Fractional Share Investing: A Possibility for the Indian Stock Market?

[By Saima Khan]

The author is a student of Dr. Ram Manohar Lohiya National Law University, Lucknow.

Introduction:

During the Covid-19 pandemic, the Indian Stock Market witnessed a massive rise in the number of retail investors with remarkable participation from millennials and Gen-Z. According to the National Stock Exchange, retail shareholding in Indian companies reached a 15-year high in June 2022. This is indeed good news for our country’s economy. However, retail investor participation in India still has a long way to go.

 The legal and regulatory framework of the Indian Capital markets is such that it disincentivizes investors from participating in the market. For instance, the Companies Act, 2013 (hereinafter referred to as “CA-13”) does not permit investors to purchase or hold fractional shares. A fractional share refers to a unit of stock that is less than one full share. Fractional shares make the world of investment more accessible to retail investors. For instance, one MRF share is currently priced at around Rs. 90,000. Now, let’s say a college student with limited savings wants to purchase this share. Since the existing regime does not allow shareholders to hold less than a whole share, it would be impossible for them to buy even one share of MRF. On the contrary, if fractional share investing were allowed in India, such investors could easily buy a fraction of the share, for example, 1/30th part of the share amounting to Rs. 3,000. Thus, Indian market participants are pitching for changes in the current framework, enabling them to buy fractional shares of the companies of their choice.

 Pursuant to their demands, the Company Law Committee (hereinafter referred to as “CLC”), in its report dated March 21, 2022, has recommended certain amendments to the CA-13 to pave the way for fractional share investing in India. Through this article, the author attempts to examine the impact of these recommendations on the present regime while discussing the future course of fractional share investing in India by providing a detailed comparison between the operation of stock trading in the USA and India.

Recommendations Of The Committee:

The CLC has, inter alia, proposed the amendment of  Section 4(1)(e)(i) and paragraph 4 of Table F – Schedule 1 of the CA-13 which restrict the issuance and holding of fractional shares in India. Section 4(1)(e)(i) creates a bar on the holding of fractional shares by stating that the amount of share capital to which the subscribers to the Memorandum of Association agree to subscribe shall not be less than one share. Notwithstanding the above restrictions, corporate actions such as stock splits, mergers and acquisitions may give rise to fractional shares in India. However, in practice, fractional shares resulting from such actions are not allotted to the shareholders. In stock splits, a company divides its shares into smaller units to lower the price per share and make the company’s stock more attainable for investors. Similarly, in the case of mergers, the share value is redefined and the shares held by the investor are converted into shares of the new entity formed by the merger, in a specific ratio, say 1:4. So, if an investor holds 17 shares of the company, 16 of his shares will be converted into 4 shares of the new entity. The remaining one share will result in 4 ¼  shares. In such cases, the resultant fractional shares are either converted into a whole number of shares or a trustee is appointed by the Board of the company, who buys back the fractional shares and credits the proceeds to the linked bank account.

The Report of the CLC has not only recommended the holding of fractional shares, but also their issuance and transfer. Once these recommendations are implemented, shareholders would be entitled to hold fractional shares resulting from such corporate actions. Furthermore, the buying and selling of fractional shares would also become possible.

Fractional Share Investing: A Boon For Investors? 

The introduction of fractional shares would open the floodgates for retail investing in India owing to their inherent advantages. In the above example, we have seen how fractional shares enable small investors to buy shares of the companies which offer their shares at high prices. Further, owning fractional shares when one has a low capital to invest can help one maintain a diversified portfolio. As the saying goes, “Don’t put all your eggs in one basket”. Hence, it would be prudent for an investor with Rs.10,000 to invest Rs.1,000 by purchasing fractional units of ten different companies rather than buying a single share of one company for Rs. 10,000.

Fractional shares also enable investors to receive dividends which are proportionate to the shares held by them. However, the other side of the coin is that fractional shares do not confer voting rights to investors. To tackle this problem, several brokers offering fractional shares have come up with proxy voting rights wherein the broker votes on behalf of the shareholders by aggregating the votes and reporting the results to the shareholders. Another drawback of fractional shares is the excessive fees charged by the brokers which makes it unfeasible to invest in them.

Fractional Share Trading In The USA: A Comparative Analysis

In the USA, Interactive Brokers set the ball rolling for fractional trade investing by offering investors the option to sell or purchase fractional shares. In response, other prominent brokers such as Schwab, Robinhood and Fidelity jumped on the bandwagon by announcing fractional share trading on their platforms. Similarly, brokers in Canada and Japan have also introduced fractional share trading. The popularity of fractional shares in these countries has inspired the CLC to recommend fractional share investing in India.

However, in its report, the CLC has overlooked the fundamental differences between the working of the Indian and the US Stock markets. In India, brokers act as agents of investors. They collect the orders from investors and send them to the exchanges for execution. Thus, in the present system, shares are not held by brokers but by depositories such as Central Depository Services Limited (CDSL) or National Securities Depository Limited (NSDL).

On the contrary, in the USA, brokers act as both brokers and dealers and are known as broker-dealers. Broker dealers in the USA enjoy greater flexibility and shares can be held either in the investor’s name or the broker-dealer’s name or street name. Hence, unlike in India, brokers in the USA are the custodian of shares which makes it possible for them to create fractional units of shares and offer them to investors. Additionally, there are two widely used methods of fractional trading by brokers in the USA:

  • Batch Trading: This is the more popular method of issuance of fractional shares. Under this, brokers accumulate Fractional Share orders throughout the day and carry out batch trades for whole units on exchanges with the purchased stocks and sale proceeds being split between the participating investors. While this approach makes bookkeeping easier for brokers, they execute the sale or purchase once they have accumulated enough fractional share orders for that batch trade. This leads to a time lag between the placing and execution of orders.
  • Real-time trading: Under this method, the broker uses their own inventory of shares to execute client fractional share orders in real-time. They do not wait to accumulate fractional orders and provide shares directly to investors dealing with leftover units in their own accounts. This approach eliminates the time lag which comes with batch orders.

The Road Ahead

The proposal to introduce fractional shares in India has created a wave of excitement among retail investors, companies and brokers while unfolding a series of challenges for the government. It is discernible that the amendments proposed by the CLC are not sufficient to allow fractional share investing in India. Buying and selling fractional shares call for a USA-like model, allowing the brokers to hold shares in their own name and maintain their own inventories of shares. Thus, along with the proposed amendments, there is a need for the market regulator SEBI to provide for such a regime in the first place.

Recently, Zerodha had applied to the SEBI requesting relaxations under clause 25 of the SEBI Master Circular for stockbrokers which regulate transactions between clients and brokers, but the application was rejected. Hence, SEBI’s reticence in allowing flexibility and independence to stock brokers is a stumbling block to the introduction of fractional share investing in India. Moreover, allowing relaxations in broker-client transactions would require a revision of the governmental policies. In all likelihood, the government would be wary of duplicating the USA model which gives more power to brokers and agents. Rather, it is possible that it would go for adopting a rigid policy for companies issuing fractional shares. Hence, the accommodation of fractional shares in the present regime requires certain important decisions to be made by the government. Further, there are many regulatory hurdles that it will have to pass through before fractional share investing turns into a reality.

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at – cbcl@nliu.ac.in