SEBI puts restrictions on companies opting for share buyback via an open market mechanism

The listed companies have two ways to do a buyback process: by tender and stock exchange (open market offer). Today, we will look at the two options at a high level and see what changes SEBI has made for the companies going for share buybacks via the open market route.

Share buyback options

A buyback is a process through which the company buys its own share to reduce the total available on the open market. Below are some reasons why companies go for share buyback:

• They have excessive cash but no new investment opportunity
• Tax-effective rewarding option for investors
• Consolidating control over the company
• To signal to the market (investors) that the stock is undervalued

Below are two types of buybacks:

Tender offer: In this option, investors have the option to submit a request to sell a percentage or all shares they hold at a price higher than the current market price. The share buyback price is pre-decided by the company. For every share tendered, investors benefit.

Open market offer: The company buys back shares from the open market over an extended period.

The problem

As discussed above, one of the purposes of the share buyback is to give benefits to the shareholders. In the tender offer, investors receive the benefit, as they can sell their shares at a higher price. In the market offer, investors don't benefit, as when an investor places a sell order, there is no clarity on whether shares are accepted under a buyback or sold in the open market. 

To avoid this, SEBI has decided that it will eventually phase out the second option. For now, it has made changes for the companies that carry out the buyback via the open market route.

The changes for the companies

SEBI has imposed restrictions on the placement of bids, price, and volume for companies doing buybacks via a market maker offer. Below are the changes introduced by SEBI for the company undertaking a share buyback through the stock exchange route:

• A company will not be able to purchase more than 25% of the average daily trading volume (value) of its shares in the ten trading days preceding the day in which such purchases are made.
• The company cannot place bids in the pre-open market (9:00 to 9:15), the first 30 minutes, or the last 30 minutes of the regular trading session. 
• Also, the company's purchase order price should be within the range of 1% on either side of the last trading price. For example, the share price of ABC Limited closed at Rs 100 on Monday. On Tuesday, the company can place purchase orders between Rs 99 and Rs 101.
• SEBI further added that with respect to the margin required for deposits in an escrow account, the account should consist of cash and/or other than cash. The percentage of the escrow account, which is in a form other than cash, will be subject to an appropriate haircut. A haircut is the percentage difference between what an asset is worth and how much a lender will recognize that value as collateral.
• The company has to utilize 75% of the proceeds of the buyback undertaken through the stock exchange route instead of the existing minimum of 50%.

Monitor the execution

SEBI asked companies and appointed brokers to ensure compliance with the provisions. The stock exchange will monitor their compliance. If any instance of non-compliance is found, the stock exchange will impose appropriate fines or other enforcement actions as deemed fit.

Conclusion

SEBI has said that the amended buyback rules will come into force from March 9. As per experts, it is a good move by SEBI to ensure investors benefit from the stock buyback. 

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