Table of Content
Introduction
Imagine if you could take a loan against your car and still not lose your asset. That's what pledging is all about -- an item/asset given as security to access a loan facility. In the capital market, investors pledge their shares and take out a loan. But what if one fails to repay? Do they lose their ownership rights to their shares? Well, keep reading, as this blog explores the pledging meaning in the share market, what happens to these pledged shares, and whether you can access your shares. Also, find out whether it's safe to invest in a company where promoters have already pledged shares, and much more.
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.
How Does Pledging Work in Stock Markets?
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.
Pledging vs. Margin Trading vs. Loan Against Shares: What's the Difference?
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.
| Pledging | Loan Against Securities (LAS) | Margin Trading Facility (MTF) | |
|---|---|---|---|
| Meaning | It's a promise to give your securities as collateral to a broker or lender. | Loan availed by pledging shares/MFs to get cash or an overdraft. | You borrow money from your broker to buy more shares than your available cash. |
| Purpose | To provide security for a collateralized loan. | To raise funds for any purpose (investment, business, or personal). | To leverage equity positions for trading or investment. |
| Who provides it | Broker / NBFC / Bank | Banks or NBFCs | Brokers (registered with SEBI) |
| Money received? | No, just a pledge created. | Yes, the loan is credited to your account. | Yes, broker funds a part of your purchased shares. |
| Collateral type | Shares, MFs, bonds | Shares, MFs, bonds | Shares bought via MTF (broker keeps them pledged) |
| End use restriction | None (depends on reason for pledge) | Can be used for any legitimate purpose. | Only for buying securities on the exchange. |
| Interest charged? | No, unless the pledged shares are used against the facility. | Yes, on the loan amount. | Yes, on the funded portion of the trade. |
| Settlement | Pledge released after the obligation ends. | Pledge released after repayment. | Shares will be transferred to the borrower after they have cleared their dues. |
Benefits and Risks of Pledging Shares
While share pledging allows investors to use their shares for borrowing funds, they have certain pros and cons.
| Benefits | Risks |
|---|---|
| Get access to quick funds without selling your existing shares. | There is a risk of a share price fall in case the promoter defaults. |
| Flexible repayment options and lower interest rates compared to other loan types. | In case of default, the lender may forcefully sell the shares |
| Retain ownership and rights (like dividends, bonuses, splits, etc) in this pledged situation. | Pledging can bring unwanted margin pressure. If share prices drop, the lender may ask for more collateral or sell pledged shares. |
| Promoters could use pledged shares to fund operations or expand positions. | High promoter pledging may signal financial stress, affecting investor confidence and stock price. |
How to Check If a Company's Promoters Have Pledged Shares?
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:
- 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.
- Review Quarterly Shareholding Reports - Every listed company files these with the exchanges, clearly mentioning "Encumbered" or "Pledged Shares" in the promoter section.
- Check the Company's Annual Report - Look for notes in the "Shareholding" or "Corporate Governance" section, which disclose promoter pledging details.
- 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.
Final Thoughts
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.
Disclaimer
The information provided in this article is for educational and informational purposes only. Any financial figures, calculations, or projections shared are solely intended to illustrate concepts and should not be construed as investment advice. All scenarios mentioned are hypothetical and are used only for explanatory purposes. The content is based on information obtained from credible and publicly available sources. We do not guarantee the completeness, accuracy, or reliability of the data presented. Any references to the performance of indices, stocks, or financial products are purely illustrative and do not represent actual or future results. Actual investor experience may vary. Investors are advised to carefully read the scheme/product offering information document before making any decisions. Readers are advised to consult with a certified financial advisor before making any investment decisions. Neither the author nor the publishing entity shall be held responsible for any loss or liability arising from the use of this information.
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