Analysing the Recommendation for Issuance of Fractional Shares in India

The Company Law Committee (CLC) Report¹ of March 2022 made recommendations for recognising the concept of fractional shares, restricted stock units (RSUs) and stock appreciation rights (SARs) under the Companies Act, 2013² (Act). The recommendations are aptly timed in light of the fast-changing retail investment movement witnessed by the country and in addressing the legal ambiguities surrounding the non-monetary form of remuneration.

Recommendation for issuance of fractional shares

A fractional share is a portion of the equity that is less than a single unit of a share. They are usually the outcome of various corporate actions such as stock splits, mergers, and amalgamations, etc. but their trading is explicitly prohibited under the Act.³ Until recently, the CLC Report has recommended allowing the trading and holding of fractional shares. The Report suggests that if implemented, it would allow retail investors to hold a part of highly-priced shares at a fraction of the cost hence, opening the doors for the new investors to invest in dearly priced shares such as MRF Tyres, Page Industries, Honeywell, etc.

Current Indian provisions

Presently fractional shares are not allowed to be purchased, sold, or traded as per Section 4(1)(e)(i) of the Act. The section clearly states that “the number of shares which the subscribers to the MoA agree to subscribe should not be less than one share”. Further, Para four of Table F provided under Schedule I to the Act⁴ prohibits the holding of fractional shares.

The Committee deliberated upon enabling trading of fractional shares to support the behavioural change that Indian retail investment segment is undergoing which can be assessed from the exponentially growing numbers of retail investors in India. The CLC apprised itself with various domestic and international practices where fractional shares were traded such as Canada [Section 49(17) of the Canada Business Corporation Act, 1985, provides for rights of fractional shareholders]⁵, Japan (Article 234 of the Japan’s Companies Act, 2005 provides for treatment of fractional shares)⁶ and United States (United States Security and Exchange Commission Bulletin, 2020 aimed at apprising investors about the nature, process, benefits and other rights and obligations associated with investing and trading in fractional shares).⁷ It also took note of National Stock Exchange – International Financial Services Centres (NSE-IFSCs) decision for allowing trading in fractional shares of global stocks under its regulatory sandbox regime in India.⁸ The move was hailed by NSE’s CEO Mr Vikram Limaye as one of the “key milestones” for stock exchange in the country.⁹

Upon deliberations and understanding of the practices in various jurisdictions, the Committee recommended that the dealings in fractional shares must occur only in dematerialised form and should be allowed only for the fresh issue of such shares. They should not apply to shares that have been already created due to corporate actions such as mergers or amalgamations, etc. It is also advised that the provisions facilitating the trading of fractional shares for listed companies must be stipulated only after consultation with the SEBI.

Analysing the Committee’s proposal

The choice of investing into a fractional share leads to a paradigm shift from opting for number of shares to invest in, to the amount of money to be invested in a share, which would further allow the investor to tailor their portfolio by eliminating monetary barriers to entry to a certain stock. Retail investors being the force behind increased market participation would only ensure that the case of fractional shares is pushed further inspired by investing mechanisms found in countries commanding developed stock markets such as the United States, United Kingdom, Canada, and Japan. However, the merits and demerits of this proposal need to be evaluated effectively, we can identify the following benefits and limitations of imposing fractional shares in India that will help us in addressing the question.

Benefits of fractional shares

(i) Construction of a balanced portfolio: Fractional shares would allow small retail investors to dedicate fixed amount of money to the stocks or exchange traded funds (ETFs) of their own choice and they will not be forced to limit the scope of diversification by either not investing in certain shares or only investing in a very limited number of stocks. This would allow the retail investors to go stop shopping with basically unlimited freedom with regards to options to choose from. The diversification assists the investors in reducing risks in relation to certain stocks which inspires further confidence in them.

(ii) Reinvestment of dividends: If the concept of fractional shares is implemented in India certain brokerage firms could offer the feature dividend reinvestment, which would result in compounding of investors’ wealth over a period of time.

(iii) Reduces entry barrier: The concept of fractional shares would allow new and small investors to dabble in the stock market and further acquire meaningful return on investments which might not have been possible otherwise.

(iv) Dollar-cost averaging options: “Dollar-cost averaging is the practice of systematically investing equal amounts of money at regular intervals, regardless of the price of a security.” Dollar-cost averaging is an option which allows the investor to incur lesser expenditure per share as acquired in the future by allowing the investors to invest regularly by dedicating small amount of money to certain cycles. This investment strategy allows the investors to counter any potential volatility which may arise in the market on account of external factors, and it also protects the investor from investing in a particular stock at a price prevailing at a given time which may later prove to be unfavourable. Similar strategy could then be availed by investors in India.

Potential limitations of fractional shares

(i) Voting rights of the shareholder: Though we do not have the necessary empirical data to judge the implications of voting rights of the shareholder in case of fractional shares in the Indian context, in the United States the practice of trading in fractional shares vests the brokerage firms to have the overarching authority in deciding as to how the voting rights would be exercised by holders of fractional shares, for example in the case of Stash voting as to the affairs of the company is not allowed. Thus, this would transfer more powers in the hands of brokers instead of the retail investors, defeating the overall intention.

(ii) Selection of stocks: Even in the jurisdictions where the practice of fractional shares is quite prevalent, stocks of many companies listed there are not available for fractional shares. Therefore, if implementing the similar concept in India for purpose of increased retail investment, the very purpose of diversified investing would stand defeated to an extent in relation to the companies which may not opt for providing tradable fractional shares in which case the investors will necessarily have to resort to the traditional approach.

(iii) Liquidity: Another potential drawback of fractional share can be that such shares may not be able to be liquidated as easily as certain other shares. This might be the case due to the fact that the trading in fractional shares could be significantly less in comparison to traditional shares. Also, it is observed in the case of brokers in the United States, they may not process orders or work on a reduced speed of filling orders if they opt to wait long enough for a certain number of fractional shares to accumulate before executing a trade. The demand and supply aspect of the fractional shares is also a criterion which may affect the pace of liquidity.

(iv) Transfers: As per the operational policies of the brokers in the case of the United States, investors may face certain issues pertaining to the transfer of shares to other brokers if the same is not allowed by the current players. Furthermore, the whole process of liquidating of fractional shares may invite tax implications which were not intended in the first place. It remains to be seen as to how the overall legislation concerned with fractional shares will be implemented by the Government, however, the limitations faced in the US can act as a reference point for Indian retail investors.

To conclude, the Committee’s recommendations are indeed laudable and aptly timed as India’s experiencing an unprecedented boom in retail participation. The country witnessed the participation of 1.42 crores new retail investors with their contribution to overall stock exchange turnover increasing to 45% from earlier 39%. The market capitalisation itself has been higher than in any other major country.¹⁰

The country’s current share of savings in shares and debentures to total household financial savings is approximately 4.8%-5.0% which is minuscule in comparison to USA (where such share is 36.5%).¹¹ This indicates the country’s huge untapped potential of household participation in the securities market that could help sustain its financial sector. Various industry experts have expressed that the current shift towards securities investment is not an ephemeral trend but a long-term phenomenon which if tapped properly, could open new avenues in the Indian securities market.¹² The current recommendation is in line with exploring such avenues.

Further from companies’ perspective, implementing fractional shares would save them from undertaking various corporate actions such as bonus issues, stock splits, etc. to reduce the share prices. Lastly, the issuance of fractional shares being an international practice would help the country to align its norms with globally set standards.

However, several operational hurdles must be preliminarily addressed before implementing any of the recommendations provided for fractional shares. Some of the major ambiguities that should be deliberated beforehand are whether a separate stock exchange platform would be required for trading of these shares, or would they continue to be traded on the existing platforms? How would the register of members be maintained, especially in cases of listed companies? Whether further issue would also include issuance of shares in exercise of employee stock options plans (ESOPs) and how would the implementation of fractional shares in overall roll out of ESOPs function?

Thus, the current recommendations would help the country gauge the maximum benefit from the increased retail investment participation and certainly is a positive development in the country’s long-term financing story.