All you need to know about pledging shares

Lets look at what the share pledge is all about

Hyderabad: Three Adani companies – Adani Ports and Special Economic Zone, Adani Transmission and Adani Green Energy- have pledged additional shares to SBI CAP Trustee Company, a unit of India’s biggest lender SBI. This pledge comes amid the over $ 100 billion loss in market value, the group suffered following a report by Hindenburg, a US short seller. The pledges are part of a $300 million letter of credit given by SBI for Adani’s Carmichael Mining project in Australia.

Lets look at what the share pledge is all about:

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Pledging of shares

Pledging of shares refers to a company offering shares as collateral to secure a loan or other credit facility. These shares are frozen until the loan is repaid and are returned to the borrower once the loan is repaid.

Fall in value

Factors like market conditions, company performance and broader economic trends can affect the value of shares. If the share price falls below a certain level, the value of the collateral securing the loan can drop below the required level. At this point, the lender gives a margin call. A margin call is a request from a lender to a borrower to deposit additional funds or securities to restore the required level of collateral. Margin call works to ensure that the loan is adequately collateralised. If the borrower fails to meet the margin call, the lender may sell some or all of the pledged shares to bridge the gap in the value.

Rise in value

If the stock price increases after pledging, the value of the collateral securing the loan also increases. This can be a positive outcome for the borrower. It can increase their net worth and potentially reduce the risk of a margin call. However, borrower cannot profit from the increase in share prices till the pledge on the shares is removed. The lender may also impose restrictions on sale of shares to protect their interests.

Sale of pledged shares

If the borrower is unable to meet the margin call, the lender has the right to sell the pledged shares to recover the loan amount. The sale of the shares could result in a loss, and the borrower would be responsible for paying any deficiency. This can result in a significant financial impact as the borrower may have to sell shares at a loss. They may even be left with a debt to the lender that they are unable to repay.

Risks for lenders

The lender is exposed to the risk of shares declining in value. There is also a credit risk as the borrower may default on the loan. The lender may not be able to recover the loan amount through the sale of the pledged shares. The lender may not be able to sell the shares quickly or at a favorable price due to market conditions. In general, if the borrower defaults on the loan and is unable to meet a margin call, the lender is likely to suffer a loss.