The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) present an abundance of choices for investors crossing easily 7000+ number of companies listed on both platforms combined. However, there is also a large market operational behind these formal stock exchanges: the unlisted market.
Although there are a plethora of companies to invest in the exchanges, there are occasions when the investor cannot invest in the company of their choice as they aren’t listed on the stock exchanges. This is where the unlisted market comes in. For instance, say you want to invest in Oravel Stays Limited (OYO). This is not possible for the time being as the company has decided to postpone its Initial Public Offering Plan (IPO) till 2022 (reportedly shelved as of now). However, you can do so by buying unlisted stocks of OYO from the unlisted market.
In this article, we will talk about what an unlisted market is, how to invest in unlisted stocks and its regulatory environment.
What is an Unlisted Shares Market?
An unlisted market is an OTC – Over The Counter platform that facilitates the purchase and sale of unlisted companies’ financial instruments. This market is composed of securities that are not listed on any recognized stock exchanges like BSE, NSE, MSEI, etc. These securities are traded over-the-counter (OTC).
While most of the unlisted market is composed of the common stock, other financial instruments such as government securities, corporate bonds, swaps, etc., are also present. The typical unlisted companies can be classified into two major categories. They are:
- Unlisted companies: Publicly Limited but not listed: Subsidiaries of established, reputed parent companies: HDB Financial Services (a leading NBFC subsidiary of HDFC Bank Limited), Tata Technologies Limited (a global engineering and product development digital services company of the Tata Group), Reliance Retail Limited (a retail undertaking of the Reliance Group), etc. are some examples.
- Pre-IPO and Startups: Startups with the potential to grow exponentially: These include companies such as Zerodha, OYO, Byju’s, etc.
The startups are available under the various umbrella-like AIF, direct stocks, convertible stocks, etc. with or without ownership transfer restrictions
While one might be inclined to understand the process for unlisted stocks, for which you can reach out to RURASH Financials, let us look at the regulatory environment that you might encounter.
Regulatory Framework for unlisted companies.
The unlisted market is governed and regulated mainly by the Ministry of Corporate Affairs (MCA) and, in certain instances, by the Securities and Exchange Board of India (SEBI). The unlisted market is subject to lesser regulatory oversight than its listed market counterpart. The Companies Act, 2013 empowers MCA to regulate and penalize any unlisted company or its board members for any illegal undertaking, such as insider trading, as specified by the Act. SEBI is authorized under the Companies Act, 2013 to regulate unlisted companies if such companies have raised funds from the public.
Read out further about the recent amendments in the unlisted shares market:
- Annual Statements – As per the recommendation of the Company Law Committee, the Company (Amendment) Act 2020 has incorporated inclusions to the Company Act, 2013. One such addition is section 129A to the Act. Before this amendment, private unlisted companies were required to submit their annual statements to the Registrar of Companies.
- With the new amendment, a certain class of unlisted companies must submit periodic financial statements, which will be audited by an external third party.
- Increasing Transparency – Only a tiny fraction of the registered companies in India are publicly traded or listed. As per the latest report by the Ministry of Corporate Affairs, out of the 11-12 lakh active registered companies in India, only 6500 are publicly traded, listed companies. Against this backdrop, the amendment of the Company Act, 2013, especially the addition of Section 129A, will have significant consequences. Although unlisted, a significant portion of the unlisted companies is exposed to banks and financial institutes, which are of public interest. This new provision will increase transparency for such companies and allow early intervention whenever necessary in the public’s interest.
- Lock-in Period – A recent regulatory overhaul of the unlisted stocks domain by the RBI and SEBI has propelled the growth of the unlisted market sector. After listing, the lock-in period of unlisted stocks has come down from 12 months to 6 months. This change will allow investors to adjust their portfolios soon and reduce the illiquidity risk.
- Related Party Transactions – Recently, the SEBI has introduced stricter regulations about related party transactions (RPTs). These reforms have ensured convergence with domestic regulations and international best practices. With the amendment of the Company Act 2013, the SEBI has extended the scrutiny of RPT regulations to encompass unlisted subsidiaries of listed companies.
- Tax Implications – The short-term capital gains is (STCG)taxed as per the investor’s tax bracket, while long-term capital gains (LTCG) tax is charged 20% after indexation benefits.
- Valuation Principle – The SEBI has mandated valuation method for unlisted shares. This ensures that companies adhere to the same guidelines while valuing unlisted shares. The valuation process discounts 15%, for illiquidity, from the net worth of the company.
Investment in unlisted stocks has the potential to generate higher returns. While the potential for profit from unlisted stocks is tremendous, investors must exercise caution while investing in the unlisted market.
With lesser regulatory oversight compared to the listed market, the unlisted market does not have the same level of security and protection provided by the listed market. There is also the risk of capital loss, illiquidity, and equity dilution after IPO allotment. Therefore, investors must perform their due diligence on the financials of the company and the promoters they want to invest in. Additionally, capital gains on unlisted stocks are taxed at 15% for short-term capital gains and 20% for long-term capital gains.
RURASH is one of India’s investment management firms, providing financial solutions to augment the client’s wealth and facilitate building a legacy.