New rules proposed by RBI for core investment companies (CICs) will make life easier for lenders and investors who often struggle to figure out the extent of debt in a cobweb of firms.
Once implemented, the sterner regulatory norms will, however, force many business groups to change the way they raise debt and equity to fund their businesses. A CIC is similar to a mother entity, closely held by promoters, which has to invest as much as 90% of its net assets in group companies that are typically listed on stock exchanges.
As they expand and diversify, conglomerates float and fund new vehicles, which emerge as new CICs and act as holding companies for new businesses. Unwilling to dilute the CIC’s stake in a listed company, promoters typically brought in financial investors to fund a group company.
This was partly due to fear that a lower stake could make a public company vulnerable to hostile takeovers. The business model built around CICs is now under challenge, with RBI moving to restrict the number of CICs in a group to two and make it tougher for one CIC to fund the other.
Thanks to light-touch regulation and the multiple purposes they served, CICs have multiplied over the years amid mergers and acquisitions. The result was to make corporate holding structures complex and mask the true size of total debt.
Recent experience has shown how loan defaults by these unlisted entities could hurt institutional as well as retail investors, with mutual funds having lent to holding entities against shares of the listed companies.
The recommendations follow stricter disclosure standard announced by Sebi on stocks pledged by promoters. ‘Debt’ is the new four-letter word in Corporate India. Pruning it is needed, even if painful.
via Reducing Opacity in Corporate Finance