What Is Pledging

A pledge refers to the "collateral or asset" given as security for obtaining a loan. So, if you wish to borrow but don't wish to sell your shares, banks/NBFCs offer a facility called "Pledging." It means investors can pledge (keep) their shares with the lender and get a loan facility in return.

Both investors and company promoters can avail a pledge facility. While the retail investor could use it to engage in trading/investing activities, it's different for promoters.

In many cases, company promoters will pledge assets to;

• Raise capital
• Fulfill the company's operational obligations
• Fund sister concerns (or companies)
• Start a new venture.

Even at this stage, the investor (or borrower) will continue to earn interest and capital gains on their shares. But the amount received will include a haircut.

What Is a Haircut in Pledging?

Haircut, in pledging terms, is a percentage reduction in the loan amount by the lender. For example, if someone approaches the bank for a loan of ₹10 lakhs, the bank may apply a 20% haircut at this point. It means you'll receive only ₹8 lakhs.

Is Collateral and Pledge the Same?

Every pledge can be collateral, but not every collateral can act as a pledge. Collateral is a broad term for any asset you offer to secure a loan. It can be shares, property, gold, or bonds. In contrast, Pledge is a specific type of collateral, where movable assets like shares or securities are given to the lender as security.

As we delve into the pledge meaning in the share market, the focus is more on shares. Investors can only pledge their stock holdings to avail the loan facility. You don't have to sell your holdings. Instead, promise them by keeping shares as security.

This pledging can happen via MTF (Margin Trading Facility) and Loan against Shares (LAS).

Here's how it works in the stock market:

• Step #1 (Pledge agreement): Between the borrower and the lender (bank or NBFC), an agreement to pledge shares is signed.
• Step #2 (Depositing pledged asset): Also, you authorize the depository participant (like NSDL or CSDL) to mark those shares as "pledged."
• Step #3 (Temporary Transfer of Rights to Lender): Under this agreement, the lender acquires the right to sell the shares in the event of default. In return, you get the loan amount (after applying a haircut).
• Step #4 (Loan Repayment): Upon successful repayment of the loan and interest, your pledged shares will return to normal.

If you default or fail to repay the loan amount, the lender may sell the pledged shares to recover the amount.

When discussing share pledging, two terms -- margin trading and LAS sound synonymous. But there lies a very thin line of difference between the three.

A pledge is just a promise made to the lender to give any asset as security. However, LAS allows you to get a loan by pledging shares as security. The same for MTF is that it allows you to borrow funds and, in return, your purchased shares are pledged.

For a detailed list of differences, refer to the table below.

While share pledging allows investors to use their shares for borrowing funds, they have certain pros and cons.

Share Pledging is a common practice among promoters to raise capital for funding the company's operations. However, this can also impact the company's share price in the market.

If the promoter is highly pledging the shares, investors or the public may interpret this as a red flag in a bearish market, unlike a bullish one. Hence, many people look for companies where the pledge percentage is minimal. But, as an investor, it is also necessary to understand the true purpose of the pledged shares.

In case you wish to check if a company's promoters have pledged shares, here's how you can:

1. Visit the NSE or BSE Website - Search for the company and check the "Shareholding Pattern" under corporate filings. The percentage of pledged shares is listed under the Promoter and Promoter Group section.
2. Review Quarterly Shareholding Reports - Every listed company files these with the exchanges, clearly mentioning "Encumbered" or "Pledged Shares" in the promoter section.
3. Check the Company's Annual Report - Look for notes in the "Shareholding" or "Corporate Governance" section, which disclose promoter pledging details.
4. Track SEBI Disclosures - Promoters must notify SEBI for every pledge or release of shares, which you can view in the SAST (Takeover Regulations) section on exchange sites.

Share pledging is a well-known facility among both promoters and investors. It helps you collateralize your shares even without selling them off. But it brings in several compliance and market risks in return. For instance, if promoters end up defaulting, the lender may sell them off, further impacting the share price.

Hence, it is necessary to know the pros and cons of pledging before using this facility. And for more information, do contact your financial advisor or bank providing this service.