its control, such as sparse trading volumes or a minimum public float, a listed company may find itself at a crossroads, deciding whether to remain listed when the benefits of continued listing no longer justify the costs associated with being publicly traded. A company may also delist for strategic reasons, to do things which would not be possible with millions of shareholders to take care of. A reasonable next step is to pursue delisting, which is also an essential step in ‘take-private’ transactions. Since delisting is a crucial element in the mosaic of processes that shape the capital markets, it’s only logical that the mechanism by which a company can exit the public markets should be as efficient as other processes. However, instances of delisting in India are rather uncommon, so much so that the process is largely considered a hit and miss. Often what holds up the delisting is a small group of people who try to negotiate a price several times higher than the fair price. The resulting failure causes loss both to the company and the vast majority of shareholders.

On this precise issue, SEBI, in August 2023, proposed a review of the voluntary delisting norms under the SEBI (Delisting of Equity Shares) Regulations, 2021, to refine the delisting process and tackle hurdles faced by listed companies while exiting public markets, which included the introduction of fixed price mechanism as an alternate pricing method. SEBI, in the recent board meeting held on June 27, 2024, has approved these proposals, marking a pivotal moment in the evolution of the delisting framework.  Some of the noteworthy proposals related to eligibility thresholds for the counter-offer mechanism, use of the adjusted book value in determining the floor price and the setting of a reference date.

The delisting framework provided for the reverse book building process as the (nearly) sole price determination mechanism for voluntary delisting. In what has been hailed as a much-awaited move, SEBI has approved the introduction of a fixed price mechanism as an alternative to the reverse book building mechanism. The fixed price offered by an acquirer must include at least a 15% premium over the floor price and can only be availed for delisting of companies whose shares are frequently traded. The fixed price mechanism was proposed to allay concerns regarding the inherent price uncertainty associated with the reverse book building mechanism and the resultant increase in volatility and speculative activities in the scrip of the company. The proposal was premised on empowering shareholders to decide upfront whether to tender their shares at the given price and provide a transparent pricing strategy that is easily understood by all stakeholders.

The stringent conditions for making a counter-offer under the current delisting framework have often led to failed delisting attempts, even when a majority of shareholders are in favor. Acquirers are only eligible to make a counter-offer, if their post-offer shareholding amounts to 90% of the company’s total issued shares. It was noted that the high threshold deprived acquirers of the opportunity to make a counter-offer, even if a few shareholders who collectively hold major shareholding chose against bidding, while a majority of the shareholders favoured the proposal. SEBI proposed to lower the threshold for making a counter-offer to provide acquirers with more flexibility and increase the likelihood of successful delisting offers. The counter-offer price was proposed to be computed based on the volume-weighted average price (VWAP) of the shares tendered in the reverse book-building process or the initial floor price, whichever is higher. This approach was aimed at ensuring that the counter-offer reflects the general expectations of the shareholders. SEBI approved the proposal to lower the threshold to 75% in the case of delisting through the reverse book-building process, provided at least 50% of public shareholding is tendered. The lower threshold is designed to provide more flexibility in negotiating a price that is acceptable to both the acquirer and the public shareholders. However, pursuant to a counter-offer, the 90% threshold would still have to be met for the delisting to succeed.

Similarly, the determination of the floor price has also been a contentious issue, often resulting in disputes over fair valuation. SEBI had proposed that the adjusted book value be considered an additional parameter for determining the floor price. This metric considers the fair market value of the company's assets, ensuring that the floor price accurately reflects the intrinsic value of the shares. SEBI has approved this added parameter for both frequently and infrequently traded shares, with the exception of public sector undertakings (PSUs). 

The floor price is calculated based on a reference date, which was the date on which the exchanges are required to be notified of the board meeting in which the delisting proposal was approved. In its proposals, SEBI emphasized the importance of a clearly defined reference date for calculating the floor price to ensure consistency and fairness in the valuation process. The proposal was based on SEBI’s observation that the interval between the public announcement of the delisting proposal by the acquirer or prior intimation to exchanges in promoter-led delisting, and the date on which exchanges are notified, carried the risk of abnormal trading activity which may disturb the calculation of the floor price. To tackle this issue, SEBI proposed to calculate the floor price as on the date when information related to the proposed delisting is publicly disclosed for the first time, or based on an ‘undisturbed price’. Accordingly, SEBI has approved the modification of the reference date from the date of board approval to the date of the initial public announcement for voluntary delisting.

The changes approved by SEBI represent a significant enhancement in the delisting process. By incorporating a fixed price mechanism and lowering the counter-offer threshold, SEBI has addressed key issues that have historically hindered successful delisting. These modifications aim to reduce speculative trading activities, thus preserving the integrity of the delisting process and minimizing adverse influences. The updated methodologies for calculating the floor price and counter-offer price are particularly notable. The adjusted book value ensures the floor price is based on the actual value of the company's assets, ensuring shareholders receive a fair and reasonable exit and are not shortchanged. While specific amendments or circulars in relation to the above are yet to be notified, in summary, SEBI’s decision to streamline the process is expected to address the fault lines which have been exposed through past delisting attempts, without influencing the outcome, which ultimately depends on the shareholders and the company. By aligning the delisting process with market realities and investor expectations, SEBI’s reforms are poised to enhance market efficiency and foster a more robust investment environment in India. One is more likely to go to a movie theatre or a hotel in california where the exit door is not too small when one wants to leave. Similarly, easier exit is, counter-intuitively likely to make IPOs more common.