final report prashant
TRANSCRIPT
A FINAL REPORTON
“THE INDIAN PRIMARY CAPITAL MARKET- IPO”
BySanjay JhanwarAnand Rathi Securities Ltd.
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Contract:
A FINAL REPORTON
“THE INDIAN PRIMARY CAPITAL MARKET- IPO”
BySanjay JhanwarA report submitted in partial fulfillment ofthe requirements ofMBA Program ofICFAI Business School, Mumbai.
Distribution List:
Prof. M.P. DeivikaranFaculty, IBS- Mumbai.
Mr. Tarun JainSenior Manager- IPO,
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Anand Rathi Securities Ltd., Mumbai.As I present the SIP Project Report on
“THE INDIAN PRIMARY CAPITAL MARKET- IPO”
I take this opportunity to offer my sincere thanks to all those who have help me and without whose guidance and help this project might have not been possible. This project has proved to be an educational and rewarding experience to me in the field of Finance.
I thank Mr. Anand Rathi (Chairman), Anand Rathi Securities Ltd. for giving me an opportunity to work with Anand Rathi Securities Ltd. His extensive experience and insight has been great source of inspiration to me.
I am immensely thankful to my guides Mr. Tarun Jain (Senior Manager –IPO, Anand Rathi Securities Ltd.) and Prof. M.P. Deivikaran (Faculty- IBS Mumbai) for guiding me with great insights about the technicalities and mechanism involved in the Project. They were a great source of inspiration all throughout the Project.
I would also wish to thank Mr. Ravi Mundra, Mr. Shekhar, Miss Bhakti, Miss Mahima , Mr. Nayan , Mr. Kiran to help me successfully work on this Project and all those who remained unmentioned here, but who nevertheless have contributed to give me a sharp and rewarding insights as to how my project would be carried out.
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Introduction
In the coming years, people will increasingly rely on the development of its capital markets to fuel its economic growth. Yet the extent to which India’s emphasis on capital markets will translate into opportunities for investors and financial services firms, particularly foreign firms, is a subject of much debate. Most experts agree that foreign firms servicing India’s securities markets currently have limited ways to make a profit, but while optimists believe that India will represent a large and attractive market within next few years, skeptics believe it could take decades for India to become a major international market for banks, brokerages and fund managers. Regardless of the debate, it is clear that domestic financial institutions, often in cooperation with foreign partners, have already started transforming a system reliant on state-owned banks into a system that will allow institutional investors to develop one of Asia’s largest capital markets.
The primary market plays an important role in the securities market by forming a link between the savings and investments. The function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have invest able funds or savings, which they lend to borrowers in the corporate and public sectors whose requirement of funds far exceeds their savings it, is through this market that the borrower’s viz., the Government and the corporate issue securities in which the investors deploy their savings. From the early 1980s onwards, there has been a shift in India’s economic policy regime, away from direct influences upon resource allocation by the State, towards a greater role for markets. The primary market comprises the public issues and the private placement market. In India, the financial sector (and securities markets in particular) attracted heightened attention from policy makers in the aftermath of the Scam of 1992. In addition, the problems in East Asia in 1997 have led to a heightened appreciation, worldwide, of the vital importance for a developing country of a financial sector, which effectively processes information and wisely allocates resources. A public issue consists of a company entering the market to raise funds from all types of investors; its debut is known as the initial public offer (IPO). In case of private placement, there are only a few select subscribers to the issue. The securities can be issued at a face value, or at a discount/premium; they may take a variety of forms such as equity, debt or some hybrid instrument.
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Table of Content
AcknowledgementIntroductionAbbreviation and Definition.Chapter1. Indian Capital Market 8
I. Indian Financial SystemII. Function of The Capital Market
III. Instrument in The Capital MarketIV. Capital Market ProcessesV. Capital Market Participant
Chapter2. Indian Primary Capital 271. Primary Capital Market2. Types of Primary Capital 3. Trends in Primary Capital Market
Chapter3. Public Issue Management 39
Chapter4. Initial Public Offering (IPO) 451. IPO Terminologies2. Allotment and IPO3. Eligibility Criteria
Chapter5. IPO Trend 69
Chapter6. IPO Scam -2006 77
Chapter7. Role of SEBI 87
Chapter8. Regulatory Authorities. 96
Chapter9. Current Issues 971. IPO Rating.2. IPO Circuit Limit
Chapter10. Recommendations 104
References
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List of Abbreviations & Definitions
Allotment - Unless the context otherwise requires, the issue and the allotment of Equity Shares, pursuant to the Issue.
Allottees - The successful Bidder to whom the Equity Shares are/have been allotted.
Bid - An indication to make an offer during the Bidding/Issue Period by a Bidder to subscribe to our Equity Shares at a price within the Price Band, including all revisions and modifications thereto.
Bidder - Any prospective investor who makes a Bid pursuant to the terms of the Draft Red Herring Prospectus and the Bid cum Application Form
Cut-off Price- Any price within the Price Band finalized by Company and the BRLMs.
Depository - A body corporate registered as a depository with SEBI under the SEBI (Depositories and Participant) Regulations, 1996, as amended from time to time.
Escrow Account - Account to be opened with an Escrow Collection Bank(s) and in whose favour the Bidder will issue cheques or drafts in respect of the Bid Amount when submitting a Bid.
Non-Resident - Non-Resident is a person resident outside India, as defined under FEMA.
Prospectus - The prospectus to be filed with the ROC containing, among other things the Issue Price that is determined at the end of the Book Building Process, the size of the Issue and certain other information.
Qualified Institutional Buyers or QIBs - Public financial institutions as specified in Section 4A of the Companies Act, FIIs, scheduled commercial banks, Mutual Funds, multilateral and bilateral development financial institutions, venture capital funds registered with SEBI, foreign venture capital investors registered with SEBI, state industrial development corporations, insurance companies registered with the Insurance Regulatory and Development Authority, provident funds with minimum corpus of Rs. 250 million and pension funds with minimum corpus of Rs. 250 million.
Syndicate Agreement - Agreement between the Syndicate and the Company in relation to the collection of Bids in this Issue
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IPO = Initial Public Offering
NSE = National Stock Exchange of India Limited
PAN = Permanent Account Number allotted under the I.T. Act
RBI = The Reserve Bank of India
ROC = The Registrar of Companies
SEBI = The Securities and Exchange Board of India constituted under the SEBI Act, 1992
BSE = Bombay Stock Exchange
CDSL = Central Depository Services (India) Limited
HNI = High Net worth Individual
HUF = Hindu Undivided Family
QIB = Qualified Institutional Buyer
SCRA = Securities Contracts (Regulation) Act, 1956, as amended from time to time
SEBI Guidelines = SEBI (Disclosure and Investor Protection) Guidelines, 2000 as amended from time to time
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The Indian Capital Market
Capital market is the backbone of any country’s economy. It facilitates conversion of savings to investments. Capital market can be classified as primary and secondary market. The fresh issue of securities takes place in primary market and trading among investors takes place in secondary market. Primary market is also known as new issues market. Equity investors first enter capital market though investment in primary market. In India, common investors participating in the equity primary market is massive. The number of companies offering equity through primary markets increased continuously in the post independence period till the year 1995. After 1995, there is a continuous slump experienced by the primary market offering equity. The main reason for slump is lack of investor confidence in the primary market. So it is important to understand the causes and measures of revival of investor confidence leading to capital mobilization and investment in right avenues creating, economic growth in the country.
From the early 1980s onwards, there has been a shift in India’s economic policy regime, away from direct influences upon resource allocation by the State, towards a greater role for markets. One major plank of these reforms has been an attempt at developing financial markets as an alternative vehicle determining the allocation of capital in the economy.
In India, the financial sector (and securities markets in particular) attracted heightened attention from policy makers in the aftermath of the Scam of 1992. This led to a set of State initiatives on the equity and debt markets in the following years. In this article, we primarily deal with changes in institutions governing securities issued by firms, i.e. shares and bonds.
In addition, the problems in East Asia in 1997 have led to a heightened appreciation, worldwide, of the vital importance for a developing country of a financial sector which effectively processes information and wisely allocates resources. Stiglitz (1998) describes the financial sector as ‘the brain of the economy’. Most policy–oriented economists have talked about the need for strengthening the financial sector.
The function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have investible funds or savings, which they lend to borrowers in the corporate and public sectors whose requirement of funds far exceeds their savings. A financial market consists of investors or buyers of securities, borrowers or sellers of securities, intermediaries and regulatory bodies. Financial market does not refer to a physical location. Formal trading rules, relationships and
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CHAPTER 1
communication networks for originating and trading financial securities link the participants in the market.
1. Indian financial system
Indian financial system consists of money market and capital Market. The money market has two components - the organized and the unorganized.
Money Market
Organized money market: Indian financial system consists of money market and capital Market. The money market has two components - the organized and the unorganized. The Organized market is dominated by commercial banks. The other major participants are The Reserve Bank of India, Life Insurance Corporation, General Insurance Corporation, Unit Trust of India, Securities Trading Corporation of India Ltd. and Discount and Finance House of India, other primary dealers, commercial banks and mutual funds. The core of the money market is the inter-bank call money market whereby short-term money borrowing/lending is effected to manage temporary liquidity mismatches. The Reserve Bank of India occupies a strategic position of managing market liquidity through open market operations of government securities, access to its accommodation, cost (interest rates), availability of credit and other monetary management tools. Normally, monetary assets of short-term nature, generally less than one year, are dealt in this market.
Un-organized money market: Despite rapid expansion of the organized money market through a large network of banking institutions that have extended their reach even to the rural areas, there is still an active unorganized
Indian FinancialSystem
Capital Market Money Market
Organized Money MarketUnorganized Money
Market
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market. It consists of indigenous bankers and moneylenders. In the unorganized market, there is no clear demarcation between short-term and long-term finance and even between the purposes of finance. The unorganized sector continues to provide finance for trade as well as personal consumption. The inability of the poor to meet the "creditworthiness" requirements of the banking sector make them take recourse to the institutions that still remain outside the regulatory framework of banking. But this market is shrinking.
The capital market consists of primary and secondary markets.
Primary market covering new public issues of all categories of securities, including G-sec, bonds and equity/preference capital.
Secondary market, which deals with already issued securities of all types. Transactions of the secondary market are carried out through one of the authorized stock exchanges, where the traded security is listed.
The Primary Stock Market
It is also called the market for public issues. This market refers to the raising of new capital (equity or debt i.e. equity shares, preference shares, debentures or Rights Issues) by corporate. Newly floated companies or existing companies may tap the equity market by offering public issues. When equity shares are exclusively offered to the existing shareholders, it is called "Rights Issue". When a Company after incorporation initially approaches the public for the first time for subscription of its public issue it is called Initial Public Officer (IPO). Successful floating of a new issue requires careful planning, timing of the issue and comprehensive marketing efforts. The services of specialised institutions, like underwriters, merchant bankers and registrars to the issue are available for the corporate body to handle this specialized job. Underwriters are financial institutions, which undertake to secure a committed quantum of equity/debt subscribed by the public, failing which they accept these shares/bonds as their own investment. It is referred to as the issue or that part of getting devolved on the underwriters. The transactions relating to the primary market i.e. public/rights issues are not carried out through stock exchanges. However there is effective regulation of SEBI at every stage of a public issue. This is done through merchant bankers, underwriters and registrars to the issue each acting at different points. Subscriptions to the new issue are collected at specific branches of one or more collecting banks within a prescribed span of time, represented by the dates of opening of the issue and closing of the issue.
Secondary Stock Market
The Secondary Market deals with the sale/purchase of already issued equity/debts by the corporate and others. The sale/purchase of these securities is carried out at the specific Stock Exchange(s), where the companies get their public issues listed for trading. The main function of the secondary market is to
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provide liquidity to the listed securities by enabling a holder to easily convert the securities into cash through the stock exchanges. An individual or an Institution can either hold a portfolio of securities as a permanent investment, or he can hold a basket of securities for short-periods and engage in buying and selling them to gain from market fluctuations. The secondary market also acts as an important indicator of the investment climate in the economy. When prices of existing securities are rising and there is large trading in the existing shares, such a boom in the secondary market correspondingly signifies that new issues if floated at that point of time would be successfully subscribed.
2.Functions of the Capital Market1. The organized and regulated capital market motivates individual to save
and invest funds. The availability of safe and profitable source of investment is an essential criterion to create propensity to save and invest on the part of the earning public.
2. It provides for the investors safe and productive channels for investment of savings and secures the recurring benefit of return thereon, as long as the savings are retained.
3. It provides liquidity to the savings of the investors, by developing a secondary capital market, and thus makes even short term savings, consistently available for long-term users
4. It thus mobilizes savings of large number of individuals, families and associations and make the same available for meeting the large capital needs of organized industry, trade and business and for progress and development of the country as a whole and its economy.
To discharge these functions, the organized capital market accepts a dual responsibility
To develop the market and to promote savings & Investment; To regulate the players in the market vis-à-vis the investor and to
enforce market discipline, through market regulators and registered intermediaries. Such that the unorganized small man is able to deal through these regulatory bodies and the intermediaries, and need not necessarily has to come into direct contact with the ultimate seekers of his savings.
The Corporate Sector draws its capital needs from the following sources:
1. Promoters Contribution, 2. Equity & Preference Capital raised from the shareholders (generally
referred to as equity capital), 3. Bonds/Debentures raised from the Public (generally referred to as Debt
Capital),
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4. Term Loans from Banks & Financial Institutions, 5. Short-term Working Capital from Banks, 6. Unsecured Loans & Deposits, and 7. Internal generation of Funds (Profits/surpluses re-ploughed).
Of the sources enumerated above, item No.1 and 2 are held permanently and form the risk capital. These are not repayable. Item No.3 is raised from the market for duration of 10 to 15 years or more, but this has to be eventually repaid. We call the source as Corporate Debt Market, and funds raised as II Tier Capital. The debt market consists of such corporate debt and also public debt (government securities & Treasury Bills) Managed by the RBI. The others sources at item 4 to 6 are supplementary or stand-by sources and these are all to be repaid as per contracted terms. Item No.4 is negotiated & raised for 3 to 7 years from Banks/FIs, but normally not exceeding 10 years. Short-term working capital Loan is generally a revolving facility and held over the years subject to satisfactory dealings and abiding by the terms & conditions stipulated by the lending Institution. Unsecured Loans & Deposits are at best supplementary sources, but these are not very dependable. Internal generation of funds (profits & surpluses are used to eventually redeem the debt borrowings mentioned at item No.3 to 6.
The basic capital edifice of a corporate body is built from item 1 to 3 above. With the strength of this edifice it is possible to raise the remaining sources at item No.4 to 6. This introduces us to the Capital Market (covering equity and corporate debt capital). Promoters equity constitutes a comparatively a smaller portion, and hence the primary source of capital for a large Corporate Institutions is from the Capital Market (providing the equity capital & debt capital to business, trade & industry)
Composition of Equity/Corporate Debt Market
This is the market consisting of large number of individual investors, household savers, professionals, agriculturists, who are able to retain a part of their current earnings. They form the class of capital providers. On the other side the corporate bodies engaged in Industry, trade and other business ventures are the productive users of significant amount of capital. It is the Capital market that transforms the savings of large number of individuals to productive channel to meet the demands of capital for Industry, trade and business.
The individual savers are not organized. They can invest if they could secure the trust and confidence that the funds invested would be prudently employed and they could normally expect to get a fair return/reward on their hard-earned savings. This is the function of organized capital market to regulate market forces to ensure fair dealings, to motivate savings on the part of the investors and to secure smooth flow of savings/capital from investors to capital seekers for productive needs.
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Stock market is also referred to as the Corporate Debt or Capital Market. While the money market, which deals with short-term financial needs of business and industry, is restricted to funds needed for a period of one year or less, instruments of the debt/capital markets are raised for medium or long term needs. Indian Stock Market consists of three distinct segments:
1. The Public Debt Market i.e. the market for Government securities (also called Gilt-edged Market). These are interest bearing and dated securities. This market is regulated by RBI, the Central Bank of the country and banker to the Government.
2. PSU Bonds Market i.e. Bonds floated by public Sector units, nationalized banks and financial Institutions for raising Tier-II capital and also debentures floated by corporate. This is represented as the Corporate Debt Market.
3. The Equity Market for rising of equity or preference share capital by all corporate. Money invested in company shares is not refundable, but if the shares are listed in a stock exchange these can be sold or purchased, thus providing liquidity to such investments. Shares do not carry interest, but shareholders can participate in sharing the profits of the corporate body declared by way of dividends, bonus shares etc. While the hope of receiving attractive dividends motivates the public to subscribe to the share capital, declaring dividend is not a legal obligation on the part of the companies, and hence not a right on the part of the shareholders. But shareholders enjoy various other rights as conferred by the Indian Companies Act, 1956. Indian Public companies generally follow the objective of increasing shareholders wealth as the prime goal of financial management.
3. Instruments in Capital Market
The changes in the regulatory framework of the capital market and fiscal policies have also resulted in newer kinds of financial instruments (securities) being introduced in the market. Also, a lot of financial innovation by companies who are now permitted to undertake treasury operations, has resulted in newer kinds of instruments - all of which can be traded – being introduced. The variations in all these instruments depend on the tenure, the nature of security, the interest rate, the collateral security offered and the trading features, etc.
Debentures
These are issued by companies and regulated under the SEBI guidelines of June 11, 1992. These are issued under a prospectus, which has to be approved
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by SEBI like in the case of equity issues. The rights of investors as debenture holders are governed by the Companies Act, which prohibits the issue of debentures with voting rights. There are a large variety of debentures that is available. This includes:
• Participating debentures• Convertible debentures with options• Third party convertible debentures• Debt/equity swaps• Zero coupon convertible notes• Secured premium notes• Zero interest fully convertible debentures• Fully convertible debentures with interest• Partly convertible debentures.
Bonds
Indian DFIs, like IDBI, ICICI, and IFCI, have been raising capital for their operations by issuing of bonds. These too are available in a large variety. These include:
• Income bonds• Tax-free bonds• Capital gains bonds• Deep discount bonds• Infrastructure bonds• Retirement bonds
In addition to the interest rates and maturity profiles of these instruments, the issuer institutions have been including a put/call option on especially the very long-dated bonds like deep discount bonds. Since the tenures of some of these instruments spanned some 20 or 25 years during which the interest rate regimes may undergo a complete change, the issuers have kept the flexibility to retire the costly debt. This they do by exercising their option to redeem the securities at pre-determined periods like at the end of five or seven years. This has been witnessed in number of instruments recently much to the chagrin of investors who were looking for secure and hassle-free long-dated instruments.
Preference SharesAs the name suggests, owners of preferential shares enjoy a preferential treatment with regard to corporate actions like dividend. They also have a higher right of repayment in case of winding up of a company. Preference shares have different features and are accordingly available as:
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• Cumulative and non-cumulative• Participating• Cumulative & Redeemable fully convertible to preference shares• Cumulative & Redeemable fully convertible to equity• Preference shares with warrants• Preference shares
Equity Shares
As the name indicates, these represent the proportionate ownership of the company. This right is expressed in the form of participation in the profits of the company. There has been some innovation in the way these instruments are issued. Some hybrid securities like equity shares with detachable warrants are also available.
Government securities
The Central Government or State Governments issue securities periodically for the purpose of raising loans from the public. There are two types of Government Securities – Dated Securities and Treasury Bills. Dated Securities have a maturity period of more than one year. Treasury Bills have a maturity period of less than or up to one year. The Public Debt Office (PDO) of the Reserve Bank of India performs all functions with regard to the issue management, settlement of trade, distribution of interest and redemption. Although only corporate and institutional investors subscribe to government securities, individual investors are also permitted to subscribe to these securities. An investor in government securities has the option to have securities issued either in physical form or in book-entry form (commonly known as Subsidiary General Ledger form). There are two types of SGL facilities, viz., SGL-1 and SGL-2. In the SGL-1 facility, the account is opened with the RBI directly. There are several restrictions on opening SGL-1 accounts and only entities, which fulfill all the eligibility criteria, are permitted to open SGL-1 account. The RBI has permitted banks, registered primary dealers and certain other entities like NSCCL, SHCIL, and NSDL to provide SGL facilities to subscribers. A subscriber to government securities who opts for SGL securities may open an SGL account with RBI or any other approved entity. Investments made by such approved entity on its own account are held in SGL-1 account, and investments held on account of other clients are held in SGL-2 account.
4.Capital Market Processes
There are various processes that Issuers of securities follow or utilize in order to tap the savers for raising resources. Some of the commonly used processes and methods are described below.
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Initial Public Offering (IPO)
Companies, new as well as old can offer their shares to the investors in the primary market. This kind of tapping the savings is called an IPO or Initial Public Offering. SEBI regulates the way in which companies can make this offering. New companies can make an IPO if they have a dividend-paying (ability) record of three years. The size of the initial issue, the exchange on which it can be listed, the merchant bankers' responsibilities, the nature and content of the disclosures in the prospectus, procedures for all these are laid down by SEBI and have to be strictly complied with. Exemption may be granted by SEBI in certain cases for minimum public offer or minimum subscription in the case of certain industry sectors like infrastructure or IT or media & communications. Several changes have also been introduced in recent years in the manner in which the IPOs can be marketed. For example they can now take the book building route or they can even be marketed through the secondary market by brokers or DPs. All these changes have been made with the objective of making the process more investor friendly by reducing risk, controlling cost, greater transparency in the pricing mechanism and protecting liquidity in the hands of the investor. Some of the IPOs have been available for subscription online - where the bids are made in real time and the information is made available on an instantaneous basis on the screen. It is possible to subscribe for IPO shares in demat form through DPs.
Private Placement
Many companies choose to raise capital for their operations through various intermediaries by taking what in marketing terms would be known as the wholesale route. The retail route - of approaching the public -is expensive as well as time consuming. This is called in financial markets as private placement. SEBI has prescribed the eligibility criteria for companies and instruments as well as procedures for private placement. However, liquidity for the initial investors in privately placed securities is ensured as they can be traded in the secondary market. But such securities have different rules for listing as well as for trading.
Preferential Offer/Rights Issue
Companies can expand their capital by offering the new shares to their existing shareholders. Such offers for sale can be made to the existing shareholders by giving them a preferential treatment in allocation or the offer can be on a rights basis, i.e., the existing holders can get by way of their right, allotment of new shares in certain proportion to their earlier holding. All such offers have also to be approved by SEBI which has laid out certain criteria for these routes of tapping the public. These have to be complied with.
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Internet Broking
With the Internet becoming ubiquitous, many institutions have set up securities trading agencies that provide online trading facilities to their clients from their homes. This has been possible since all the players in the securities market, viz., stockbrokers, stock exchanges, clearing corporations, depositories, DPs, clearing banks, etc., are linked electronically. Thus, information flows amongst them on a real time basis. The trading platform, which was converted from the trading hall to the computer terminals at the brokers' premises, has now shifted to the homes of investors. This has introduced a higher degree of transparency in transactions. The investor knows exactly when and at what rate his order was processed. It also creates an end-to-end audit trail that makes market manipulation difficult. The availability of securities in demat form has given a further fillip to this process. However, the emergence of, what is known as, "day-traders" has resulted in the business environment of brokers which has changed. Investors, who can now trade directly, no longer require their intermediation. Service charges have therefore been declining - all of which has been in favour of investors.
5. Capital Market Participants:
There are several major players in the primary market. These include the merchant bankers, mutual funds, financial institutions, foreign institutional investors (FIIs) and individual investors. In the secondary market, there are the stock brokers (who are members of the stock exchanges), the mutual funds, financial institutions, foreign institutional investors (FIIs), and individual investors. Registrars and Transfer Agents, Custodians and Depositories are capital market intermediaries that provide important infrastructure services for both primary and secondary markets.
Market regulation: It is important to ensure smooth working of capital market, as it is the arena where the players in the economic growth of the country. Various laws have been passed from time to time to meet this objective.
The financial market in India was highly segmented until the initiation of reforms in 1992-93 on account of a variety of regulations and administered prices including barriers to entry. The reform process was initiated with the establishment of Securities and Exchange Board of India (SEBI).
The legislative framework before SEBI came into being consisted of three major Acts governing the capital markets:
1. The Capital Issues Control Act 1947, which restricted access to the securities market and controlled the pricing of issues.
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2. The Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities, and disclosures to be made in Public issues.3. The Securities Contracts (Regulation) Act, 1956, which regulates transactions in securities through control over stock exchanges. In addition, a number of other Acts, e.g., the Public Debt Act, 1942, the Income Tax Act, 1961, the Banking Regulation Act, 1949, have substantial bearing on the working of the securities market.
Capital Issues (Control) Act, 1947
The Act had its origin during the Second World War in 1943 when the objective of the Government was to pre-empt resources to support the War effort. Companies were required to take the Government's approval for tapping household savings. The Act was retained with some modifications as a means of controlling the raising of capital by companies and to ensure that national resources were channeled into proper lines, i.e., for desirable purposes to serve goals and priorities of the government, and to protect the interests of investors. Under the Act, any firm wishing to issue securities had to obtain approval from the Central Government, which also determined the amount, type and price of the issue. This Act was repealed and replaced by SEBI Act in 1992.
Securities Contracts (Regulation) Act, 1956
The previously self-regulated stock exchanges were brought under statutory regulation through the passage of the SC(R) A, which provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges. This gives the Central Government regulatory jurisdiction over (a) stock exchanges, through a process of recognition and continued supervision, (b) contracts in securities, and (c) listing of securities on stock exchanges. As a condition of recognition, a stock exchange complies with conditions prescribed by Central Government. Organized trading activity in securities in an area takes place on a specified recognized stock exchange. The stock exchanges determine their own listing regulations which have to conform to the minimum listing criteria set out in the Rules. The regulatory jurisdiction on stock exchanges was passed over to SEBI on enactment of SEBI Act in 1992 from Central Government by amending SC(R) Act.
Companies Act, 1956
Companies Act, 1956 is a comprehensive legislation covering all aspects of company form of business entity from formation to winding-up. This legislation (amongst other aspects) deals with issue, allotment and transfer of securities and various aspects relating to company management. It provides for standards of disclosure in public issues of capital, particularly in the fields of company management and projects, information about other listed companies under the same management, and management perception of risk factors. It
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also regulates underwriting, the use of premium and discounts on issues, rights and bonus issues, substantial acquisitions of shares, payment of interest and dividends, supply of annual report and other information.
This legal and regulatory framework contained many weaknesses. Jurisdiction over the securities market split among various agencies and the relevant was scattered in a number of statutes. This resulted in confusion, not only in the minds of the regulated but also among regulators. It also created inefficiency in the enforcement of the regulations. It was the Central Government rather than the market that allocated resources from the securities market to competing issuers and determined the terms of allocation. The allocation was not necessarily based on economic criteria, and as a result the market was not allocating the resources to the best possible investments, leading to a sub-optimal use of resources and low allocation efficiency. Informational efficiency was also low because the provisions of the Companies Act regarding prospectus did not ensure the supply of necessary, adequate and accurate information, sufficient to enable investors to make an informed decision. The many formalities associated with the issue process under various regulations kept the cost of issue quite high.
Under the SC(R) Act, the secondary market was fragmented regionally, with each stock exchange a self-regulating organization following its own policy of listing, trading and settlement. The listing agreement did not have the force of law, so that issuers could get away with violations.
The interests of the brokers, who were market players and dominated the governing boards of stock exchanges, took priority over the interest of investors. The market was narrow and investors did not have an opportunity to have balanced portfolios. The settlement of trades took a long time, because it required physical movement of securities, and the transfer of securities was very cumbersome under the Companies Act and SC(R)Act, thus depriving the investor of liquidity. Law expressly forbade options and futures. These weaknesses were corrected by passing SEBI Act and giving overall regulatory jurisdiction on capital market to SEBI. SEBI framed regulations and guidelines to improve efficiency of the market, enhance transparency, check unfair trade practices and ensure international standards in market practices necessitated by the large entry of foreign financial institutions.
National Stock Exchange
The National Stock Exchange was set up in 1995 as a first step in reforming the securities market through improved technology and introduction of best practices in management. It started with the concept of an independent governing body without any broker representation thus ensuring that the operators' interests were not allowed to dominate the governance of the
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exchange. Before the NSE was set up, trading on the stock exchanges in India used to take place through open outcry without use of information technology for immediate matching or recording of trades. This was time consuming and inefficient. The practice of physical trading imposed limits on trading volumes and, hence, the speed with which new information was incorporated into prices. To obviate this, the NSE introduced screen-based trading system (SBTS) where a member can punch into the computer the quantities of shares and the prices at which he wants to transact. The transaction is executed as soon as the quote punched by a trading member finds a matching sale or buy quote from counterparty. SBTS electronically matches the buyer and seller in an order-driven system or finds the customer the best price available in a quote-driven system, and, hence, cuts down on time, cost and risk of error, as well as on the chances of fraud. SBTS enables distant participants to trade with each other, improving the liquidity of the markets. The high speed with which trades are executed and the large number of participants who can trade simultaneously allows faster incorporation of price sensitive information into prevailing prices. This increases the informational efficiency of markets. With SBTS, it becomes possible for market participants to see the full market, which helps to make the market more transparent, leading to increased investor confidence. The NSE started nation-wide SBTS, which have provided a completely transparent trading mechanism. Regional exchanges lost a lot of business to NSE, forcing them to introduce SBTS. Today, India can boast that almost 100% trading take place through electronic order matching.
Prior to the setting up of NSE, trading on stock exchanges in India took place without the use of information technology for immediate matching or recording of trades. The practice of physical trading imposed limits on trading volumes as well as the speed with which the new information was incorporated into prices. The unscrupulous operators used this information asymmetry to manipulate the market. The information asymmetry helped brokers to perpetrate a manipulative practice known as "gala". Gala is a practice of extracting highest price of the day for "buy" transaction irrespective of the actual price at which the purchase was actually done and give lowest price of the day for "sell" transactions irrespective of the price at which sale was made. The clients did not have any method of verifying the actual price. The electronic and now fully online trading introduced by the NSE has made such manipulation difficult. It has also improved liquidity and made the entire operation more transparent and efficient.
The NSE has set up a clearing corporation to provide legal counterparty guarantee to each trade thereby eliminating counterparty risk. The National Securities Clearing Corporation Ltd. (NSCCL) commenced operations in April 1996. Counterparty risk is guaranteed through fine-tuned risk management systems and an innovative method of on-line position monitoring and automatic disablement. Principle of "novation" is implemented by NSE capital market segment. Under this principle, NSCCL is the counterparty for every
20
transaction and, therefore, default risk is minimized. To support the assured settlement, a "settlement guarantee fund" has been created. A large settlement guarantee fund provides a cushion for any residual risk. As a consequence, despite the fact that the daily traded volumes on the NSE run into thousands of crores of rupees, credit risk no longer poses any problem in the marketplace.
Depository System
The erstwhile settlement system on Indian stock exchanges was also inefficient and increased risk, due to the time that elapsed before trades were settled. The transfer was by physical movement of papers. There had to be a physical delivery of securities -a process fraught with delays and resultant risks. The second aspect of the settlement related to transfer of shares in favour of the purchaser by the company. The system of transfer of ownership was grossly inefficient as every transfer involves physical movement of paper securities to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. In many cases the process of transfer would take much longer than the two months stipulated in the Companies Act, and a significant proportion of transactions would end up as bad delivery due to faulty compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities were rampant. In addition, the issuer had the right to refuse the transfer of a security. All this added to costs and delays in settlement, restricted liquidity and made investor grievance redress time consuming and, at times, intractable.
To obviate these problems, the Depositories Act, 1996 was passed. It provides for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security. It does so by (a) making securities of public limited companies freely transferable subject to certain exceptions; (b) dematerializing the securities in the depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order to streamline both the stages of settlement process, the Act envisages transfer ownership of securities electronically by book entry without making the securities move from person to person. The Act has made the securities of all public limited companies freely transferable, restricting the company's right to use discretion in effecting the transfer of securities, and the transfer deed and other procedural requirements under the Companies Act have been dispensed with. Two depositories, viz., NSDL and CDSL, have come up to provide instantaneous electronic transfer of securities.
In any stock exchange, trades or transactions have to be settled by either squaring up the carrying forward positions or settling by payment of net cash or net delivery of securities. This account settlement period, if it is long, leads to several price distortions and allows for market manipulation. It increases the chances of speculation resulting in volatility, which hurts the small investors. With the application of IT in the securities market - screen-based trading and
21
trading through the Internet - it has been possible to reduce this settlement period.
Capital Market Intermediaries
There are several institutions, which facilitate the smooth functioning of the securities market. They enable the issuers of securities to interact with the investors in the primary as well as the secondary arena.
Merchant Bankers
Among the important financial intermediaries are the merchant bankers. The services of merchant bankers have been identified in India with just issue management. It is quite common to come across reference to merchant banking and financial services as though they are distinct categories. The services provided by merchant banks depend on their inclination and resources - technical and financial. Merchant bankers (Category 1) are mandated by SEBI to manage public issues (as lead managers) and open offers in take-overs. These two activities have major implications for the integrity of the market. They affect investors' interest and, therefore, transparency has to be ensured. These are also areas where compliance can be monitored and enforced.
Merchant banks are rendering diverse services and functions. These include organising and extending finance for investment in projects, assistance in financial management, acceptance house business, raising Euro-dollar loans and issue of foreign currency bonds. Different merchant bankers specialise in different services. However, since they are one of the major intermediaries between the issuers and the investors, their activities are regulated by:
(1) SEBI (Merchant Bankers) Regulations, 1992.
(2) Guidelines of SEBI and Ministry of Finance.
(3) Companies Act, 1956.
(4) Securities Contracts (Regulation) Act, 1956.
Merchant banking activities, especially those covering issue and underwriting of shares and debentures, are regulated by the Merchant Bankers Regulations of Securities and Exchange Board of India (SEBI). SEBI has made the quality of manpower as one of the criteria for renewal of merchant banking registration. These skills should not be concentrated in issue management and underwriting alone. The criteria for authorisation take into account several parameters. These include: (a) professional qualification in finance, law or business management, (b) infrastructure like adequate office space, equipment and manpower, (c) employment of two persons who have the experience to conduct the business of merchant bankers, (d) capital adequacy and (e) past track record, experience, general reputation and fairness in all their transactions.
22
SEBI authorizes merchant bankers for an initial period of three years, if they have a minimum net worth of Rs. 5 crore. An initial authorization fee, an annual fee and renewal fee is collected by SEBI. According to SEBI, all issues should be managed by at least one authorized merchant banker functioning as the sole manager or lead manager. The lead manager should not agree to manage any issue unless his responsibilities relating to the issue, mainly disclosures, allotment and refund, are clearly defined. A statement specifying such responsibilities has to be furnished to SEBI. SEBI prescribes the process of due diligence that a merchant banker has to complete before a prospectus is cleared. It also insists on submission of all the documents disclosing the details of account and the clearances obtained from the ROC and other government agencies for tapping peoples' savings. The responsibilities of lead manager, underwriting obligations, capital adequacy, due diligence certification, etc., are laid down in detail by SEBI. The objective is to facilitate the investors to take an informed decision regarding their investments and not expose them to unknown risks.
Credit Rating Agencies
The 1990s saw the emergence of a number of rating agencies in the Indian market. These agencies appraise the performance of issuers of debt instruments like bonds or fixed deposits. The rating of an instrument depends on parameters like business risk, market position, operating efficiency, adequacy of cash flows, financial risk, financial flexibility, and management and industry environment.
The objective and utility of this exercise is twofold. From the point of view of the issuer, by assigning a particular grade to an instrument, the rating agencies enable the issuer to get the best price. Since all financial markets are based on the principle of risk/reward, the less risky the profile of the issuer of a debt security, the lower the price at which it can be issued. Thus, for the issuer, a favorable rating can reduce the cost of borrowed capital. From the viewpoint of the investor, the grade assigned by the rating agencies depends on the capacity of the issuer to service the debt. It is based on the past performance as well as an analysis of the expected cash flows of a company when viewed on the industry parameters as well as company performance. Hence, the investor can judge for himself whether he wants to place his savings in a "safe" instrument and get a lower return or he wants to take a risk and get a higher return.
The 1990s saw an increase in activity in the primary debt market. Under the SEBI guidelines all issuers of debt have to get the instruments rated. They also have to prominently display the ratings in all that marketing literature and advertisements. The rating agencies have thus become an important part of the institutional framework of the Indian securities market.
23
R& T Agents - Registrars to Issue
R&T Agents form an important link between the investors and issuers in the securities market. A company, whose securities are issued and traded in the market, is known as the Issuer. The R&T Agent is appointed by the Issuer to act on its behalf to service the investors in respect of all corporate actions like sending out notices and other communications to the investors as well as dispatch of dividends and other non-cash benefits. R&T Agents perform an equally important role in the depository system as well. These are described in detail in the second section of this Workbook.
Stock Brokers
Stockbrokers are the intermediaries who are allowed to trade in securities on the exchange of which they are members. They buy and sell on their own behalf as well as on behalf of their clients. Traditionally in India, individuals owned firms providing brokerage services or they were partnership firms with unlimited liabilities. There were, therefore, restrictions on the amount of funds they could raise by way of debt. With increasing volumes in trading as well as in the number of small investors, lack of adequate capitalization of these firms exposed investors to the risks of these firms going bust and the investors would have no recourse to recovering their dues.
With the legal changes being effected in the membership rules of stock exchanges as well as in the capital gains structure for stock-broking firms, a number of brokerage firms have converted themselves into corporate entities. In fact, NSE encouraged the setting up of corporate broking members and has today has only 10% of its members who are not corporate entities.
Custodians
In the earliest phase of capital market reforms, to get over the problems associated with paper-based securities, large holding by institutions and banks were sought to be immobilized. Immobilization of securities is done by storing or lodging the physical security certificates with an organization that acts as a custodian - a securities depository. All subsequent transactions in such immobilized securities take place through book entries. The actual owners have the right to withdraw the physical securities from the custodial agent whenever required by them. In the case of IPO, a jumbo certificate is issued in the name of the beneficiary owners based on which the depository gives credit to the account of beneficiary owners. The Stock Holding Corporation of India was set up to act as a custodian for securities of a large number of banks and institutions who were mainly in the public sector. Some of the banks and financial institutions also started providing "Custodial" services to smaller investors for a fee. With the introduction of dematerialization of securities there has been a shift in the role and business operations of Custodians. But they still
24
remain an important intermediary providing services to the investors who still hold securities in a physical form.
Mutual Funds
Mutual funds are financial intermediaries, which collect the savings of small investors and invest them in a diversified portfolio of securities to minimize risk and maximize returns for their participants. Mutual funds have given a major fillip to the capital market - both primary as well as secondary. The units of mutual funds, in turn, are also tradable securities. Their price is determined by their net asset value (NAV) which is declared periodically. The operations of the private mutual funds are regulated by SEBI with regard to their registration, operations, administration and issue as well as trading.
Depositories
The depositories are important intermediaries in the securities market that is scrip-less or moving towards such a state. In India, the Depositories Act defines a depository to mean "a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under sub-section (IA) of section 12 of the Securities and Exchange Board of India Act, 1992." The principal function of a depository is to dematerialize securities and enable their transactions in book-entry form.
Dematerialization of securities occurs when securities, issued in physical form, are destroyed and an equivalent number of securities are credited into the beneficiary owner's account. In a depository system, the investors stand to gain by way of lower costs and lower risks of theft or forgery, etc. They also benefit in terms of efficiency of the process. But the implementation of the system has to be secure and well governed. All the players have to be conversant with the rules and regulations as well as with the technology for processing. The intermediaries in this system have to play strictly by the rules. A depository established under the Depositories Act can provide any service connected with
recording of allotment of securities or transfer of ownership of securities in the record of a depository. A depository cannot directly open accounts and provide services to clients. Any person willing to avail of the services of the depository can do so by entering into an agreement with the depository through any of its Depository Participants. The services, functions, rights and obligations of depositories, with special reference to the NSDL are provided in the second section of this Workbook.
Depository Participants
A Depository Participant (DP) is described as an agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement
25
made between the two under the Depositories Act. In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the provisions of the SEBI Act. As per the provisions of this Act, a DP can offer depository related services only after obtaining a certificate of registration from SEBI. SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers, R&T agents and non-banking finance companies (NBFC), for granting them a certificate of registration to act as DPs. If a stockbroker seeks to act as a DP in more than one depository, he should comply with the specified net worth criterion separately for each such depository. No minimum net worth criterion has been prescribed for other categories of DPs. However, depositories can fix a higher net worth criterion for their DPs. NSDL requires a minimum net worth of Rs. 100 lakh to be eligible to become a DP as against Rs. 50 lakh prescribed by SEBI (D&P) Regulations. The role, functions, responsibilities and business operations of DPs are described in detail in the second section of this book.
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The Indian Primary Capital Market
The primary market plays an important role in the securities market by forming a link between the savings and investments. It is through this market that the borrower’s viz., the Government and the corporate issue securities in which the investors deploy their savings. The primary market comprises the public issues and the private placement market. A public issue consists of a company entering the market to raise funds from all types of investors; its debut is known as the initial public offer (IPO). In case of private placement, there are only a few select subscribers to the issue. The securities can be issued at a face value, or at a discount/premium; they may take a variety of forms such as equity, debt or some hybrid instrument. Apart from raising funds in domestic markets, resources are mobilized in international markets through the issuance of American Depository Receipts (ADRs)/Global Depository Receipts (GDRs) and External Commercial Borrowing (ECB) route.
Role of the ‘Primary Market
The primary market provides the channel for sale of new securities. Primary market provides opportunity to issuers of securities; Government as well as corporate, to raise resources to meet their requirements of investment and/or discharge some obligation. They may issue the securities at face value, or at a discount/premium and these securities may take a variety of forms such as equity, debt etc. They may issue the securities in domestic market and/or international market.
Need to issue shares to the public
Most companies are usually started privately by their promoter(s). However, the promoters’ capital and the borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a long term. So companies invite the public to contribute towards the equity and issue shares to individual investors. The way to invite share capital from the public is through a ‘Public Issue’. Simply stated, a public issue is an offer to the public to subscribe to the share capital of a company. Once this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid down by SEBI.
Different kinds of issues
Primarily, issues can be classified as a Public, Rights or Preferential issues (also known as private placements). While public and rights issues involve a detailed procedure, private placements or preferential issues are relatively simpler. The classification of issues is illustrated below:
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CHAPTER 2
Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s securities.
A follow on public offering (Further Issue) is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document.
Rights Issue is when a listed company which proposes to issue fresh securities to its existing shareholders as on a record date. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. This route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders.
A Preferential issue is an issue of shares or of convertible securities by listed companies to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. The issuer company has to comply with the Companies Act.
After a long period of subdued activity, there were signs of revival in the public issues in 2003-04. This was due to the offers made by quality issuers evoking buoyant investors’ interest. In the private placement market, the SEBI, for the first time, imposed stringent disclosure norms in September 2003. As a result, the resources mobilized by non-government entities fell from 88% in 2002-03 to 85% in 2003-04. The public issues mobilized Rs 71,900
28
million during this year. Further, the resources raised by Indian corporate from the international capital market through the issuance of FCCBs, GDRs and ADRs have declined marginally during 2003-04. With a view to integrate the Indian capital market, the foreign companies have been allowed to access the Indian capital market through Indian Depository Receipts (IDR).
Resource mobilization from the primary market through public issues (excluding offers for sale) increased by 23.1 per cent to Rs.26, 940 crore during2005-06. The increase in resource mobilization during 2005-06 was entirely onAccount of private sector companies as resources raised by public sector companies were lower than a year ago. Private sector companies continued to
Report from RBI Annual Report 2006
29
Dominate the public issues market, mobilizing 78.5 per cent of the total resource mobilization during 2005-06 as compared with 61.6 per cent during 2004-05. Banks were the major issuers during the year in view of their requirements for capital adequacy purposes. Banks and financial institutions in both public and private sectors mobilized 48.8 per cent of resources by public issues in 2005-06. Six public sector banks raised equity worth Rs.5, 413 crore through public issues, and accounting for about 20.1 per cent of the resources raised during 2005-06. Almost one-half (46.7 per cent) of the amounts raised during the year were through the initial public offerings (IPOs). Equity issues constituted 99.1 per cent of the total resource mobilization through public issues during 2005-06 as compared with 82.3 per cent during the previous year
Capital Raised during 2005-06
During 2005-06, 139 companies accessed the primary market through public and rights issues and mobilized Rs.27,382 crore compared to 60 companies raising Rs.28,256 crore in 2004-05. While the number of issues in 2005-06 was more than twice of that in 2004-05, the amount mobilized was marginally lower. Excluding the offer for sale, the amount raised during 2005- 06 stood at Rs.27,104 crore, which was higher than that of Rs.25,056 crore mobilized in the previous year. There were 103 public issues in 2005-06, of which 79 were initial public offerings (IPOs) and 24 were further public offerings (FPOs). The resources mobilized through IPOs and FPOs during 2005-06 were Rs.10,936 crore and Rs.12,358 crore, respectively. The average size of the public issues was significantly lower at Rs.226 crore in 2005-06 compared to Rs.725 crore in 2004-05. The number of rights issues during 2005-06 was higher at 36 than that of 26 in 2004-05. The amount mobilised through rights issues was also higher at Rs.4,088 crore in 2005-06 compared to Rs.3,616 crore in the previous year.
Resource Mobilization through Public and Right Issues
Particular 2004-05Rs crore
2005-06Rs crore
Percentage share in total Amount
No. Amount No. Amount 2004-05 2005-061 2 3 4 5 6 7Public issues 34 24640 103 23294 87.20 85.07IPOs 23 12382 79 10936 43.82 39.94FPOs 11 12258 24 12358 43.38 45.13Right issues 26 3616 36 4088 12.80 14.93Total 60 28256 139 27382 100.00 100.00Memo itemOffer for sale 3 3200 3 278 11.32 1.01
30
Share of broad categories of issue in the Total Amount of Capital issued
43.8 43.4
12.8
39.9
45.1
14.9
0
5
10
15
20
25
30
35
40
45
50
IPOs FPOs Rights
2004-05 2005-06
All the public issues through IPOs emanated from the private sector companies in 2005-06, except one i.e., Gujarat State Petronet Ltd., which was a public sector nonfinancial company. As the average size of IPOs was small, the share of resources mobilized through IPOs in the total amount raised declined from 43.8 per cent in 2004-05 to 39.9 per cent in 2005-06 . However, the share of the resources raised through FPOs by the listed companies in the total amount mobilised rose from 43.4 per cent in 2004-05 to 45.1 per cent in 2005-06. The share of resources mobilised through rights issues in the total amount mobilised also rose from 12.8 per cent in 2004-05 to 14.9 per cent in 2005-06. The largest rights issue during 2005-06 was that of Hindalco Industries Ltd. (Rs.2,227 crore), followed by Nicholas Piramal Ltd. (Rs.333 crore). Barring two composite issues, all other issues were equity issues. Month wise, the highest amount was mobilised in December 2005 (Rs.8,984 crore), followed by January 2006 (Rs.3,798 crore) and February 2006 (Rs.2,790 crore). However, the number of issues was the highest at 21 during March 2006, followed by 17 each during December 2005 and February 2006.
Sector-wise Resource Mobilisation
Sector-wise classification reveals that private sector garnered Rs.20,199 crore through 131 issues in 2005-06 compared to Rs.17,162 crore raised through 55 issues in 2004-05. Most of the nongovernmental public limited companies accessed the primary market mainly due to congenial investment climate prevailing in the economy, supported by sustained buoyancy in the secondary
31
market. In fact, the share of private sector in the total resource mobilisation rose significantly from 60.7 per cent in 2004-05 to 73.8 per cent in 2005-06 . During 2005-06, there were 8 issues from the public sector which mobilized Rs.7,183 crore compared to 5 issues which raised Rs.11,094 crore in 2004-05. Out of 8 public sector issues, 6 were from the public sector banks and the remaining two issues were from Gujarat State Petronet Corporation Ltd. and Infrastructure Development Finance Company Ltd.
Sector wise Mobilisation of resources (Rs. Crore)
Sector 2004-05 2005-06Percentage share in the Total Amount
No. Amount No Amount 2004-05 2005-06
1 2 3 4 5 6 7
Private 55 17,162 131 20,199 60.74 74
Public 5 11,094 8 7,183 39.26 26
Total 60 28,256 139 27,382 100 100
Sectoral Shares in the Total Resource Mobilization
60.74
39.26
74
26
0
10
20
30
40
50
60
70
80
Private Public
2004-05
2005-06
Size-wise Classification of Resources Mobilised
During 2005-06, the size of the issues was generally smaller than those in the previous year. The average size of the issues in 2005-06 was Rs.197 crore compared to Rs.471 crore in 2004-05. This indicates rise in the number of medium and small sized companies accessing the capital market for their financing needs. It also shows a shift in the financing mode from the traditional sources of finance like banks/financial institutions to the capital market. In the
32
category of above Rs.500 crore, there were 9 issues which mobilised Rs.15,506 crore compared to 8 such issues which raised Rs.23,431 crore in 2004-05 . As a result, the share of above Rs.500 crore category in the total amount declined from 82.9 per cent in 2004-05 to 56.6 per cent in 2005-06. The share of all other size groups witnessed significant improvement except Rs.5 crore to Rs.10 crore category which recorded marginal decline.There were 17 mega issues in 2005-06. The largest issue during 2005-06 was that of ICICI Bank Ltd. (Rs.5,101 crore), followed by Hindalco Industries Ltd. (Rs.2,227 crore) and Bank of Baroda (Rs.1,633 crore) (Table 2.4). During 2005-06, the largest IPO was issued by Suzlon Energy Ltd., which raised Rs.1,496 crore. The issue of ICICI Bank Ltd. was the largest FPO in 2005-06. Of the 17 mega issues, seven were by banks and one issue was by a financial institution. There were two rights issues among the 17 mega issues during 2005-06. The remaining mega issues were from diverse sectors like paper, power, entertainment, finance etc.
Issue Size2004-05 2005-06
percentage of total amount
No. Amount No Amount 2004-05 2005-061 2 3 4 5 6 7Rs.5 crore 2 3 6 20 0.01 0.07=> Rs.5 crore & < Rs.10 crore 5 44 4 32 0.16 0.12=> Rs.10 crore & < Rs.50 crore 17 461 47 1,325 1.63 4.84=> Rs.50 crore & < Rs.100 crore 11 723 33 2,189 2.56 7.99=> Rs.100 crore & < Rs.500 crore 17 3,594 40 8,309 12.72 30.35=> Rs.500 crore 8 23,431 9 15,506 82.92 56.63Total 60 28256 139 27381 100.00 100.00
Industry-wise Resource Mobilisation
Industry-wise, banks/financial institutions continued to dominate the amount of resources mobilised from the primary market during 2005-06 and raised Rs.12,439 crore through 12 issues . During 2004-05, there were 12 issues from the banks /financial institutions which raised Rs.11,311 crore. The share of the banks/financial institutions in the total amount raised increased to 45.4 per cent in 2005-06 from 40.0 per cent in 2004-05. The highest number of issues were from the information technology sector (15 issues), followed by textile sector (13 issues). Other sectors which mobilised sizeable amount of resources from the primary market were power (Rs.2,164 crore), engineering (Rs.1,124 crore), cement and construction (Rs.1,020 crore) and information technology (Rs.902 crore). The share of the power sector, which was 20.7 per cent of the total resource mobilization in 2004-05, declined to 7.9 per cent in 2005-06. Six public sector banks raised Rs.5,413 crore through equity issues in 2005-06. Apart from the public sector banks, five private sector banks viz., ICICI Bank Ltd., Yes Bank Ltd., Lakshmi Vilas Bank Ltd., the South Indian Bank Ltd., and United Western Bank Ltd., accessed the primary market for raising resources . As mentioned earlier, the largest issue among the banks/financial institutions was that of ICICI Bank Ltd. which raised Rs.5,101 crore. This was incidentally
33
the biggest issue of the financial year. Banks/ financial institutions accessed the capital Market on a larger scale to increase their capital adequacy ratio in accordance with the Basel II norms.
Industry
2004-05 2005-06
No. Amount
% Share in the Total Amount No. Amount
% share in the Total Amount
1 2 3 4 5 6 7
Banks/FIIs 12 11,311 40.03 12 12,439 45.43
Cement and Construction 2 169 0.60 11 1,020 3.72
Chemical 4 128 0.45 2 128 0.47
Electronics 2 61 0.22 2 54 0.20
Engineering 3 133 0.47 6 1,124 4.10
Entertainment 3 154 0.54 7 710 2.59
Finance 3 116 0.41 7 824 3.01
Food processing 6 317 1.12 9 427 1.56
Healthcare 2 109 0.39 10 651 2.38
Information Technology 5 5095 18.03 15 902 3.29
Paper and Pulp 1 60 0.21 4 182 0.66
Power 2 5854 20.72 6 2,164 7.90
Printing 1 130 0.46 1 43 0.16
Telecom 2 25 0.09 0 0 0.00
Textile 0 0 0.00 13 771 2.82
Miscellaneous 12 4595 16.26 34 5,944 21.71
Total 60 28,257 100 139 27,383 100.00
PUBLIC ISSUE MOBILISATION MAY CROSS RS. 45,000 CRORE IN 2006-07: On the heels of a buoyant capital market, 2006 may witness a bumper period for public issues. According to Mr.Prithvi Haldea of PRIME, country’s leading database on the primary market, the current pipeline is already Rs. 85,000 crore strong and is building up by the day. However, all of this cannot and will not mature within 2006 and it is estimated that the year may have public issues of about Rs. 45,000 crore. This will be the highest-ever amount raised in a year-the previous highest was Rs. 30,511 crore in 2004. The calendar 2005, despite an extremely bullish secondary market and a high-return primary market, had ended with a lower mobilization of Rs. 22,754 crore, which nevertheless was the second highest-ever.
DATABASE COVERAGE:1989-90 to 2006-07 (18 years)
34
YearAmount(Rs.crore)
No. ofIssues
1989-90 2,793 187 1990-91 1,704 141 1991-92 1,898 196 1992-93 6,252 528 1993-94 13,443 770 1994-95 13,312 1,343 1995-96 11,822 1,428 1996-97 11,687 753 1997-98 3,061 62 1998-99 7,911 32 1999-00 7,673 65 2000-01 6,618 124 2001-02 6,423 19 2002-03 5,732 14 2003-04 22,145 35 2004-05 25,526 34 2005-06 (as on 31/01/06) 19,894 73 ________ ________ 1,67,893 5,804 + Current year 2006-07
PUBLIC EQUITY ISSUES REACH A RECORD RS. 22,754 CRORE IN 2005:
The calendar 2005, despite an extremely bullish secondary market and a high-return primary market, has ended with a mobilization of only Rs. 22,754 crore through public issues which is 25 per cent lower than the previous year which had seen raisings of Rs. 30,511 crore, the highest-ever. According to Prithvi Haldea of PRIME, the premier database on the primary capital market, nevertheless, the year’s mobilization of Rs. 22,754 crore is still the second highest-ever in the history of the Indian capital market
The good news in 2005 has been the very sharp rise in raising of fresh capital (which typically goes into productive assets) with the amount increasing to an impressive Rs. 20,380 crore, higher by nearly 2 times than Rs. 10,703 crore in the previous year, as per PRIME
PUBLIC EQUITY OFFERINGS OF 2005
SNO. COMPANY OPENINGDATE
ISSUEAMOUNT(Rs.crore)
FACEVALUE(Rs.)
OFFERPRICE(Rs.)
35
PSUs/ DIVESTMENTS SUB TOTAL 0.00 BANKS 1 DENA BANK 24/01/2005 216.00 10.00 27.00 2 PUNJAB NATIONAL BANK 07/03/2005 3120.00 10.00 390.00 3 ALLAHABAD BANK 06/04/2005 820.00 10.00 82.00 4 ORIENTAL BANK OF
COMMERCE 25/04/2005 1450.00 10.00 250.00
5 YES BANK LTD. 15/06/2005 315.00 10.00 45.00 6 SYNDICATE BANK 07/07/2005 250.00 10.00 50.00 7 ICICI BANK LTD.
- INST. 01/12/2005 3837.50 10.00 525.00
- RETAIL
01/12/2005 1912.50 10.00 498.75
SUB TOTAL 11921.00 OTHERS 1 JET AIRWAYS (INDIA) LTD. 18/02/2005 1899.35 10.00 1100.00 2 UTV SOFTWARE
COMMUNICATIONS LTD. 21/02/2005 91.00 10.00 130.00
3 EMAMI LTD. 04/03/2005 35.00 2.00 70.00 4 GATEWAY DISTRIPARKS LTD. 09/03/2005 151.20 10.00 72.00 5 IVRCL INFRASTRUCTURES &
PROJECTS LTD. 18/03/2005 144.90 10.00 395.00
6 JAIPRAKASH HYDRO-POWER LTD.
22/03/2005 576.00 10.00 32.00
7 GOKALDAS EXPORTS LTD. 30/03/2005 132.81 10.00 425.00 8 3I INFOTECH LTD. 30/03/2005 230.00 10.00 100.00 9 SAKSOFT LTD. 30/03/2005 7.50 10.00 30.00 10 SHRINGAR CINEMAS LTD. 05/04/2005 43.20 10.00 53.00 11 ALLSEC TECHNOLOGIES LTD. 13/04/2005 42.41 10.00 135.00 12 MANGALAM DRUGS &
ORGANICS LTD. 19/04/2005 14.30 10.00 22.00
13 INDIA INFOLINE LTD. 21/04/2005 90.27 10.00 76.00 14 SHOPPER`S STOP LTD. 28/04/2005 136.98 10.00 238.00 15 CYBER MEDIA (INDIA) LTD. 04/05/2005 16.93 10.00 60.00 16 NANDAN EXIM LTD. 12/05/2005 12.00 10.00 20.00 17 SHREE GANESH FORGINGS LTD. 18/05/2005 15.00 10.00 30.00 18 BEEYU OVERSEAS LTD. 26/05/2005 10.00 10.00 14.00 19 JINDAL POLY FILMS LTD. 09/06/2005 300.00 10.00 360.00
36
20 UNIPLY INDUSTRIES LTD. 09/06/2005 12.00 10.00 24.00 21 PROVOGUE (INDIA) LTD. 10/06/2005 60.74 10.00 150.00 22 MSP STEEL & POWER LTD. 20/06/2005 16.00 10.00 10.00 23 NECTAR LIFESCIENCES LTD. 22/06/2005 92.88 10.00 240.00 24 ERA CONSTRUCTIONS (INDIA)
LTD. 24/06/2005 41.04 10.00 72.00
25 SPL INDUSTRIES LTD. 29/06/2005 63.00 10.00 70.00 26 YASH PAPERS LTD. 30/06/2005 18.82 10.00 14.00 27 IL&FS INVESTSMART LTD. 04/07/2005 142.50 10.00 125.00 28 SHRI RAMRUPAI BALAJI
STEELS LTD. 08/07/2005 44.00 10.00 22.00
29 VIVIMED LABS LTD. 09/07/2005 17.50 10.00 70.00
30 INFRASTRUCTURE DEVELOPMENT FINANCE CO.LTD.
15/07/2005 1372.24 10.00 34.00
31 HT MEDIA LTD. 04/08/2005 407.62 10.00 530.00 32 SASKEN COMMUNICATION
TECHNOLOGIES LTD. 11/08/2005 130.00 10.00 260.00
33 FCS SOFTWARE SOLUTIONS LTD.
22/08/2005 17.50 10.00 50.00
34 AMAR REMEDIES LTD. 25/08/2005 42.00 10.00 28.00 35 TALBROS AUTOMOTIVE
COMPONENTS LTD. 01/09/2005 47.50 10.00 102.00
36 SOUTHERN ONLINE BIO TECHNOLOGIES LTD.
14/09/2005 11.07 10.00 10.00
37 ALPS INDUSTRIES LTD. 20/09/2005 31.80 10.00 120.00 38 SUZLON ENERGY LTD. 23/09/2005 1496.34 10.00 510.00 39 AURIONPRO SOLUTIONS LTD. 27/09/2005 27.00 10.00 90.00 40 PARADYNE INFOTECH LTD. 30/09/2005 13.86 10.00 42.00 41 SHREE RENUKA SUGARS LTD. 07/10/2005 110.00 10.00 285.00 42 GUJARAT INDUSTRIES POWER
CO.LTD. 13/10/2005 200.00 10.00 68.00
43 K.M.SUGAR MILLS LTD. 14/10/2005 33.28 10.00 52.00 44 BANNARI AMMAN SPINNING
MILLS LTD. 19/10/2005 94.50 10.00 135.00
45 PBA INFRASTRUCTURE LTD. 24/10/2005 30.00 10.00 60.00 46 VIKASH METAL & POWER LTD. 24/10/2005 25.00 10.00 20.00 47 PRITHVI INFORMATION
SOLUTIONS LTD. 25/10/2005 135.00 10.00 270.00
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48 PIRAMYD RETAIL LTD. 10/11/2005 60.00 10.00 120.00 49 BOMBAY RAYON FASHIONS
LTD. 11/11/2005 94.33 10.00 70.00
50 AIA ENGINEERING LTD. 17/11/2005 148.05 10.00 315.00 51 TRIVENI ENGINEERING &
INDUSTRIES LTD. 18/11/2005 240.00 1.00 48.00
52 ABG SHIPYARD LTD. 18/11/2005 157.25 10.00 185.00 53 EVEREST KANTO CYLINDER
LTD. 22/11/2005 90.00 10.00 160.00
54 COMPULINK SYSTEMS LTD. 25/11/2005 27.23 10.00 60.00 55 KERNEX MICROSYSTEMS
(INDIA) LTD. 28/11/2005 99.01 10.00 250.00
56 REPRO INDIA LTD. 28/11/2005 43.23 10.00 165.00 57 PVR LTD. 08/12/2005 166.50 10.00 225.00 58 TULIP IT SERVICES LTD. 09/12/2005 108.00 10.00 120.00 59 RADHA MADHAV CORP.LTD. 12/12/2005 20.00 10.00 20.00 60 RAMSARUP INDUSTRIES LTD. 13/12/2005 30.00 10.00 60.00 61 PUNJ LLOYD LTD. 13/12/2005 642.11 10.00 700.00 62 GINNI FILAMENTS LTD. 19/12/2005 48.00 10.00 22.00 63 EDUCOMP SOLUTIONS LTD. 19/12/2005 50.00 10.00 125.00 64 CELEBRITY FASHIONS LTD. 19/12/2005 81.90 10.00 180.00 65 BARTRONICS INDIA LTD. 20/12/2005 45.00 10.00 75.00 SUB TOTAL 10832.65 GRAND TOTAL 22753.65
SOURCE : PRIME DATABASE
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The Public Issue Management
Entry Norms – Who can come out with a public issue
Entry norms for the public issues are governed by the SEBI guidelines, SEBI (Disclosure for Investor and Protection), Guidelines, 2000. SEBI, keeping in view the objective of greater transparency, investor protection and development of capital market, has from time to time amended the entry norms for companies to come out with the public issue. Entry norms are categorized into the following:-
Unlisted Companies Listed Companies
Unlisted Companies
Unlisted companies are those public limited companies, which are presently not listed at any of the recognized stock exchanges in India. The shares of such companies are therefore not traded at any of the Stock Exchanges in India.Presently, there are two options available for the unlisted companies to come out with public issue: -
1st Option It should have a track record of distributable profits for at least 3 out of
immediately preceding 5 years and The pre-issue net worth (i.e. net worth before the issue) should be at
least Rs 1 crore in 3 out of 5 years, with the minimum net worth in the immediately preceding 2 years.
The issue size (includes offer to public, firm allotment, promoters’ contribution through offer document) should not exceed 5 times its pre-issue net worth as per the last available audited accounts
2nd Option
With the recent guidelines amended on August 04, 2000 SEBI has amended the second option available for an unlisted companies. Earlier the guidelines stated that if the company is not able to satisfy the 1st option as mentioned above, the company can come out with the public issue provided the project is appraised by any bank or public financial institution with at least 10% of the project cost financed by such appraiser.
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CHAPTER 3
As per the recent guideline, if the company is unable to satisfy the 1st option or if the issue size is more than 5 times its pre-issue net worth, then the second option to come out with the issue is through the book building process only.
The issue can come out through book building process provided 60% of the issue size is allotted to the Qualified Institutional Buyers (QIB). If the company fails to allot 60% of the issue size to QIB the entire money so received shall be refunded.
"Three years out of immediately preceding five years" means 3 years audited accounts for a period of at least 36 months are available for computation of the minimum track record of 3 years of distributable profits.
Listed Companies
Listed Companies are those which are presently listed on any one or more recognized Stock Exchanges in India. The securities of such companies are traded on such stock exchanges where they are listed.All listed companies can come out with further public issue provided the net worth of the company after the proposed issue is less than 5 times the net worth prior to the issue. In case the net worth is more than 5 times the net worth prior to the issue, the company should comply with any of the options as available for unlisted companies.
Advantages of Public Issue are: -
Money non-refundable except in the case of winding up or buy back of shares
No financial burden i.e. no fixed rate of interest payable. However, in order to service the equity, dividend may be paid.
Enhances shareholder's value if the company performs well Greater Transferability Trading & Listing of securities at stock exchanges Better Liquidity of securities Helps building reputation of promoters, company & its products /
services, provided the company performs well
Public Issues have disadvantages too. Some of the main ones are :- Time consuming process Expensive Several Legal formalities. Involvement of many intermediaries Transparency Requirements and public disclosure of information may
lead to lack of privacy
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Continuous Compliance of provisions of listing agreement and other legal requirements
Constant scrutiny of performance by investors May lead to takeover of the company Securities of the company may be made subjective to speculative
attacks.
Applicable Laws
A company is required to comply with the following laws in connection with a public issue: -
Provisions of Companies Act, 1956 Securities Contracts (Regulations) Act, 1956 SEBI rules & regulations Compliance of Listing Agreement with the concerned stock exchanges
after the listing of securities. RBI regulations in case of foreign/nri equity participation.
Role of SEBI – Regulatory Body
The Controller of Capital Issue (CCI) formed under the Capital Issues Control Act controlled Upto 1992, the capital primary market. During that period, the
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pricing of capital issues was controlled by CCI. The premium on issue of equity shares issued through the primary markets was done in accordance with the Capital Issues Control Act.
The CCI guidelines were abolished with the introduction of Securities & Exchange Board of India (SEBI) formed under the SEBI Act, 1992 with the prime objective of protecting the interests of investors in securities, promoting the development of, and regulating, the securities market and for matters connected therewith or incidental thereto.’
The SEBI Act came into force on 30th January, 1992 and with its establishment, all public issues are governed by the rules & regulations issued by SEBI.
SEBI was formed to promote fair dealing in issue of securities and to ensure that the capital markets function efficiently, transparently and economically in the better interests of both the issuers and the investors.
The promoters should be able to raise funds at a relatively low cost. At the same time, investors must be protected from unethical practices and their rights must be safeguarded so that there is a steady flow of savings into the market. There must be proper regulation and code of conduct and fair practice by intermediaries to make them competitive and professional.
Since, its formation, SEBI has been instrumental in bringing greater transparency in capital issues. Under the umbrella of SEBI, companies issuing shares are free to fix the premium provided adequate disclosure is made in the offer documents.
Focus being the greater investor protection, SEBI has become a vigilant watchdog.
Role of Intermediaries
Many intermediaries are involved in connection with the public issue. Following are the intermediaries who have to be registered with SEBI and must have valid certificate from SEBI to act as an intermediaries: -
Merchant Bankers
Registrar and Share Transfer Agents
Bankers to the Issue
Underwriters
Stock Brokers and Sub Brokers
Depositories
Merchant Bankers play the most vital role amongst all intermediaries. They assist the company right from preparing prospectus to the listing of securities at the stock exchanges. Merchant Bankers have to satisfy themselves about the correctness and propriety of all the information provided in the prospectus. It is mandatory for them to carry due diligence for all the information provided in the prospectus and they must issue a certificate to this
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effect to SEBI. A Company may appoint more than one Merchant Banker provided Inter-Se Allocation of Responsibilities between the Merchant Bankers are properly structured.
Underwriters are those intermediaries who underwrite the securities offered to the public. In case there is under subscription (in short, the company does not receive good response from public and amount received from is less than the issue size), underwriters subscribe to the unsubscribed amount so that the issue is successful.
Registrar & Share Transfer Agents processes all applications received from the public and prepare the basis of allotment. The dispatch of share certificates / refund orders are handled by them.
Bankers to the Issue are banks which accept application from the public on behalf of the company. These applications are then forwarded to Registrar & Share Transfer Agent for further processing.
Stock Brokers & Sub-Brokers are those intermediaries who through their contacts / sources invite the public for subscribing shares for which they get commission.
Depositories are the intermediaries who holds securities in dematerialized form on behalf of the shareholders.
The main Players in issue capital market
Investment Bankers Syndicate Members (w.e.f.1.4.2001) Brokers Registrars Printers Advertising Agencies Collecting Bankers Underwriters Stock Exchanges
The terminology used in issue capital market
1. Period 2. Issue Type (IPOs/FPOs) 3. Type of Sale (Public Issues/Offers for Sale)4. Pricing Method (Book building/Fixed Price)5. Book building Option (%)6. Instrument (Equity/FCD/NCD//PCD/Pref. /SPN) 7. Issue Amount 8. Industry 9. Product
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10. Company Type(Private/Joint/PSU) 11. Foreign Financial Collaboration (Y/N) 12. Foreign Technical Collaboration 13. 100% EOU (Y/N) 14. Stock Exchange Listing 15. Primary Stock Exchange 16. Underwritten (Y/N) 17. Appraised (Y/N) 18. Preferential Offer to NRIs (Y/N) 19. Offer Price 20. Premium (on Face Value) 21. Application Amount (%) 22. Post Issue Capital 23. Lead Managers
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Initial Public Offering (IPO)
Companies, new as well as old can offer their shares to the investors in the primary market. This kind of tapping the savings is called an IPO or Initial Public Offering. SEBI regulates the way in which companies can make this offering. New companies can make an IPO if they have a dividend-paying (ability) record of three years. The size of the initial issue, the exchange on which it can be listed, the merchant bankers' responsibilities, the nature and content of the disclosures in the prospectus, procedures for all these are laid down by SEBI and have to be strictly complied with. Exemption may be granted by SEBI in certain cases for minimum public offer or minimum subscription in the case of certain industry sectors like infrastructure or IT or media & communications. Several changes have also been introduced in recent years in the manner in which the IPOs can be marketed. For example they can now take the book building route or they can even be marketed through the secondary market by brokers or DPs. All these changes have been made with the objective of making the process more investor friendly by reducing risk, controlling cost, greater transparency in the pricing mechanism and protecting liquidity in the hands of the investor. Some of the IPOs have been available for subscription online - where the bids are made in real time and the information is made available on an instantaneous basis on the screen. It is possible to subscribe for IPO shares in demat form through DPs.
Definition of Important Terms
Book Building: means a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.
"Composite Issues": means an issue of securities by a listed company on a public cum rights basis offered through a single offer document wherein the allotment for both public and rights components of the issue is proposed to be made simultaneously.
Green Shoe option: means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism in accordance with the provisions of Chapter VIII-A of these Guidelines, which is granted to a company to be exercised through a Stabilizing Agent.
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CHAPTER 4
Offer document: means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue
Offer for sale: means offer of securities by existing shareholder(s) of a company to the public for subscription, through an offer document.
Preferential Allotment: means an issue of capital made by a body corporate in pursuance of a resolution passed under sub-section (1A) of section 81 of the Companies Act,1956.
"Public issue": means an invitation by a company to public to subscribe to the securities offered through a prospectus;
"Listed Company": means a company which has any of its securities offered through an offer document listed on a recognized stock exchange and also includes Public Sector Undertakings whose securities are listed on a recognized stock exchange.
"Unlisted Company": means a company which is not a listed company.
"Rights issue" means an issue of capital under sub-section (1) of Section 81 of the Companies Act, 1956, to be offered to the existing shareholders of the company through a Letter of Offer.
"Qualified Institutional Buyer" shall mean -
1. public financial institution as defined in section 4A of the Companies Act, 1956;
2. scheduled commercial banks; 3. mutual funds 4. foreign institutional investor registered with SEBI 5. multilateral and bilateral development financial institutions; 6. Venture capital funds registered with SEBI) 7. Foreign Venture capital investors registered with SEBI) 8. State Industrial Development Corporations
‘Retail individual investor’ means an investor who applies or bids for securities of or for a value of not more than Rs.100, 000/-
A 'depository': shall mean a depository registered with the Board under the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996.
Issue price The price at which a company's shares are offered initially in the primary market is called as the Issue price. When they begin to be traded, the market price may be above or below the issue price.
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Face Value of a share/debenture
The nominal or stated amount (in Rs.) assigned to a security by the issuer. For shares, it is the original cost of the stock shown on the certificate; for bonds, it is the amount paid to the holder at maturity. Also known as par value or simply par. For an equity share, the face value is usually a very small amount (Rs. 5, Rs. 10) and does not have much bearing on the price of the share, which may quote higher in the market, at Rs. 100 or Rs. 1000 or any other price. For a debt security, face value is the amount repaid to the investor when the bond matures (usually, Government securities and corporate bonds have a face value of Rs. 100). The price at which the security trades depends on the fluctuations in the interest rates in the economy.
Premium and Discount in a Security Market
Securities are generally issued in denominations of 5, 10 or 100. This is known as the Face Value or Par Value of the security as discussed earlier. When a security is sold above its face value, it is said to be issued at a Premium and if it is sold at less than its face value, then it is said to be issued at a Discount.
Market CapitalizationThe market value of a quoted company, which is calculated by multiplying its current share price (market price) by the number of shares in issue is called as market capitalization. E.g. Company A has 120 million shares in issue. The current market price is Rs. 100. The market capitalisation of company A is Rs. 12000 million.
The difference between public issue and private placementWhen an issue is not made to only a select set of people but is open to the general public and any other investor at large, it is a public issue. But if the issue is made to a select set of people, it is called private placement. As per Companies Act, 1956, an issue becomes public if it results in allotment to 50 persons or more. This means an issue can be privately placed where an allotment is made to less than 50 persons.
An Initial Public OfferAn Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s securities. The sale of securities can be either through book building or through normal public issue.
Decides the price of an issueIndian primary market ushered in an era of free pricing in 1992. Following this, the guidelines have provided that the issuer in consultation with Merchant
47
Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI does not play any role in price fixation. The company and merchant banker are however required to give full disclosures of the parameters, which they had considered while deciding the issue price. There are two types of issues, one where company and Lead Merchant Banker fix a price (called fixed price) and other, where the company and the Lead Manager (LM) stipulate a floor price or a price band and leave it to market forces to determine new the final price (price discovery through book building process).
Price discovery through Book Building Process
Book Building is basically a process used in IPOs for efficient price discovery. It is a mechanism where, during the period for which the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The offer price is determined after the bid closing date.
Book Building Process
Book building is a price discovery mechanism. Based on the bids received at various prices from the investors, demands are assessed and then the price of the securities is discovered. The issuer proposing to issue capital through book building has two options, viz., 75% book building route and 100% book building route. In case of issue of securities through the first route, 75% of the net offer is made through book building process and 25% at the price determined by book building. In this case not more than 50% should be available for allocation to QIBs and not less than 25% to non-QIBs. The balance 25% should be made to the public at the price determined through book building. In case a company makes a issue of 100% of the net offer to public through 100% book building process, then not less than 25% should be available for allocation to retail individual investors, not less than 25% to non-institutional investors and not more than 50% for QIBs. Allotment to retail individual investors and non institutional investors are made on the basis of the proportionate allotment system within 15 days of the closure of the issue; failing of which attracts a penal charge of 15% which is paid to the investors. In case of under subscription in any category, the unsubscribed portions can be allocated to the bidders in other categories. Besides, book building also requires that: issuer should provide indicative floor price and no ceiling price, bids to remain open for at least 5 days, only electronic bidding is permitted, bids are submitted through syndicate members, investors can bid at any price, retail investors have option to bid at cut off price, bidding demand is displayed at the end of every day, the lead manager analyses the demand generated and determines the issue price in consultation with the issuer, etc.
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The main difference between offer of shares through book building and offer of shares through normal public issue
Price at which securities will be allotted is not known in case of offer of shares through Book Building while in case of offer of shares through normal public issue, price is known in advance to investor. Under Book Building, investors bid for shares at the floor price or above and after the closure of the book building process the price is determined for allotment of shares. In case of Book Building, the demand can be known everyday as the book is being built. But in case of the public issue the demand is known at the close of the issue
Cut-Off Price
In a Book building issue, the issuer is required to indicate either the price band or a floor price in the prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called “Cut-Off Price”. The issuer and lead manager decides this after considering the book and the investors’ appetite for the stock.
The floor price in case of book building
Floor price is the minimum price at which bids can be made
Price Band in a book built IPO
The prospectus may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20%. In other words, it means that the cap should not be more than 120% of the floor price. The price band can have a revision and such a revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing a press release and also indicating the change on the relevant website and the terminals of the trading members participating in the book building process. In case the price band is revised, the bidding period shall be extended for a further period of three days, subject to the total bidding period not exceeding ten days.
It may be understood that the regulatory mechanism does not play a role in setting the price for issues. It is up to the company to decide on the price or the price band, in consultation with Merchant Bankers.
Minimum number of days for which a bid should remain open during book building
The Book should remain open for a minimum of 3 days.
Shares listed after issue
It would take around 3 weeks after the closure of the book built issue.
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The role of a ‘Registrar’ to an issue
The Registrar finalizes the list of eligible allottees after deleting the invalid applications and ensures that the corporate action for crediting of shares to the demat accounts of the applicants is done and the dispatch of refund orders to those applicable are sent. The Lead Manager coordinates with the Registrar to ensure follow up so that that the flow of applications from collecting bank branches, processing of the applications and other matters till the basis of allotment is finalized, dispatch security certificates and refund orders completed and securities listed.
NSE provide facility for IPO
NSE’s electronic trading network spans across the country providing access to investors in remote areas. NSE decided to offer this infrastructure for conducting online IPOs through the Book Building process. NSE operates a fully automated screen based bidding system called NEAT IPO that enables trading members to enter bids directly from their offices through a sophisticated telecommunication network. Book Building through the NSE system offers several advantages:
The NSE system offers a nation wide bidding facility in securities. It provides a fair, efficient & transparent method for collecting bids using the latest electronic trading systems. Costs involved in the issue are far less than those in a normal IPO. The system reduces the time taken for completion of the issue process The IPO market timings are from 10.00 a.m. to 3.00 p.m. On the last day of the IPO, the Book Running Lead Manager can further extend the session timings on specific request.
Prospectus
A large number of new companies float public issues. While a large number of these companies are genuine, quite a few may want to exploit the investors. Therefore, it is very important that an investor before applying for any issue identifies future potential of a company. A part of the guidelines issued by SEBI (Securities and Exchange Board of India) is the disclosure of information to the public. This disclosure includes information like the reason for raising the money, the way money is proposed to be spent, the return expected on the money etc. This information is in the form of ‘Prospectus’ which also includes information regarding the size of the issue, the current status of the company, its equity capital, its current and past performance, the promoters, the project, cost of the project, means of financing, product and capacity etc. It also contains lot of mandatory information regarding underwriting and statutory compliances. This helps investors to evaluate short term and long-term prospects of the company.
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Draft Offer document
‘Offer document’ means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed with the Registrar of Companies (ROC) and Stock Exchanges (SEs). An offer document covers all the relevant information to help an investor to make his/her investment decision. ‘Draft Offer document’ means the offer document in draft stage. The draft offer documents are filed with SEBI, atleast 21 days prior to the filing of the Offer Document with ROC/SEs. SEBI may specify changes, if any, in the draft Offer Document and the issuer or the lead merchant banker shall carry
out such changes in the draft offer document before filing the Offer Document with ROC/SEs. The Draft Offer Document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI.
Abridged Prospectus
‘Abridged Prospectus’ is a shorter version of the Prospectus and contains all the salient features of a Prospectus. It accompanies the application form of public issues.
Prepares the Prospectus/Offer Documents
Generally, the public issues of companies are handled by ‘Merchant Bankers’ who are responsible for getting the project appraised, finalizing the cost of the project, profitability estimates and for preparing of ‘Prospectus’. The ‘Prospectus’ is submitted to SEBI for its approval.
Lock-in
‘Lock-in’ indicates a freeze on the sale of shares for a certain period of time. SEBI guidelines have stipulated lock-in requirements on shares of promoters mainly to ensure that the promoters or main persons, who are controlling the company, shall continue to hold some minimum percentage in the company after the public issue.
Listing of Securities
Listing means admission of securities of an issuer to trading privileges (dealings) on a stock exchange through a formal agreement. The prime objective of admission to dealings on the exchange is to provide liquidity and marketability to securities, as also to provide a mechanism for effective control and supervision of trading.
Listing Agreement
At the time of listing securities of a company on a stock exchange, the company is required to enter into a listing agreement with the exchange. The listing agreement specifies the terms and conditions of listing and the disclosures that shall be made by a company on a continuous basis to the exchange.
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Delisting of securities
The term ‘Delisting of securities’ means permanent removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange.
SEBI’s Role in an Issue
Any company making a public issue or a listed company making a rights issue of value of more than Rs 50 Lakh is required to file a draft offer document with SEBI for its observations. The company can proceed further on the issue only after getting observations from SEBI. The validity period of SEBI’s observation letter is three months only i.e. the company has to open its issue within three months period.
SEBI recommends an issue
SEBI does not recommend any issue nor does take any responsibility either for the financial soundness of any scheme or the project for which the issue is proposed to be made or for the correctness of the statements made or opinions expressed in the offer document. SEBI mainly scrutinizes the issue for seeing that adequate disclosures are made by the issuing company in the prospectus or offer document.
Foreign Capital Issuance
Indian companies are permitted to raise foreign currency resources through two main sources: a) issue of foreign currency convertible bonds more commonly known as ‘Euro’ issues and b) issue of ordinary shares through depository receipts namely ‘Global Depository Receipts (GDRs)/American Depository Receipts (ADRs)’ to foreign investors i.e. to the institutional investors or individual investors.
American Depository Receipt
An American Depositary Receipt ("ADR") is a physical certificate evidencing ownership of American Depositary Shares ("ADSs"). The term is often used to refer to the ADSs themselves. An American Depositary Share ("ADS") is a U.S. dollar denominated form of equity ownership in a non-U.S. company. It represents the foreign shares of the company held on deposit by a custodian bank in the company's home country and carries the corporate and economic rights of the foreign shares, subject to the terms specified on the ADR certificate. One or several ADSs can be represented by a physical ADR certificate. The terms ADR and ADS are often used interchangeably. ADSs provide U.S. investors with a convenient way to invest in overseas securities and to trade non-U.S. securities in the U.S. ADSs are issued by a depository bank, such as JPMorgan Chase Bank. They are traded in the same manner as shares in U.S. companies, on the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX) or quoted on NASDAQ and the over-the-counter (OTC) market. Although ADSs are U.S. dollar denominated securities and pay dividends in U.S. dollars, they do not eliminate the currency risk associated with an investment in a non-U.S. company.
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Global Depository Receipts
Global Depository Receipts (GDRs) may be defined as a global finance vehicle that allows an issuer to raise capital simultaneously in two or markets through a global offering. GDRs may be used in public or private markets inside or outside US. GDR, a negotiable certificate usually represents company’s traded equity/debt. The underlying shares correspond to the GDRs in a fixed ratio say 1 GDR=10 shares.
Allotment and IPO
Transparency has been the buzzword in the capital market since inception of NSE and be it primary market, secondary market or other markets, various measures have been initiated by the Government, Regulators, Stock Exchanges and Self Regulating Organizations in this area. In a way, it is a continuous process and is quite dynamic in as much as it has to match the changing needs of various classes of participants in the market, with a view to make our markets on one hand ‘model markets at global level’ and on the other hand ‘investors friendly’ so as to offer best of the protection through dissemination of critical and vital information to make the informed decision and discourage any kind of undesirable practice which may vitiate the confidence and faith in the markets through strong surveillance and enforcement mechanisms. In this regard, quite a good deal of work has been done whereby our markets have become quite comparable to any of the markets in the international map, in the areas of primary market, there is a scope of further transparency to make the total process of post-issue absolutely transparent and thereby bringing in added responsibility on the parts of the agencies involved in managing those activities. The points required to be taken care of are brought as under:
1. In the application forms relating to the public issues, conditions for rejection of applications are clearly spelt out and the application cannot be rejected for reasons other than the specified ones. Of these reasons, there are a few reasons, which are technical in its nature whereas a few others are substantive in its nature.
2. While processing the applications by the concerned registrar, all these conditions are applied and consequently the applications not fulfilling the conditions are rejected. This process of weeding out applications not fulfilling the conditions and meeting the conditions is opaque and not transparent since the applicant is unaware of the reasonof rejection.
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3. In the public issue managed through the book building process, there are certain specific terms being used and which at times the investors leading to the applications being found not eligible possibly interpret differently. Therefore, it is * Director (O&S), NSE. The views expressed and the approach suggested in this paper is of the author and not necessarily of NSE. Necessary to cite an example to make the terms clear for understanding. There is a term called ‘cut-off’ price and a term called ‘cap price’. These two terms have different meaning for the purpose of treatment while carrying out the exercise of weeding out the applications. The cut-off price relates to the price chosen by the investor whereas the cap price relates to the price fixed by the issuer. The cap price is the highest price for a range of price bands where the cut-off price is the price chosen by the investor as the highest price up to which his application can be considered. For example, if the price band is say Rs.80 to Rs.95, the cap price is Rs.95, which is fixed by the issuer. However, in the application form the investor may choose any price between Rs.80 and Rs.95 by going for cut-off price option. It means that though his application would have been valid, it would be eligible for further process of allotment if the issue price is Rs.95 or less. If the issuer decides any issue price, such applicant shall be eligible for further process of allotment.
4. The present process only reveals whether the applicant is chosen for allotment, either full or partial, and/or application is rejected but in fact every application is clearly weeded out to be either valid or invalid. All valid applications qualify for further process in allotment and all invalid applications are treated as rejected. Neither the reason for non-allotment nor the reason for rejection is made known under the present system of allotment.
5. To make the total process transparent, it is imperative to evolve a mechanism to distinguish the application forms not fulfilling the prescribed conditions as invalid and the application forms fulfilling the conditions as valid. Further where the applications forms are found to be not fulfilling the prescribed conditions, such application forms be categorized through giving appropriate numeric codes for each of the reasons under which the application forms could be rejected (which must also be clearly stipulated in the applications forms themselves). The application forms which are found to be meeting the conditions and thus valid for allotment be also given distinct codes; one where the allotment is in full, another where the allotment is in part, third where there is no allotment on account of large number of applications and the application not chosen in the draw taken out for the purpose of allotment and fourth where the applicant chose the cutoff at a price which is lower than the issue price, such applications though treated as valid applications, are not eligible for further process of allotment.
6. Once the above mechanism of codification is put in place for each of the categories viz. (1) full allotment, (2) partial allotment, (3) no allotment though application form found to be valid, (4) not eligible for further process of
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allotment and (5) rejection on account of non-fulfillment of the prescribed conditions, the registrar or the issuer should ensure to intimate to the applicants the appropriate code as the status of the application while sending the refund orders. This will ensure that where the applicant committed an error in filling up the application form and thus the application form was treated as invalid, such applicant would be able to know the exact reason of rejection and consequently be able to exercise due care in future to avoid recurrence of such error on his part. To facilitate the proposed process, an endeavor is made to collate all the possible reasons, which get factored at the time of weeding out the applications to bifurcate them into valid and invalid applications, and codify them as per the list attached per Annexure-
7. The above classified/category wise information will be very useful to the stock exchange deciding the basis of allotment as well as to the investing public to know for which reasons the application forms have been rejected or for which reasons they have not got the allotment. This will also help the regulator and the stock exchanges to review the policy relating to the conditions for rejection based on the statistical details available for each of the issues and also use them for educative purpose so as to reduce number of technical rejections to the extent possible.
8. While making a public announcement about the basis of allotment, the registrar or the issuer should ensure to give a summary of total applications showing category wise number of application forms received and number of application forms found to be valid for considering allotment and number of application forms found to be invalid and thus rejected.
9. Like in case of the trades/transactions done on the stock exchanges, the stock exchanges are required to make available the details of the trades/transactions on their respective websites for the purpose of facilitating the investing public/investors to verify the details of the trades/transactions, in like manner, it should be made mandatory for the respective registrars/lead managers/issuers having their own websites to keep the data relating to the allotment so as to facilitate the investing public/investors to verify the reasons for allotment/non-allotment/rejection by punching in the application form number and name of the first applicant. This will bring in desired level of transparency in the process of allotment.
10. Many processes have been streamlined over a period of time with a view to bring in efficiency in the management of post issue related work to ensure expeditious process and reduction in cost. Like, in a book building issue, the securities are getting directly credited to the beneficiary account of the allottees, it is imperative to directly/electronically credit the refund amount to savings bank accounts specified by the applicants in their application forms since most banks now offer a facility of ECS. Consequently only the intimation/advice be sent to the applicants by courier/post. This will not only
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reduce the cost to the issuer (of posting the refund orders through registered post as is required mandatory) but also credit the savings bank accounts of the applicants expeditiously and thus will make the total post public issue process very efficient. However, wherever the banks do not offer ECS facility, the present procedure of sending the refund orders by registered post by stating on the refund order the account number and name of the bank be continued. Considering phenomenal growth of technology in the banking industry, most private sector banks offering anywhere banking and electronic facilities as well as those public sector banks, which also offer like facilities would be able, to offer this facility of directly crediting the refund amount to the savings bank accounts specified in the application forms. Further, even RBI is contemplating to put in place the RTGS (Real time gross settlement) initially for limited number of locations and thereafter on a full-fledged basis nationwide.
Since most of the measures relating to transparency and reforms have been put in place through regulatory requirements, it becomes necessary for the regulator to review this aspect and consider making it mandatory to credit the refund amount to the bank accounts of the applicants specified in the application forms through ECS except where the banks (mostly co-operative) do not have such facility or do not extend such facility at certain locations. In such cases only the refund orders need to be allowed to be sent by registered post as applicable now.
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Eligibility Criteria
In order to refine the primary market design and boost the waning investors’ confidence, Various measures have been taken by the Government, RBI and SEBI. This section throws light on the policy measures initiated during the financial year 2003-04 and till June 2004.
DIP Guidelines, 2000
Disclosure and Investor Protection (DIP) Guidelines of SEBI, issued in June 1992, governs the issues of capital by Indian companies. SEBI has since then been issuing clarifications/ amendments to these guidelines from time to time, in order to streamline the public issue process. In January 2000, a comprehensive coverage of all DIP guidelines has been made available through a series of compendium ‘SEBI (DIP) Guidelines, 2000’. The guidelines provide norms relating to the eligibility for companies issuing securities, pricing of issues, listing requirements, disclosure norms, lock-in period for promoters’ contribution, contents of offer documents, pre and post-issue obligations, among others. The guidelines apply to all public issues, offer for sale, and rights issues by listed and unlisted companies. This section attempts to highlight some of the important clauses in the guideline in a precise manner.
Eligibility Norms
Any company issuing securities has to satisfy the following conditions at the time of filing the draft offer document and the final offer document with SEBI and Registrar of Companies (ROCs)/Designated Stock Exchange respectively.
• A company making a public issue of securities has to file a draft prospectus with SEBI, through an eligible merchant banker, at least 21 days prior to the filing of prospectus with the ROCs. For a rights issue, filing of offer document is mandatory where the aggregate value of securities, including premium, if any, exceeds Rs. 50 lakh. An application for listing of those securities with stock exchange(s) is also to be made. Further, the company must enter into an agreement with the depository for dematerialization of its securities and should give an option to subscribers/shareholders/ investors to receive the security certificates either in physical or in dematerialized form. A company cannot make an issue if the company has been prohibited from accessing the capital market under any order or discretion passed by SEBI.
• An unlisted company can make an IPO of equity shares or any other security, which may be converted into equity shares, only if it has a track record of profitability and required net worth and net tangible assets. Some of the conditions are specified hereunder: (i) it has net tangible assets of at least Rs. 3 crore in each of the preceding 3 full years, of which not more than 50% is held in monetary assets; (ii) it has a net worth of at least Rs. 1 crore in each of the
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preceding 3 full years; (iii) it has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least 3 out of the immediately preceding 5 years; (iv) the aggregate of the proposed issue and all previous issues made in the same financial year in terms of size (offer through offer document plus firm allotment plus promoters contribution through the offer document) does not exceed five times its pre-issue net worth and (v) in case the company has changed its name within the last one year, at least 50% of the revenue for the preceding one full year is earned by the company from the activity suggested by the new name.
• Even if the above mentioned conditions are not satisfied, an unlisted company can still make an IPO on compliance of the guidelines as specified: (a)(i) issue should be made through the book building process with at least 50% of the issue size being allotted to the QIBs, if not, then the full subscription monies has to be refunded, OR (a)(ii) the project should have at least 15% participation by FIs/SCBs of which at least 10% should come from the appraiser. In addition, at least 10% of the issue size should be allotted to QIBs, otherwise, the full subscription monies would be refunded; AND (b)(i) minimum post-issue face value capital of the company should be Rs. 10 crore, OR (b)(ii) there should be compulsory market making for at least 2 years from the date of listing subject to certain conditions as specified in the guidelines.
• For a listed company the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size should not exceed 5 times its pre-issue net worth. In case of the change in name of the issuer company within the last 1 year, the revenue accounted for by the activity suggested by the new name should not be less than 50% of its total revenue in the preceding one full year period.
• Infrastructure companies are exempt from the requirement of eligibility norms if their project has been appraised by a public financial institution (PFI) or Infrastructure Development Finance Corporation (IDFC) or Infrastructure Leasing and Financing Services Ltd. (ILFS) or a bank which was earlier a PFI and not less than 5% of the project cost is financed by any of the institutions referred above, jointly or individually, by way of loan and/or subscription to equity or a combination of both.
• No public issue or rights issue of debt instruments (whether convertible or not) can be made unless (a) it has a credit rating of not less than investment grade from not less than two credit rating agencies registered with SEBI, all the credit ratings, including the rejected ones, needs to be disclosed. All the credit ratings obtained during the 3 years preceding the public or rights issue of debt instrument for any listed security of the issuer company should also be disclosed in the offer document. (b) the company should not feature in the list of willful defaulters of RBI (c) company has not defaulted on payment of interest or repayment of principal of debentures issued to the public, if any
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Contribution of Promoters and lock-in
The promoters’ contribution in case of public issues by unlisted companies should not be less than 20% of the post issue capital. In case of public issues by listed companies, promoters should contribute to the extent of 20% of the proposed issue or should ensure post-issue share holding to the extent of 20% of the post-issue capital. For a composite issue, the promoters’ contribution should either be 20% of the proposed public issue or 20% of the post-issue capital. At least one day prior to the opening of the issue, the promoters should bring in the full amount of the promoters contribution including premium. Except for (i) public issue of securities which have been listed for at least 3 years and has a track record of dividend payment for at least 3 immediate preceding years, (ii) companies wherein no identifiable promoter or promoter group exists, and (iii) rights issues. The minimum promoters’ contribution should be locked in for a period of 3 years in case of all types of issues. However, if the promoters’ contribution exceeds the required minimum, then the excess is locked in for a period of one year. The lock-in period starts from the date of allotment in the proposed public issue and the last date of the lock-in is to be reckoned as three years from the date of commencement of commercial production or the date of allotment in the public issue whichever is later. In case of pre-issue share capital of unlisted company, the entire pre-issue share capital, other than that locked in as promoters contribution, is locked for a period of one year from the date of commencement of commercial production or the date of allotment in the public issue, whichever is later. Securities allotted in firm allotment basis are also locked in for a period of one year. The locked-in securities held by promoters may be pledged only with banks or FIs as collateral security for loans granted by such banks or F
Preferential Issues
• As in case of equity shares, the transfer of the locked in preference shares/instruments is subject to the same norms and comply with SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
• The lock-in period in respect of the shares issued on preferential basis pursuant to a scheme approved under Corporate Debt Restructuring framework should commence from the date of allotment. The lock-in period should continue for a period of one year. In case of partly paid up shares the lock-in period should commence from the date of allotment and continue for a period of one year from the date when shares become fully paid up.
• Unless the entire shareholding is held in dematerialized form, no listed company is permitted to make preferential issue of equity shares, warrants, Partly Convertible Debentures (PCDs), Fully Convertible Debentures (FCDs) or any other financial instruments convertible into or exchanged with equity shares at a later date.
• In case of the shares, warrants, PCDs, FCDs or any other financial instruments convertible into equity shares, which are issued on preferential basis, the entire pre-preferential allotment shareholding should be under lock-
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in. The lock-in period shall start from the relevant date up to a period of six months from the date of preferential allotment. In addition, the shareholders, who have sold their shares during the six months period prior to the relevant date, would not be eligible for allotment of shares on preferential basis.
Designated Stock Exchange
Following the withdrawal of the concept of a regional stock exchange, companies have to choose one stock exchanges as a designated stock exchange for the purpose of finalization of the basis of allotment.
Book Building Guidelines
• The issuer company should enter into an agreement with one or more stock exchange(s), which have the requisite system to offer on-line securities. The agreement should specify the rights, duties, responsibilities and obligations of the company and the stock exchange(s). The agreement should also provide for a dispute resolution mechanism between them.
• The freedom is given to the issuer company to list the securities on any other exchange and not necessarily on the exchange through which the company has offered the securities.
• The book runner(s)/syndicate members should appoint SEBI registered brokers to accept bids, applications and placing orders with the company. The appointed brokers should be financially capable of honoring their commitments arising out of defaults of their clients/ investors, if any.
• The company should pay the broker/s a commission/fee for the services rendered. The brokers’ are not allowed levying a service fee on his clients/investors for his services.
• If the offer is through 100% book building process, then the following rules apply: (a) not less than 25% of the net offer should be made to retail individual investors; (b) not less than 25% of the net offer to non-institutional investors i.e. other than retail individual investors and QIBs; (c) not more than 50% of the net offer for QIBs.
• If 75% of the net offer is through book building process and 25% at the price determined through book building, then — (a) in the book built portion, not less than 25% and not more than 50% of the net offer should be available for allocation to non QIBs; (b) the balance 25%, offered at a price determined through book building, should be available only to retail individual investors. They will be either those who have not participated or have not received any allocation, in the book built portion. It is mandatory that 50% of the issue size is allotted to the QIBs.
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Pricing of Issues
For an IPO by an unlisted company, if the issue price is Rs. 500 or more, the issuer company has the discretion to fix the face value below Rs. 10 per share subject to a lower limit of not less than Re. 1 per share. In case the issue price is below Rs. 500 per share, the face value ought to be Rs. 10 per share. The face value of shares should be disclosed in the advertisements and offer documents.
Post Issue Obligations
The allotment of shares should be on a proportionate basis within the specified categories, rounded off to the nearest integer. This will be subject to a minimum allotment being equal to the minimum application size as fixed and disclosed in the offer document.
Green Shoe Option
An issuer company making a public offer of equity shares can avail of the Green Shoe Option (GSO) for stabilizing post listing of its shares, subject to certain provisions in the guidelines such as:
• A company desirous of availing the option should seek authorization in the general meeting for allotment of the additional shares to the ‘stabilizing agent’ (SA) at the end of the stabilization period. The company should appoint one of the merchant bankers or book runners, as the SA. They will be responsible for the price stabilization process, if required. Prior to filing of offer document with SEBI, the SA should enter into an agreement with the issuer company clearly stating all the terms and conditions relating to this option including fees charged/expenses to be incurred.
• The SA should also enter into an agreement with the promoter(s) or pre-issue shareholders who will lend their shares. The agreement should specify the maximum number of shares that may be borrowed from the promoters or the shareholders which should not be in excess of 15% of the total issue size.
• The allocation of these shares should be on pro-rata basis to all the applicants. The stabilization mechanism should be available for not more than 30 days from the date when trading is permitted on the exchange(s).
• The promoters and pre-issue shareholders, of both unlisted and listed company, holding more than 5% shares should lend the shares for the purpose of GSO.
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Contents of Offer Document
The draft offer document and the final offer document should be approved by the Board of Directors and signed by all the Directors (including the managing director), Chief Executive Officer and Chief Financial Officer. They should also certify that all the disclosures made in the offer document are true and correct.
• Some of the pertinent information have to be disclosed irrespective of the issue prices viz., Earnings per share, EPS pre-issue for the last three years, P/E pre-issue, average return on net worth in the last 3 years, minimum return on increased net worth required to maintain pre-issue EPS, NAV per share based on last balance sheet, NAV per share after issue and comparison thereof with the issue price, comparison of all the accounting ratios of the issuer company. However, the projected earnings should not be used as a
justification for the issue price in the offer document. Further, the accounting ratios disclosed in the offer documents in support of the issue price should be calculated after giving effect to the consequent increase in capital on account of compulsory conversions outstanding as well as on the assumption that the options outstanding, if any, to subscribe
for additional capital will be exercised.
Guidelines for Issue of Advertisements
Every time the issue is advertised on television screen, the risk factors should not be scrolled on the screen, but the advertisement should advise the viewers to refer to the red herring prospectus or other offer document for details.
Miscellaneous
• The Board should provide exemptions regarding any particular provision(s) of these guidelines viz., (i) on an application made by any listed company or intermediary connected with the issue, (ii) of a technical violation or a possible violation, or (iii) on being satisfied that the violation was caused or may be caused due to factors beyond the control of the applicant.
• The minimum application value should be within the range of Rs. 5,000 to Rs. 7,000 and in multiples thereof. In a public issue by a listed company, the reservations can be made for the shareholders, who hold shares worth up to Rs. 50,000 on the record date, for allotment on proportionate basis as in case of allotment in public category.
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II. Debenture Trustees Regulations, 2003SEBI amended the SEBI (Debenture Trustees) Regulations, 2003 to include the following:
(a) The capital adequacy should not be less than the net worth of Rs. 1 crore, provided that a debenture trustee, who already is registered, should fulfill the net worth requirements within two years from that date. (b) The net worth should be monitored by the debenture trustee on a continuous basis and inform SEBI for any shortfall in it. In such a case, they would not be entitled to undertake new assignments until they restore the net worth to the required level within a specified time.
(c) Debenture trustee should not relinquish its assignments unless and until another debenture trustee is appointed in its place.
(d) No debenture trustee should act as such for any issue of debentures in case it has lent and the loan is not yet fully repaid or is proposing to lend money to the body corporate. However, this requirement is not applicable in respect of debentures issued prior to the commencement of the Companies (Amendment) Act, 2000, where (i) recovery proceedings in respect of the assets charged against security has been initiated, or (ii) the body corporate has been referred to BIFR under the Sick Industrial Companies (Special Provisions) Act, 1985, prior to commencement of the SEBI (Debenture Trustees) (Amendment) Regulations, 2003.
III. Unlisted Public Companies (Preferential Allotment) Rules, 2003The Unlisted Public Companies (Preferential Allotment) Rules, 2003, which came into force w.e.f. December 4, 2003, are applicable to all unlisted public companies issuing equity shares, FCDs, PCDs or any other financial instruments, which would be convertible or exchanged with equity shares. It states that no issue of shares on a preferential basis can be made by a company unless authorized by its articles of association and unless a special resolution is passed by the members in a General Meeting. The special resolution should be acted upon within a period of 12 months. In case, if warrants are issued on preferential basis with an option to apply for and get the shares allotted, then the issuing company should determine in advance the price of the resultant shares. In case of every issue of shares/warrants or any other financial instrument with a conversion option, the statutory auditor has to certify that the issue of securities has been done in accordance to the Rules.
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Market Design
The primary market is governed by the provisions of the Companies Act, 1956, which deals with issues, listing and allotment of securities. Additionally the SEBI (Disclosure and Investor Protection) guidelines issued under the securities law prescribes a series of eligibility and disclosure norms to be complied by the issuer, promoter for accessing the market. However, in this section we discuss the market design as stipulated in the SEBI (DIP) guidelines.
Pricing of Issues
The companies, including the eligible infrastructure companies, have the freedom to price their equity shares or any security convertible into equity in public or rights issues as the case may be. The banks, however, can price their shares subject to the approval by the RBI. A company (listed or unlisted) should issue shares to applicants in the firm allotment category at a different price from the one at which the net offer to the public is made. That is, at a higher price than at which the securities are offered to the public. A listed company making a composite issue of capital may issue securities at differential prices in its public and rights issue. Further, an eligible company is free to make public/rights issue of equity shares in any denomination determined by it in accordance with sub-section (4) of section 13 of the Companies Act, 1956 and norms as specified by SEBI from time to time.
Issue Obligations
Each company issuing securities has to enter into a Memorandum of Understanding with the lead merchant banker, which specifies their mutual rights, liabilities and obligations. The lead merchant banker has to exercise due diligence and satisfies himself about all aspects of offering, veracity and adequacy of disclosures in the offer document. All the other formalities like, allotment, refund and dispatch of certificates are also taken care by the lead merchant banker. The lead manager should also ensure that the issuer company has entered into agreements with all the depositories for dematerialization of securities. Also, the investors should be given an option to receive securities in dematerialized form through any of the depositories. In case of under-subscription of an issue, the lead merchant banker invokes underwriting obligations and ensures that the underwriters pay the amount devolved. The merchant banker has to appoint a compliance officer who will directly liaise between the Board and the issuer company with regard to compliance of various laws, rules, regulations and other directives issued by the Board. Twenty-one days after the draft offer document has been made public, the lead merchant banker should file a statement with the SEBI giving a list of
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complaints received, a statement as to whether it is proposed to amend the draft offer document or not, and highlighting those amendments. Subsequent to the post issue, the lead merchant banker should ensure that the post-issue monitoring reports are submitted irrespective of the level of subscription. Also, the merchant banker should be associated with allotment, refund and dispatch and also monitor the redressal of investor grievances arising there from. In a public-issue, the Managing Director of the Designated Stock Exchange along with the post issue Lead Merchant Banker and the Registrars to the Issue would be responsible for the finalization of allotment in a fair and proper manner. Allotment should be on proportionate basis within the specified categories rounded off to the nearest integer subject to the minimum allotment being equal to the minimum application size as fixed and disclosed by the issuer.
e-IPOs
A company proposing to issue capital to public through the on-line system of the stock exchanges has to enter into an agreement with the stock exchange(s). SEBI registered brokers should be appointed for the purpose of accepting applications and placing orders with the company. The issuer company should also appoint a Registrar to the Issue having electronic connectivity with the Exchanges. The issuer company can apply for listing of its securities on any Exchange other than the Exchange through which it has offered its securities. The lead manager coordinates all the activities amongst various intermediaries connected in the issue/system.
Credit Rating
Credit Rating Agencies (CRA) can be promoted by public financial institutions, scheduled commercial banks, foreign banks operating in India, and by any body corporate having continuous minimum net worth of Rs. 100 crore for the previous five years. Further, foreign credit rating agencies having at least five years experience in rating can also operate in the country. The SEBI (Credit Rating Agencies) Regulations, 1999 cover the rating of the securities listed and not fixed deposits, foreign exchange, country ratings and real estates. The applicant/ promoters of a CRA should have professional competence, financial soundness and general reputation of fairness and integrity in business transaction; they should not be involved in any legal proceedings connected with the securities market. The CRAs are required to have a minimum net worth of Rs. 5 crore. A CRA can not rate (i) a security issued by its promoter, (ii) securities issued by any borrower, subsidiary, an associate promoter of CRA, if there are common Chairman, Directors and Employees between the CRA or its rating committee and these entities (iii) a security issued by its associate or subsidiary if the CRA or its rating committee share a common Chairman, Director or Employee.
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For debt securities with issue size greater than or equal to Rs. 100 crore, two ratings from different CRAs are required. The issuer should disclose in the offer documents all the ratings it has got during the previous 3 years for any of its listed securities, irrespective of whether it has been accepted or not. CRAs should continuously monitor the securities rated by them and disseminate any changes in its ratings, along with its history through websites, press releases etc.
Merchant Banking
The merchant banking activity in India is governed by SEBI (Merchant Bankers) Regulations, 1992. Consequently, all the merchant bankers have to be registered with SEBI. The details about them are presented in the table below:
Only a corporate body other than a non-banking financial company having necessary infrastructure, with at least two experienced persons employed can apply for registration as a merchant banker. The applicant has to fulfill the capital adequacy requirements, with prescribed minimum net worth. The regulations cover the code of conduct to be followed by merchant bankers, responsibilities of lead managers, payments of fees and disclosures to SEBI. They are required to appoint a Compliance Officer, who monitors compliance requirements of the securities laws and is responsible for redressal of investor grievance.
Demat issues
SEBI has mandated that all new IPOs compulsorily should be traded in dematerialized form only. Further, the section 68B of the Companies Act, 1956, requires that every listed public company making IPO of any security for Rs. 10 crore or more should issue the same only in dematerialized form. The investors, however, would have the option of either subscribing to securities in physical or dematerialized form.
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Private Placement
The private placement involves issue of securities, debt or equity, to selected subscribers, such as banks, FIs, MFs and high net worth individuals. It is arranged through a merchant/ investment banker, who acts as an agent of the issuer and brings together the issuer and the investor(s). Since these securities are allotted to a few sophisticated and experienced investors, the stringent public disclosure regulations and registration requirements are relaxed. The Companies Act, 1956, states that an offer of securities to more than 50 persons is deemed to be public issue.
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IPO TRENDThis kind of response to an IPO raises a moot question, “Is IPO always a good bet?” Therefore, the present research probes into the statistics of IPOs in the last two years at the National Stock Exchange (NSE)—2005 and 2006.
Analysis of First-Day Returns
In the last two years, 123 IPOs were issued through NSE, out of which 78scrips gave positive returns while 29 showed negative return on the very first day of the listing. If an investor had invested in all the IPOs and if he had sold the shares on day one, his average returns on investment would be 25.7%. Of course, simplistic assumptions have been made that the investor would be lucky enough to be successfully allotted the shares in all the IPOs and coupled to that he would also have received all the shares applied by him. Further, the average is based on the assumption that the amount invested in each IPO was Rs 50000.
Top Ten First- Day Returns (2005 and 2006)
Sr. No. Name of the issue
Issue Price (Rs.) listing return%
1 Nissan Copper Limited 39 130.9 235.64
2 Educomp Solutions Limited 125 284.05 127.24
3Infrastructure Development Finance Company Limited 34 69.5 104.41
4 Amar Remedies Limited 28 56.2 100.71
5 Voltamp Transformers Limited 345 640.85 85.75
6 Development Credit Bank Limited 26 47.45 82.50
7Sasken Communication Technologies Limited 260 464.6 78.69
8 Parsvnath Developers Limited 300 526.4 75.47
9 Sadbhav Engineering Limited 185 320.65 73.32
10 Sun TV Limited 875 1464.8 67.41
Among these 97 issues, some were star performers and some great disappointers. For example, Nissan Copper Limited gave the best return on the first day, i.e.235.64%. Similarly, Educomp Solution Limited and Infrastructure Development Finance Company Limited, gave 127.24% and 104.41% respectively. The worst performers were K Sera Sera Productions Limited,
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CHAPTER 5
Talbros Automotive Components Limited, and Deccan Aviation Limited with a loss of 54.85%, 40.25% and 33.04% respectively.
Worst Ten First day Returns (2005 and 2006)
Worst ten First day Returns
listing return%Sr. No. Name of the issue
Issue Price (Rs.)
1 K Sera Sera Productions Ltd 68 30.7 -54.85
2Talbros Automotive Components Limited 102 60.95 -40.25
3 Deccan Aviation Limited 148 99.1 -33.044 Unity Infraprojects Limited 675 470.9 -30.245 Raj Rayon Limited 65 50.65 -22.086 Prime Focus Limited 417 326.15 -21.797 Jagran Prakashan Limited 320 270.9 -15.348 Shringar Cinemas Limited 53 44.95 -15.199 Cairn India Limited 160 137.4 -14.1310 Gitanjali Gems Limited 195 167.6 -14.05
All these statistics reveal a mixed picture, but the fact is that the investor may or may not be get allotted in IPO. Even if they are, they may not get 100% of the allotment. Thus, the Return on Investment (ROI) may be lesser than the return on share price. Recently, ICRA Ltd IPO got overall oversubscribed by 72 times in a week. Naturally, one cannot expect all the subscribers to get the shares they applied for.
Analysis of Three-Month Returns
In this case, it has been analyzed what would be the return if one follows the strategy of holding the share for the first three months from the date of issue. The numbers from the past two years show that out of 97 companies, 60 gave positive returns while 37 gave negative returns.
Worst Ten 3 Months Returns (2005 and 2006)
Sr. No. Name of the issue
Issue Price (Rs.) 3 months return%
1 Raj Rayon Limited 65 24.95 -61.622 K Sera Sera Productions Limited 68 28 -58.823 Visa Steel Limited 57 27.3 -52.114 Uttam Sugar Mills Limited 340 167.9 -50.62
5 Emkay Share and Stock Brokers Ltd 120 61.9 -48.426 R Systems International Limited 250 137.8 -44.887 Ruchira Papers Limited 23 13.3 -42.178 Talbros Automotive Components Ltd 102 62.95 -38.289 Blue Bird (India) Limited 105 65.9 -37.24
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10 Deccan Aviation Limited 148 93.4 -36.89
Sr. No. Name of the issue
Issue Price (Rs.) 3 months return%
1 Atlanta Limited 150 1022.2 581.472 Development Credit Bank Limited 26 80.35 209.043 Tech Mahindra Limited 365 1116.3 205.844 Educomp Solutions Limited 125 359.05 187.245 Tulip IT Services Limited 120 341.45 184.546 Pyramid Saimira Theatre Limited 100 281 181.007 Shree Renuka Sugars Limited 285 799.5 180.538 Everest Kanto Cylinder Limited 160 420 162.509 Action Construction Equipment Ltd 130 308.85 137.5810 Sadbhav Engineering Limited 185 387.65 109.54
Top Ten 3 Months Returns (2005 and 2006)
Surprisingly, the average return on issue price for the 97 companies was 31.67% as compared to 25.7% of the first month return. One major reason was an unpredictably wonderful performance of Atlanta Limited( 581.47%)
Analysis of Six-Month Returns
What would be the return if one follows the strategy of holding the share for the first six months from the date of issue? Statistics show that out of 89 companies 54 gave positive returns while 35 companies gave negative returns. The average return was 33.57%. Again the better performance of the averages can be contributed to Shree Renuka Sugars Limited return of 394.60%.
Worst Ten 6 Months Returns ( 2005 and 2006)
Sr. No. Name of the issue
Issue Price (Rs.) 6 months Return%
1 K Sera Sera Productions Limited 68 15.75 -76.842 Talbros Automotive Components Ltd 102 45.1 -55.783 Nitin Spinners Limited 21 10.1 -51.904 Visa Steel Limited 57 27.7 -51.405 JHS Svendgaard Laboratories Ltd 58 32.2 -44.486 Emkay Share and Stock Brokers Ltd 120 66.75 -44.387 Uttam Sugar Mills Limited 340 190.6 -43.948 Ruchira Papers Limited 23 13.8 -40.009 GVK Power & Infrastructure Ltd 310 187.4 -39.5510 Blue Bird (India) Limited 105 66.9 -36.29
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Sr. No. Name of the issue
Issue Price (Rs.) 6 months return%
1 Shree Renuka Sugars Limited 285 1409.6 394.602 Tech Mahindra Limited 365 1435.5 293.293 Educomp Solutions Limited 125 412.15 229.724 Amar Remedies Limited 28 85.4 205.005 Gateway Distriparks Limited 72 215.45 199.246 Development Credit Bank Limited 26 71.85 176.357 Bombay Rayon Fashions Limited 70 186 165.718 Suzlon Energy Limited 510 1285.75 152.119 Tulip IT Services Limited 120 257 114.1710 Sadbhav Engineering Limited 185 388.9 110.22
Top Ten 6 month Returns (2005 and 2006)
Average of Holding for One-Year Strategy
Educomp Solutions Limited had beaten all the records and was definitely an exception to the market, which provided an unbelievable return of 708.8 %(Its issue price was Rs 125 and its price at the end of the year was Rs 1011). Not only did the price of its share appreciate but also the company gave regular dividends. It has made a big influence in all the statistics.
Sr. No. Name of the issue
Issue Price (Rs.) 1 year % return
1 Educomp Solutions Limited 125 1011 708.802 Tulip IT Services Limited 120 550 358.333 AIA Engineering Limited 315 1330 322.224 Everest Kanto Cylinder Limited 160 651 306.885 Bombay Rayon Fashions Limited 70 252 260.006 Gateway Distriparks Limited 72 253.6 252.227 India Infoline Limited 76 203.7 168.038 Suzlon Energy Limited 510 1347.9 164.299 Shoppers Stop Limited 238 616.75 159.1410 Sadbhav Engineering Limited 185 460.55 148.95
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Worst Ten Issues 1 Year (CY 2005 and 2006)
Sr. No. Name of the issue
Issue Price (Rs.) 1 year % return
1 Uttam Sugar Mills Limited 340 131.4 -61.352 Visa Steel Limited 57 27.4 -51.933 Nectar Lifesciences Limited 240 123.45 -48.56
4Emkay Share and Stock Brokers Ltd 120 65.7 -45.25
5 SPL Industries Limited 70 38.5 -45.006 R Systems International Limited 250 140.9 -43.647 Shri Ramrupai Balaji Steels Ltd 22 12.7 -42.278 Solar Explosives Limited 190 110.1 -42.059 Repro India Limited 165 97 -41.2110 Kernex Microsystems (I) Limited 250 155 -38.00
Holding IPO Scrip for more than a year
The past data that it would not be wise to hold the IPO share for more than a year. A majority of the companies were found to have dipped below their issue price, when they were held for a period of more than a year. There are only two or three companies like Divi’s Laboratories Ltd, Bharti Tele, and Balaji Telefilm , which are still in positive territory compared to the issue price.
Issues to be addressed
There are many reasons which affect the return on an IPO like the fundamentals of the company, management of the company, pricing of the issue, FII investment and many other economic and market factors. Each of these factors differ from company to company and so differ the returns. However, on an average, strong evidence indicates that on the basis of the past data, an IPO may be listed at a premium to the issue price. The present research suggests that the investor may go for an IPO, but may not hold the share for a very long period.
Though all the above statistics lure investors to invest via the IPO route, there is no exhaustive and full proof evidence that investment in IPO will give good returns every time. Basically, investment in IPO too needs careful thought and proper revision of the sector and the company fundamentals.
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Out of Ten top Cities 6 are from Gujrat
Statistics shows the Gujrat state is leading investor in the intial public offer, in the entire country because of the following reasons:
1) Excess liquidity in the system: As Gujrat state is known for its manufacturing and textile markets, these people have an ample liquidity with them in the non-seasons time, so they want to part their investments in other options like IPO and other instruments which encourage them to participate heavily to good public offers with their surplus money.
2) Risk appetite of the people: The Gujrat and the Maharashtra regional belt known for its industries and companies, the people over here know, about the companies much better and access to information of the Gujrati communities among their circles is far much higher, also their speculative motive over here far more higher than any other state. Which contributes to the reason for the higher participation in the initial public offering.
3) Gujrati community in the Markets: There is huge participation of the Gujrati community in the markets, investor have an easy access to the information through investor circles among them. Also participation in the IPO markets, give them the chance of earning somewhat less risky confirmed returns. Encourages them to participate more in the primary markets. Most of the broking firms are owned by Gujrati’s and Marwari people not even that their staff is also Gujrati or marwari.
4) Seasonal Business: Businesses in Gujrat have seasonal in nature like textile and manufacturing also somewhat diamond business, so these traders look for better arena to park the fund somewhere other to get the returns.
IPO Business Cycle
Looking at the current scenario of the capital markets overall, we think the Indian IPO business Cycle is also in the nascent stage as like our capital markets, Markets might be rocking and rolling ahead to the new highs and capturing new peaks, but history has always shown that IPO cycle is always somewhat related to the performance of the capital markets and the sentiments and confidence among the participating investors. Promoters and Bankers always want to cash on the bullish sentiments and the confidence of the investor, so they try to raise as much money from the primary markets to gain on that confidence of the investors. Statistics shows us that number of public offers and amount raised through it had gone on increasing on the bullish
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capital markets period and the vice versa happening on the bearish phase of the capital markets. So the reasons the IPO business cycle to be at nascent stage:
1) In India the small and medium fast growing business are still unlisted, there are as much companies unlisted, as much listed ones. So they still need to raise funds for their expansion.
2) As the economy grows by 8-8.5% CAGR, which translates the corporate earnings to grow at around 17-20%, meaning the capital markets to give an average return of around 20-25% CAGR, making the room ahead for the companies to raise money from the primary capital markets.
3) The business like Hutch, Haldia, Indian Railways, DLF etc are still unlisted with such an beautiful and growing businesses give more room ahead for the fund raising from the corporates.
4) Also with the strict norms and the guidelines from the regulatory of the Indian capital market, with better management the IPO and also the capital markets are on the right track to move forward.
5) Liberalization and Securitization, with the reformist moves from the Indian government front have boosted the confidence for the Indian corporates and the public sector units to come up and disinvest their business models to the public for the growth and the expansion, which is also signaling the better time IPO or the primary markets ahead.
MNC’s in India
The number MNC doing business are to more compared with any other emerging markets, like brazil and Taiwan which are mainly driven by the commodity and oil stocks, probably that’s why their price earning ratio is too low as compared with Indian and china. Indian capital markets have always seen an floury of MNC rushing to do business in India, to focus and deliver results of this huge pool of consumption driven economy. We have always seen very well diversified group of companies in both manufacturing and services sectors like technology, in which with combinations of best of the talent and lower labour cost as compared to other counter parts, have motivated all MNC from around the world to come an do business in India.
International Happenings – IPO Highlights
2005 was a watershed year for IPO activity in the Middle East and Africa: soaring liquidity from oil revenues contributed to many big ticket IPOs raising more than $500 million each in the United Arab Emirates (UAE), Saudi Arabia, Oman, Lebanon and Egypt. The UAE alone saw issues worth $1.9 billion compared to just $0.5 billion in 2004.
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In the next few years, assuming the necessary political stability, the Middle East is likely to become an important source of IPO activity as oil revenues are recycled into the local economy.
Asia continues to be a hotbed of activity. Towed along by mainland China and Hong Kong’s continuing strength, other economies in the area displayed vigorous IPO activity, notably Malaysia, Taiwan, South Korea, and India.
One of the three biggest deals to date this year was Lotte, the South Korean Department Store, which raised $3.5 billion when it dual-listed in London and Seoul.
India has evoked lively investor interest and will continue to do so. While the amounts raised fell from $2.9 billion to $2.3 billion in 2005, reflecting fewer privatizations, numbers of transactions surged from 21 to 53.
Many Indian IPOs have been oversubscribed 20 to 30 times in markets that have been scaling record levels. Following Jet Airways’ successful launch — one of the most successful Indian IPOs of recent times — a number of state-run airlines are poised to float in the near future.
In Latin America, Brazil saw an increase in both the amount of capital raised – up 48% to $1.8 billion, and the number of transactions – up 20% on the previous year. Brazilian companies currently account for one-third of all Latin American listings on the New York Stock Exchange.
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IPO Scam 2006.
The recent IPO scam reveal the fraudulent ways in which one can manipulate the demat account. As in the past , retail investor have been the losers . this is the right time for SEBI to become proactive in preventing unhealthy practices in the market.
The Indian investor had much to cheer about in 2005. The stock markets have seen a great run at the Sensex for the third successive year. The market has also seen a huge level of FII inflows into the country. FII investment in India in 2005 stood at $10.67 bn and the cumulative amount went up to $41 bn. the Indian stock market charged ahead, and the Sensex zoomed to a new high touching above 9400 point. The primary market too witnessed a positive response from investor .a total of 53 IPOs hit the market and about 46 received positive returns from investors. About Rs 22,731 Crore was raised from the primary market and about Rs 23,000 cr was raised through IPO and FPO. During 2005, broking firms like IL&FS, India Infoline, and India bull tapped the market through IPOs along with big issues like Shopper’s Stop, Provogue, and Suzlon Energy. The year also saw FPOs from ICICI Bank, oriental bank of Commerce and Punjab National Bank. The public issue market has been in full swing for the last two and half year and a huge amount of Rs 55458 Cr was raised.
Behind the scenes
When the investor cheerfully painted a pretty picture in 2005 and wished for the situation to continue in 2006, the Yes Bank demat scam and the IDFC IPO scam greeted the investors. SEBI, based on the investigation of possible manipulation of the other IPOs issued in 2005, has directed National Securities Depository Limited (NSDL) and Stock exchange to look after the off market transaction in shares after the allotment of IPOs.
The IPO shock come out with the income tax Department discovering about 5000 demat Account of one Purshottam Budhwani. It referred the case to the SEBI, and SEBI in turn has asked the stock exchange to look into the off market transactions of IPOs issued. The BSE investigation revealed startling activities of multiple demat Account used to corner shares in IPOs. The investigation by SEBI uncovered that two Gujarat based entities, Roopalben Panchal and Sugandh Estates and Investment Pvt Ltd. Together had more than 8,000 demat account and bank accounts to corner shares in the Yes Bank IPO.
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CHAPTER 6
The art of manipulation.
The Modus operandi adopted in manipulation of yes bank and IDFC Bank IPO issues involved the opening of ‘benami’ account or bogus demat account with NSDL through depository participants (DPs). SEBI investigation revealed that application and funds were canalized through these account for garnering large shares from the IPO, which were normally reserved for retail investors.
According to SEBI DP guidelines, Qualified Institutional Buyers (QIBs), Non Institutional Buyers, and Retail investor are allotted in the ratio 50:15:35 respectively in a book building process. And generally the NIBs leverage IPO financing and are the maximum sellers in the market as soon as the issue opens for trading. SEBI (DIP) also defines the retail investor as one who could apply for shares worth up to Rs 100000. An Investor whose bids in excess of the said amount is considered to be High Net worth Investors (HNI). In the case of Yes Bank IPO scam, SEBI Investigation revealed that over 8000 Benami Demat account were opened to garner the retail Investor shares.
The Yes bank Ltd came up with a public issue of up to 70,000,000 equity shares of each Rs 10 at an offering Price of between Rs 38-45 per share. The issue opened on June 15, 2005 and closed on June 21, 2005 for subscription. The issue was made through 100% book building process, where up to 50 % of the issue size was allotted on a discretionary basis to QIBs, 15 % on proportionate basis to NIBs and remaining 5% to retail investor, DSP Merrill Lynch Ltd, and Enam Financial Consultants Pvt. Ltd, acted as BRLMs and Karvy Computershare Pvt Ltd was the registrar for the Issue. The issue received a total of Rs 183.34 Cr from Subscription of over 26 times. The bank Raised Rs 3.15 bn from the Issue
The modus Operandi.
The modus Operandi adopted in manipulating the Yes Bank Ltd IPO involved channeling the fund of HNI investor into the Retail segment in order to increase the chances of the allotment of IPO. According to the market sources, the chances of allotment through ‘benami’ mat account rise five times than an application as a HNI. SEBI investigations showed that about 6,221 of the 6315 demat account from Roopalben Panchal received shares of Yes bank had listed the same address as 402-403 Shashwat , Opposite Gujarat College, Ellsberg Ahemdabad , and all the 6315 demat account were opened with NSDL through Karvy Stock broking Ltd. and had bank account with Bharat overseas Bank, worli Mumbai. Sugandh estates and investment Pvt ltd Opened 1315 demat account and had bank account with Vijaya bank.
Roopalben Panchal originally applied for 1050 Yes bank shares and paid the application money of Rs 47250. She did not receive any allotment in the HNI category but later investigation revealed that after IPO was closed and before
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the scrip was listed on the stock exchanges. She received 150 Shares each from 6315 ‘benami’ demat account within a day after the allotment adding up to 9, 47,250 shares. Yet her, name did not figure among top 100 individuals allotters of the Yes bank IPO issue. Roopalben Panchal transferred the entire equity shares in off-market transactions to six entities prior to the listing of equity on the stock exchange, of which five sold their entire holding on the day of the listing. Yes bank was listed on the Bombay Stock Exchange (BSE) and NSE on July 12, 2005, According to SEBI, Panchal and others could have booked profit to the tune of about Rs 1.35 Cr. Sugandh estate and investment Pvt Ltd. too acting on similar lines garnered 1,97,250 shares. Receiving 150 shares from 1315 benami’ Demat account and sold the shares in off market transaction. Sugandh Estates and Investment Pvt. Ltd, later in offline market transaction sold the shares to three entities who sold the shares on the day of listing making profit of more than Rs 32 lakhs. Yes bank shares were issued at Rs 45 per shares and on the day of listing the scrip opened with a price of Rs 65.90 and intraday high was Rs 70 and closed at 60.85.
In the normal process both Roopalben Panchal and Sugandh Estates and Investment Pvt Ltd, in order to get an allotment of 9, 31,600 shares would have had to apply for Crores of shares which mean paying Crores of rupees as application money. But both through ‘benami’ demat accounts applied for the maximum possible number of shares per application under the retail investor category by putting in large number of application and 150 shares per application, shares which should have been allotted to genuine retail investors, thus abusing the IPO allotment process.
The outcome in the detection of large scale ‘benami’ demats account gives ample proof of loopholes in the protection of investors against fraudulent transfer of shares from demats account. SEBI’s swift and decisive action set the ball rolling to discover one more IPO scam larger than Yes Bank-IDFC IPO, again involved Roopalben Panchal , Sugandh Estates and investment Pvt ltd , Purshottam Budhwani , and Manojdev Seksaria, benefiting through ’benami’ demat account with accounts in Bharat overseas bank, HDFC bank, Indian overseas bank, ING Vysya bank and Vijaya bank. While karvy Computershare Pvt Ltd acted as the registrar for the IDFC IPO, Kotak mahindra Capital Company acted as major BRLM and DSP Merrill Lynch Limited, SBI capital market ltd. and JM Morgan Stanley Ltd as minor BRLM.
According to SEBI report, the four entities opened 42,000 Benami Demat account and garnered 8.29% of the 14.12 Cr Shares meant for Retail investors. Roopalben Panchal received 39, 43,184 shares from 14807 demat account in CDSL and 32, 61,426 shares from 12,257 demat account in NSDL through off-market transaction. Manojdev seksaria and Purshottam Budhwani , received 5.29 Lakh IDFC shares and 10.95 Lakh Shares respectively, from bogus demat accounts. Like in the Yes bank case, the shares were later transferred to some other entities before the listing of the shares on BSE and NSE on august 12 2005
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The modus operandi in both the IPO scams has been receiving the IPO allotment through fictitious demat Account and off-market transferring of the shares to the financiers prior to the listing and the financiered selling the shares on the day of the listing , thus, booking profits as the scrip’s were listed by 50%-60% higher than the allotted price. SEBI’s intensified probe has revealed that several entities have concerned IPO shares reserved for retail investors by making application in the retail category through ‘benami’ IPO accounts. In both IPO scams, SEBI investigation revealed that some investors have used fictitious names to buy more shares than they are legally entitled to.
SEBI in action
G Ananthraman , whole time member, SEBI directed the market regulator to conduct an inspection on karvy RTI and BRLMs associated with the issue of IPOs with immediate effect and the reasons for systematic failure, and also to determine the Qualification of karvy –RTI. The Market regulator has referred several banks to the banking regulator-Reserve Bank of India (RBI)- and also directed the depositories , NSDL and CSDL, to look into the functioning of depository participants and asked NSDL to plug the loopholes in the KYC( Know your customer ) guidelines,
SEBI’s investigation of malpractices in the IPO issues has revealed the misuse of bank account and wider use of bogus demats account in IPO malpractice. Market sources believe that ‘benami’ demat account are opened not only with the intention of converting black money into white money, but also for mopping up IPOs and creating artificial volumes, circular trading and price manipulation. Market sources suspect the possible role of the issuer –lead managers –registrar –merchant banker – broker- depositary Participants- Banks nexus in abetting the IPO scam. SEBI investigation revealed that the demat account were opened back in 2003 strengthening their role and putting all IPOs issues offered to public between 2004 and 2005. SEBI, suspecting similar modus operandi in the issue of suzlon Energy, SPL industries, Shopper’s stop, Provogue India. Nectar Life sciences, IL&FS investment , gokuldas Exports began probing the role of various players in the IPO issue.
SEBI’s investigations of the demat scam reveals the violation of KYC norms by Depository Participants and the bank Anti Money laundering (AML). SEBI’s investigation clearly shows the willful negligence of Banks and surveillance failure of self-regulatory NSDL and CSDL over DPs. Speaking on the NDSL failure to detect the multiple demat account SEBI said “it’s a matter of concern that NSDL, which is a self-regulatory organization and within whose regulatory domain Karvy-DP falls, could not detect in advance the apparently systemic deficiencies in karvy DP.” However, when SEBI blamed NDSL regarding the Yes bank IPO scam, NDSL said that the ‘important regulation’ on market manipulation was entirely ‘within the jurisdictions of SEBI’.
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A detailed inspection of karvy in Yes bank IPO allotment by NSDL, on the order of SEBI, revealed lapses in the processing account –opening applications for demat account which did not adhere to the KYC norms. C Parthasarthy , chairman of karvy Computershare Pvt Ltd, registrar to Yes Bank IPO said “ we have followed all the systematic norms and never carried out a check based on common address and having common address for different demat accounts is a widespread phenomenon and noted that the failure lies in the system itself which does not bar an individual investor opening multiple demat account, either with one more DPs.”
Public Offering –Saga of Scams.
The Indian capital market is booming like never before. The secondary market is on an upsurge and is reaching new highs every next week. The primary markets is also active with lots of initial and follow-on public issues. In such a scenario, investors have to be more specific in their choice of investment. We saw the instances of circular trading and the issues of penny stocks in the secondary market a few months ago. The regulatory body, the Securities and Exchange Board of India (SEBI), unearthed this issue and made the retail investor cautions and more vigilant in picking up the right stocks. Once again, SEBI has done well to detect the violation of regulations in the primary market relating to demat accounts and public offerings. This throws some light on the functioning of banks, depository and registrar. SEBI’s stance on this issue will further decide the strength of Indian Capital Markets. This issue of multiple demat accounts has definitely created panic among investors, but it has also prompted them to make cautionary moves in the forthcoming public offers.
Motives
From 2004-05, the primary market has witnessed increased activity by Foreign Institutional Investors (FII) and others. The Sensex moved up by leaps and bounds. Earlier, the great primary market rally was witnessed during the Harsad Mehta Scam in 1992 and later in 1996 when technology stocks were on the rise. In the year 2005 many public offerings came and most of them are now trading higher than their listing price. They opened with a considerable premium at the time of listing. These huge profits in a very short span of time had lured some investors to explore IPO investments. They started applying for the public offerings with more than one demat accounts. Some unscrupulous people started taking advantage of this situation by opening a number of benami/fictitious demat accounts with the help of bankers and depository participants. They had successfully hidden their identity till they were exposed.
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Reasons for using multiple and Benami Demat account
Various reasons can be cited for resorting to multiple demat accounts. First, using more than one demat account for applications in a retail investor category of a public offer will significantly swell up the possibility of getting the allotment. Secondly, banks cannot lend more than Rs. 10 lakhs to a single investor for a public issue. This prompts them to open multiple and benami accounts. Thirdly, as per the banking norms and the government guidelines and investment or deposit beyond Rs. 50000 has to be through a cheque or cash by indicating the (PAN) permanent account number. It has also been revealed that the benami account holders created duplicate PAN. And finally, the modus operandi encouraged money laundering. Through benami accounts one can refine one’s unaccounted money. This can be explained by the following example.
Mr. X had applied for 5000 shares in a public offer with a price of Rs. 10. he was able to make a contract with Mr. Y, who agreed to buy those shares at Rs. 12 on the date of listing. If on the listing date the share price opened with a 30% premium, then Mr. Y would earn Re. 1. At the same time, Mr. X also fixed a profit of Rs. 2. In this situation, Mr X would get a cheque of Rs, 65,000 on the sale of 5000 shares at Rs 13 each. He would give Rs. 5000 in cash from his unaccounted money. So, Mr. X was able to convert his unaccounted Rs. 5000 to account it.
The benami accounts scam came to light when SEBI discovered the tainted allotment of shares in the IPO of Yes bank. Box I provides the entire story in a nutshell.
The Yes Bank Episode
Yes Bank Limited (YBL) came out with a public issue in June 2005. The total size of the issue was 70,000,000 equity shares of Rs. 10 each at price of Rs. 45 per equity share. Out of these total number of shares offered, 35,000,000 equity shares were reserved for Qualified Institutional Buyers (QIBs), 17,500,000 equity shares were allotted to Non- institutional Investors and 17,500,000 equity shares were reserved for the retail investors. The retail portion of the issue was oversubscribed by 9.96 times.
Roopalben Panchal, one of the applicants, applied for 1050 equity shares, she was entitled for an allotment of 150 shares as per the basis of allotment which was finalized in July 2005. But on July 11, 2005, i.e., one day prior to the day of listing, she made the off-market transfer of 9, 31,000 shares to various entities. So, the obvious question is how she acquired these shares. By going through the transaction statement of her demat account held with DP Karvy stock broking limited, it was observed that Roopalben Panchal received 150 shares each from 6,315 demat accounts, the total of which stands to 9,47,250
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shares. And she transferred the funds to these entities that made the application on her behalf.
Now, the question that arises is who are those 6,315 demat holders? As per the demat account date furnished by National Securities Depository Limited (NSDL), out of these 6,315 entities, 6,221 have their address as 402-403 Shashwat, opposite Gujarat college, Ellis bridge, Ahemdabad- 380-006. This address is the same address as that of Devangi Panchal, who is the sister of Roopalben. Of the remaining entities, 50 and 44 of them have the address Shahibaug, Ahemdabad and Paldi, Ahemdabad respectively, interestingly all the 6,315 have their bank accounts with Bharat overseas Bank and demat accounts with Karvy-DP. These facts raise doubts as to whether these 6,315 entities are the holders of multiple accounts of Roopalben or are benami/fictitious entities.
Roopalben made off market transfer from the 6,315 demat account on july11, 2005 to entities mentioned in Table 1 and they in turn sold the shares in the market.
In SEBI’s findings, it has been clarified that Sujal Leasing and Finance Pvt. Ltd. Approached SEIPL and provided about Rs. 7 cr for making the application for the issue. SEIPL, in turn, applied for 15 Lakh shares in the IPO through 1,500 friends and about 1, 97,000 shares were allotted to it. SEIPL then transferred these shares to Rita Ben Thakkar, Veenaben Thakkar and Sujal Leasing and Finance Pvt. Ltd. And the total profit earned by these three entities was around Rs. 32.26 lakhs. Now, from the above a case we can observe that the total reservation for retail investors was 1, 75, 00,000 shares out of that Roopalben Panchal and SEIPL acquired approximately 1, 97,000 which accounts for 6.54% of the total reservation made for retail investors.
Putting IPO’s under the Scanner
After a few days of the Yes Bank scam, SEBI unveiled another scam- that of the IDFC IPO. SEBI’s investigation revealed that about 8.29% of the retail portion of the IDFC IPO was received by fictitious applicants who operated multiple demat accounts. Roopalben Panchal received 39,43,184 shares from 14,807 demat accounts and Purshottam Ghanshyam Budhwani received 2,98,418 shares from 1,122 demat accounts. It was also found that Budhwani had adopted a similar process in other IPOs such as Suzlon Energy, SPL Industries, Shoppers stop, Provogue India, Nectar Life sciences, IL&FS Investments, Gokuldas Exports, Gateway Distriparks, etc. Roopalben Panchal and her associates were also said to be involved in the IPOs of Sasken Communication and Jet Airways. All these demat account holders had their bank account with Bharat overseas Bank and demat account with Karvy-DP. Other issues, which are under scanner, are Jaiprakash Hydro-power, Punj Lloyd, FCS Software, PVR Cinema and Sringar Cinema.
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IPO Funding
Banks are allowed to fund an investment of up to Rs.10 lakhs as a loan. While financing IPOs, banks make it mandatory for the customer to keep the shares allotted to a special beneficiary account and also pledge those shares. Thus, funding an IPO is a good business for banks as it is the source of good fee and interest income. On the other hand, investors have to pay only a part of the investment and this helps them apply more, thus, increasing the change of receiving more shares. These benefits lure both parties to get involved and make some money out of the IPO funding.
Registrar’s Role
The registrar provides administrative support to the issue process. It is responsible for the verification and reconciliation of bank schedule and application forms. It is also responsible for the data entry of the contents of all the application forms after screening for invalid and multiple applications. Thus, somewhere in this whole IPO scam, the involvement of the registrar cannot be completely ruled out. The problem is not with the allotment mechanism, but the way in which some banks and depository participants associate with exploiters in opening of bogus accounts (demat and bank accounts).
The systems shortcomings
We witnessed the shortcomings of the system when the Harsad Mehta and Ketan Parekh scams took place. Now there are two new scams involving Roopalben Panchal. Various entities along with the said person are involved in these scams. In each of these scams, we had seen that banks are involved. In the Yes Bank Scam, Bharat overseas Bank and Vijaya Bank were said to be involved. The involvement of the depository participant is also being probed into. The opening of multiple bank and demat accounts initiated the scam. Opening multiple bank and demat accounts is not an offense. In the above given scam the names of the identity are only slightly different from each other and the addresses in most of the cases are the same. This violates the ‘Know Your customer’ norms (KYC).
Identifications Crisis
For compliance of the key norms, a robust and powerful identification system needs to be put in place. Many countries have their own identification mechanism. In US, a Social Security Number (SSN) is commonly used as the identification Mechanism. Those persons who are not qualified for SSN are issued an Individual Taxpayer Identification Number (ITIN). This number is given to foreign national and other who have tax reporting or filling requirement and do not qualify for SSN. The UK is in process of having a national identity card system Germany has an identity card system which is
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compulsory for all citizens. Some other countries also have similar arrangements for identifying their citizens.
In India we have various identification mechanisms like the birth certificate, school leaving certificate, driving license, phone bill, electricity bill, passport, voter’s ID , PAN and MAPIN. MAPIN was introduced to create a unique non-duplicable ID for all investors in order to establish an audit trail SEBI had initiated MAPIN, but later halted it, with a view that there will be a multiple unique ID. However, instead of making a new identity base, the government should make PAN compulsory for all capital market actions. On the basis of the PAN card, a new Identity based on the Biometric system should be introduced. Thus PAN will become the sole identity for all financial transactions. All customer identification should be based on the PAN card. This unique number will enable SEBI and the government to cover different segments of the market, check fraud and manipulation and assist in building other government database.
There is also a crucial need to continuously observe flow in demat account. Both NSDL and CSDL should move toward better surveillance mechanism and should take up greater responsibility in the interest of the investors.
Making Retail Investor happy
SEBI’s discovery in the multiple demat account scam will not have a major impact on the pricing of the forthcoming issues as pricing is determined based on the demand and supply and on the fundamentals, but the investigation may improve the proportion of allotment for genuine retail investors. The oversubscription will be less in the forth coming IPOs as multiple / benami account holders will draw out, which will improve the prospectus of allotment. The allotment procedure and lock-in period will be discouraged the opening of multiple accounts for example, with regard to the allotment procedure, if an issue is oversubscribed five times , then instead of giving allotment to one of five application , allotment on proportionate basis should be made, so that there won’t be any incentive for multiple applications. This will also increase the number of satisfied investors. The other way is to keep the lock in period of a minimum six months. This will reduce the excessive speculation as only genuine investor will invest.
Thus, a reform in the primary market is imperative. There are more public issues lined up. Retailers are the major class of investors in public offering. They should have enough confidence in the system to invest in it whether or not redesigning present procedure will end IPO scams is a question to be debated . with SEBI being regarded as one of the best regulators , one expects it to come to the retail investors rescue when , required.
Conclusion
Though the IPO scam is not as big as the Harsad Mehta and Ketan Parekh Scam, all three have banks involved in them, which shows their willful
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negligence and violation of KYC norms, giving room to anti-money laundering .bank should have notices when continuous serial numbers on particular branches are submitted towards application money. They should have noticed when a series of refund orders were addressed to one single account. It is absolutely wrong to deny that they do not have the system for cross check of addresses. As the Finance Minster. P Chidambaram , reiterated, banks and depository participants should not have accepted a system that does not detect multiple accounts from the same address.
The high level of fraud in the IPO issue has denied small investors an opportunity for allotment. Though the market regulator has come down heavily on the offenders by banning all the 13 entities –seer Finlease Pvt Ltd, Excell Multitech Ltd, Zenet Software Ltd, Tauras Infosys Ltd, Sugandh estates and Investment Pvt. Ltd , Sujal Leasing and Finance Pvt Ltd, Ritaben R Thakkar, Veenaben Y Thakkar, Jayantilal Jitmal, Bhargav Panchal, Rajan Vasudev Dapki, RoopalBen Nareshbhai Panchal and Devangi Dipakbhai Panchal involved in the Yes bank IPO scam – And Has directed the depositories to take action on the DPs and concerned BRLMs to the issue, alerted RBI to examine the role of Bharat Overseas Bank, HDFC bank, Indian Overseas Bank, ING Vysya Bank and Vijaya bank in opening ‘ benami’ accounts and funding their IPO application, it is time for the market regulator to bring in stringent regulation and protect the retail investor from fraudulent and unhealthy practices in the market.
It is time for the regulator to consider a unique identification number for each individual. Earlier UIN was suggested only for individual investing more than Rs 5 lakhs. As the demat account were exploited to garner shares meant for retail investors, the introduction of the UIN system will prevent those kinds of malpractices. Moreover, UIN cannot be obtained unless a person is physically present so the question of non existent persons having a UIN will not arise.
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The Role of SEBI
With the objectives of improving market efficiency, enhancing transparency, checking unfair trade practices and bringing the Indian market up to international standards, a package of reforms consisting of measures to liberalize, regulate and develop the securities market was introduced during the 1990s. This has changed corporate securities market beyond recognition in this decade. The practice of allocation of resources among different competing entities as well as its terms by a central authority was discontinued. The secondary market overcame the geographical barriers by moving to screen-based trading. Trades enjoy counterparty guarantee. Physical security certificates have almost disappeared. The settlement period has shortened to three days.
Role of Primary Market as procurer of long-term resources for Industry & Business
The Primary Market mops up resources from the public (investors) and makes available to meet the long term capital requirements of corporate business & industry in the form of equity/debt capital, while the secondary market provides liquidity to the investments made by the individual investors. It is primary market that is in the center-stage of the capital market bringing together the two principal segments of the market that of investors and the seekers of capital. Regular growth of the economy of the country is possible only through a robust and vibrant primary market. The secondary market provides captive dealings amongst investors themselves, who trade/speculate in the stock markets. Operations in the secondary market do not result in the accretion of capital resources of the country, but it indirectly promotes savings and investment, by providing the unique quality of liquidity to investment in securities.
Primary Market is the medium for floating pubic issues. Public issue means an invitation by a company to the public to subscribe to the securities offered through a prospectus. Similarly the Primary market infuses new listed securities in the market generated through new public issues floated regularly and thus enlarges the security base traded in the secondary market. There is thus inter-dependency between the two markets.
Beneficial Effects of Primary Market
a. Mobilizes risk capital to the Issuers. Resources mobilsed are not repayable except in the case of winding up or buy back of shares.
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CHAPTER 7
b. No committed payment of charge/interest. Payment of dividend is optional and subject to availability of disposable profits, after meeting all other overheads/obligations
c. A well managed and profitable company enhances shareholders' wealth. In fact the company functions with this goal as its main corporate objective.
d. The shareholders enjoy the benefit of liquidity of their investment, when the shares are listed and traded in the stock-exchange.
e. Brisk trading of the securities of a well-managed and high profit earning company serves as an index of the reputation of the company's promoters, its products /services.
Disadvantages/Problems Faced by Corporates
a. Raising capital/funds through the primary market is time consuming, expensive.
b. The Issuer has to engage the services of a number of intermediaries and comply with complex legal and other formalities
c. Listing agreement with the stock exchange burdens the company with recurring disclosure obligations.
d. The company may suffer directly on account of operations by unscrupulous speculators & gamblers in the market
e. Dispersed ownership with recourse for easy transferability of shares may lead to attempts by corporate predators to take over the company
Threats faced by Investors & Responsibilities on SEBI
The investor faces limited risk in the secondary market, but he needs much more protection and safeguards in the primary market. This is because in an initial public issue, except for the offer documents/prospectus he has no other source of information about the bonafides of the issue-raisers. Instances of vanishing companies and fly-by-night promoters act as a deterrent to investor confidence. Further secondary market deals are isolated transactions involving sale/purchase of individual lots of shares/bonds, while in the primary market news issues are for very large amounts sometimes even hundreds of crores of rupees. Fraudulent promoters may try to dupe the entire community of investors, who opt to invest in a new issue.
Up to 1992, the capital/primary market was controlled by the Controller of Capital Issue (CCI) formed under the Capital Issues Control Act. During that period, the pricing of capital issues was controlled by CCI. The premium on issue of equity shares issued through the primary markets was done in accordance with the Capital Issues Control Act. The CCI guidelines were abolished with the introduction of Securities & Exchange Board of India (SEBI) formed under the SEBI Act, 1992 with the prime objective of protecting the interests of investors in securities, promoting the development
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of, and regulating, the securities market and for matters connected therewith or incidental thereto.' All public issues since January, 1992 are governed by the rules & regulations issued by SEBI.
SEBI was formed to promote fair dealing in issue of securities and to ensure that the capital markets function efficiently, transparently and economically in the better interests of both the issuers and the investors. The promoters should be able to raise funds at a relatively low cost. At the same time, investors must be protected from unethical practices and their rights must be safeguarded so that there is a steady flow of savings into the market. There must be proper regulation and code of conduct and fair practice by intermediaries to make them competitive and professional.
The regulation of primary issues thus poses an acid test for SEBI. On the one hand in view of the leading role of these issues in the development and economic growth of the country, SEBI in view of its responsibility for development of the market has to do every thing to promote new issues and make it easier for bonafide promoters to raise funds for productive ventures, and on the other hand SEBI has to ensure that the interests of the investors are protected to the best possible extent.
To fulfill its objectives relating to responsibility for regulation and responsibility for market development, which may not overlap at all times, SEBI while opening up the market to the Issuers, regulates the issue process providing for full safeguards and transparency through disclosure of all relevant information by the issuers so that the investor can make an informed decision.
Since, its formation, SEBI has been instrumental in bringing greater transparency in capital issues. Under the umbrella of SEBI, companies issuing shares are free to fix the premium provided adequate disclosure is made in the offer documents. Focus being the greater investor protection, SEBI has become a vigilant watchdog. Over a period of nearly a decade of its existence, SEBI has established itself as a 'regulator of consequence'. Today, if the Indian economy has grown into robust and strong economy – strong enough to successfully swim against the currents of global competition, it is due, in no small measure, to the contribution of the Indian capital market. The capital market has proved to be an effective medium of canalizing the savings of the investors from every nook and corner of the country, for investment needed for capital formation and economic growth.
The Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000
SEBI in the year 1992 issued detailed guidelines to standardize disclosure obligations and make it incumbent for corporates floating public issues to disclose all relevant information affecting investors' interest. Based on
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experience gained these regulations were reviewed and revised in the year 2000 and presently "The Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000" as amended subsequently from time to time are operative and in force now.
SEBI constantly reviews its guidelines to make them more market/ investor friendly. In this direction, SEBI has set up two committees to deliberate on the issues pertaining to Primary Market. One under the chairmanship of Shri Y.H.Malegam, Managing Partner, S B Billimoria & Co. (Referred as Malegam Committee) and the other under the Chairmanship of Sh M S Varma, Chairman, TRAI (referred as Primary Market Advisory Committee (PMAC). These committees comprise of representatives of merchant bankers, investor associations, ICAI, ICSI etc.
The Primary Market Advisory Committee advises SEBI on various issues relating to development of primary Market whereas the Malegam Committee mainly focuses on the disclosure requirements in the offer documents. Besides this, various issues are examined by SEBI internally. These reports are displayed on the website of SEBI for eliciting public comments and decision taken by SEBI in due course based on the feedback from the market.
Principal Steps involved in floating a Public Issue
The strategy to deal with complexities in a given task is to analyze and break the complex task into a number of simple one-step processes or jobs and further group them as per sequential time-schedules. It is part of this strategy that jobs needing specialised knowledge/job skills are out-sourced to competent professionals or service-providers qualified and experienced in the particular line. A public issue is kept open by the issuer and issue-managers soliciting subscription by investors over a period between three days (minimum) and ten days (maximum). This is the core or principal segment of the whole task. Whatever steps to be complied with, prior to this are preparatory steps/legal obligations to be complied with and whatever is to be done subsequent to the closure of the issue are identified as 'post-issue obligations' to complete the process and realize benefits thereof (capital to the Issuer and tradable investment (equity shares) to the investor. We can therefore identify three distinct stages in the successful completion of a public issue, as under:
1. Pre-issue Preparatory tasks 2. Issue opens and at the expiry of the stipulated period closes 3. Post-issue obligations.
Pre-issue preparatory Tasks
The tasks to be attended at this stage are:
Drafting & Finalization of the Prospectus
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Selecting & entering into agreements with the Intermediaries Attending to preliminary formalities (getting approvals) from
SEBI/stock exchange.
Prospectus
This is the essential document that addresses all the data/information, which a prospective investor would like to know to arrive at an informed decision to subscribe to the issue of the company. It is thus a communication from the issuer to the investors. The Companies Act 1956 defines a prospectus as - "any document described or issued as a prospectus and includes any notice, circular, advertisement or other document inviting deposits from the public or inviting offers from the public for the subscription or purchase of any shares in, or debentures of, a body corporate."
As earlier stated prospectus is a document by way of which the investor gets all the information pertaining to the company in which they are going to invest. It gives the detailed information about the Company, Promoter / Directors, group companies, Capital Structure, Terms of the present issue, details of proposed project, particulars of the issue etc. There are certain mandatory disclosures, which have to be made in the prospectus. The mandatory disclosures to be made in the prospectus includes in Schedule II of the Companies Act, 1956. SEBI has issued guidelines, SEBI (Disclosure for Investor and Protection), Guidelines, 2000 which gives details about the contents of prospectus. (Chapter VI)
Appointment of Intermediaries
Guidelines relating to appointment of intermediaries are set out in Chapter V Clause 4 of the DIP Guidelines. All intermediaries connected with the public issue (primary market) are registered with SEBI. Brief information about them and their functions are discussed in the module dealing with Intermediaries.
Principal steps/procedure for a Public Issue
Pre-Issue Processes
To initiate the process the Company to pass a Board Resolution and proceed to appoint a Merchant Banker, with whom an MOU may be entered into. Subsequent sequential steps are as under:
a. Prepare Draft Prospectus. This is to be approved by the Board.
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b. A Resolution at a meeting of Shareholder's in terms of Section 81(1A) of the Companies Act, 1956. is also necessary
c. Form 23 to be filed with ROC for passing special resolution for issuing shares as above
d. Appointment of intermediaries and entering into MOU with them ( underwriters, Bankers to the Issue, Registrars, brokers to the issue for marketing the same
e. Filing of prospectus with the SEBI/Registrar of Companies : The draft prospectus along with the copies of the agreements entered into with the Lead Manager, Underwriters, Bankers, registrars and Brokers to the issue is filed with SEBI and the Registrar of Companies of the state where the registered office of the company is located along with the fees & other prescribed requirements, (with due diligence by merchant banker)
f. Vetting of prospectus by SEBI as per suggestions, if any, received from SEBI
g. Obtaining in-principle approval from stock exchange h. File final prospectus with SEBI / stock exchanges / ROC i. Printing and dispatch of Application forms : The prospectus and
application forms are printed and dispatched to all the merchant bankers, underwriters, brokers to the issue.
j. Filing of the initial listing application : A letter is sent to the Stock exchanges where the issue is proposed to be listed giving the details and stating the intent ;of getting the shares listed on the Exchange. The initial listing application has to be sent with a fee of Rs. 7,500/-.
k. Statutory announcement : An abridged version of the prospectus and; the Issue start and close dates are published in major English ;dailies and vernacular newspapers.
l. Submission of 1% Security Deposit with the Regional Stock Exchange. m. Depositing Promoter's Contribution in the issue in a separate bank
account.
Post-Issue Obligations
a. Processing of applications : After the close of the Public Issue all the application forms are collected, at the Registrars to the issue and scrutinized, tabulated in consultation with the merchant banker.
b. Establishing the liability of the underwriter : In case the Issue is not fully subscribed to, then the liability for the subscription falls on the underwriters who have to subscribe to the shortfall, incase they have not procured the amount committed by them as per the Underwriting agreement.
c. Allotment of shares : after the issue is subscribed to the minimum level. Basis of allotment in consultation with the regional stock exchange. Refer detailed allotment procedure as prescribed by SEBI.
d. Release Post Issue Advertisement
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e. Dispatch of share certificates / refund orders f. Listing of the Issue : The shares after having been allotted have to be
listed compulsorily in the regional stock exchange and optionally at the other stock exchanges. For this purpose enter into an listing agreement with stock exchange(s). Also obtain permission from Stock Exchanges for listing & trading of securities for Commencement of trading of securities
g. File Form No. 2 for Return of Allotment with ROC h. Attend to Redress of Investors Grievances received i. 78-day post issue monitoring report to be submitted by merchant banker
with SEBI.
Guidelines for Allotment1. Allotment has to be made within 16 days of the closure of the Public
Issue and 42 days in case of a Rights issue. 2. Net Offer to the General Public has to be at least 30% of the Total Issue
Size for listing on a Stock exchange 3. For listing an IPO on the NSE Paid up capital should be Rs. 20 Crores,
secondly the issuer or the promoting company should have a track record of profitability and thirdly the project should be appraised by a financial Institution, banks or Category I merchant bank. For knowledge based companies like IT the paid up capital should be Rs. 5 Crores, but the market capitalization should be at least Rs. 50 Crores.
4. It is mandatory for a company to get its shares listed at the regional stock exchange where the registered office of the issuer is located.
5. In an issue of more than Rs. 100 Crores the issuer is allowed to place the whole issue by book building.
6. All the listing formalities for a public Issue has to be completed within 70 days from the date of closure of the subscription list.
7. There should be at-least 5 investors for every 1 Lakh of equity offered. 8. Quoting of permanent Account number or GIR No. in application for
allotment of securities is compulsory where monetary value of Investment is Rs.50,000/- or above.
9. Firm Allotment to permanent and regular employees of the issuer is subject to a ceiling of 10% of the issue amount.
10. Indian development financial institutions ad Mutual Fund can be allotted securities up to 75% of the Issue Amount.
11. Allotment to categories of FIIs and NRIs/OCBs is up to Maximum of 24% which can be further extended to 30% by an application to the RBI - supported by a resolution passed in the General Meeting.
12. 10% individual ceiling for each category a) Permanent employees' b) Shareholding of the promoting companies.
13. Securities issued to the promoter, his group companies by way of firm allotment and reservation have a lock-in period of 3 years. However shares allotted to FII's and certain Indian and multilateral development
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financial institutions and Indian Mutual Funds are not subject to Lock-in periods
14. The minimum period for which a public issue has to be kept open is 3 working days and maximum 10 days. The minimum period for a rights issue is 15 working days and the maximum 60 working days.
15. A public issue is affected if the issue is able to procure 90% of the Total issue size during the Public Issue. In case of over - subscription the company may have the right to retain the excess application money and allot shares more than the proposed issue which is referred to as the 'green-shoe' option.
Difference between Book Building and Public Issue
“Book Building”: means a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document. In Book Building securities are offered at prices above or equal to the floor prices, whereas securities are offered at a fixed price in case of a public issue. In case of Book Building, the demand can be known everyday as the book is built. But in case of the public issue the demand is known at the close of the issue
Instances Where Companies are permitted to Make Public Issues only through Book Building Process
1. An unlisted company can make a public issue of equity shares or any security convertible into equity shares at a later date, only through the book-building process if, it does not comply with the conditions of the Regulation with regards to Net Worth and Track record.
2. its proposed issue size exceeds five times its pre-issue net-worth as per the last available audited accounts either at the time of filing draft offer document with the Board or at the time of opening of the issue
3. Provided that sixty percent (60%) of the issue size shall be allotted to the Qualified Institutional Buyers (QIBs), failing which the full subscription monies shall be refunded.
4. A listed company which does not fulfil the condition given in the proviso to clause 2.3.1 of the Regulation (Net worth & Past Track Record) above, shall be eligible to make a public issue only through the book building process. Provided that sixty percent (60%) of the issue size shall be allotted to the Qualified Institutional Buyers (QIBs), failing which the full subscription monies shall be refunded.
5. A company, whose equity shares or any security convertible at later date into equity shares are offered through an offer for sale, shall comply with the eligibility provisions relating to net worth & past track record Offer for sale can also be made only through the book-building process
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Rights Issue
The rights issue involves selling of securities to the existing shareholders in proportion to their current holding. When a company issues additional equity capital it has to be offered in the first instance to the existing shareholders on a pro-rata basis as per Section 81 of the Companies Act, 1956. The shareholders may by a special resolution forfeit this right, partially or fully by a special resolution to enable the company to issue additional capital to the public or alternatively by passing a simple resolution and taking the permission of the Central Government.
Private Placement
A private placement results from the sale of securities by the company to one or few investors. The distinctive features of private placement are that there is no need for a formal prospectus as well as underwriting arrangement. The terms of the issue are negotiated between the company and the investors. The issuers are normally the listed public limited companies or closely held public or private limited companies which cannot access the primary market. The securities are placed normally with the Institutional investors, Mutual funds or other Financial Institutional.
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Regulatory Authorities.
To understand the regulatory and control systems in-built in the market, we must study the structural framework of the capital market. The capital market consists of the following elements.
1. On the one hand are the innumerable, but not organized savers, and2. At the other end are those seeking capital from the capital market; 3. Regulatory Body :
SEBI (the Securities & Exchange Board of India) an autonomous and statutory body acts as the market regulator and market developer. It regulates and controls the capital users and all functionaries between the users and the investors.
4. The Stock Exchanges :
There are 23 Stock Exchanges registered with SEBI and under its regulation. They provide a transparent and safe (risk-free) forum of a market for investors to transact and invest their funds
5. The Depositories :
The depositories are innovative institutions, which are able to render the market paperless by holdings securities electronically, providing ease and speed for those transacting in the market
6. The Registered Intermediaries :
They consist of brokers, sub-brokers, Trading and Clearing Members, portfolio managers, Bankers to Issue, merchant bankers, registrars, underwriters and credit rating agencies. They all provide a basket of services to the investors to lesson risk and make transacting earlier and smooth. They are all registered with SEBI and act under the regulation of SAEBI abiding by the Code of Conduct prescribed for each of them governing their respective roles.
So vast and well established is the market that the daily turn over in the main Stock Exchange in the Country National Stock Exchange of India averages Rs.2000 Crores presently and bound to multiply further in the coming future.
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CHAPTER 8
Current Issues
1. IPO Rating – A Primer
SEBI, in its role as a regulator of the capital market and safeguarding the investors, has announced the professional rating of IPOs and also the registered brokers, a service that is not available on any bourse across the world. The primary objective is to enhance governance issues. The article speaks on related issues.
In late December 2005, the Securities and Exchange Board of India (SEBI’s) after its board meeting announced its plans for introducing voluntary ratings of Initial Public Offerings (IPOs), giving promoters and investors a possible topic for debate. SEBI’s decision comes at the backdrop of the YES Bank and IDFC IPO scams, where fictitious demat accounts kept the retail investor from getting his share of the IPO allotment.
Lessons Learnt from Recent IPO Scam
The recent multiple demat account episode brought into light a few high net worth investors who resorted to corner shares from IPO issues through multiple demat accounts posing as retail investors. The fraudulent parties sold the shares on the day of listing and earned premium on the speculation price. SEBI’s in order to address the problem of multiple demat accounts, and then took measures to make IPOs more transparent. The announcement by SEBI’s will provide investors, in the near future, with the benefit of having their issues related by credit rating agencies approved by SEBI. By introducing IPO rating, SEBI intends to enable more realistic pricing of shares and help investors by providing more detailed information of the issue. According to SEBI, the fee for rating IPOs will not be borne by the issuer and SEBI has requested the Ministry of Company Affairs to fund the ratings of IPOs from its Investor Education and Protection Fund (IEPF). The fund constitutes unpaid dividends, application money, unpaid debentures and redemption fund. SEBI has listed CRISIL, Fitch Rating, ICRA and CARE as the rating agencies. It is to be noted here that the rating of IPOs has been made optional and is not mandatory. The choice is left to the issuer. It is to be recalled that the plan to introduce the rating of IPOs was mulled by SEBI some two years back. In May 2004, Sebi planned to introduce mandatory IPO rating covering promoters, management record and past performance. But today, SEBI decided to make IPO rating voluntary. It has raised debates and doubts among analysts and markets.
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Chapter 5CHAPTER 9
Rating of IPOS
An IPO rating is one time relative assessment of fundamentals of the IPO at the time of issue and is meant to aid interested investors in their decision-making. The grading is normally on a five-point scale; a high score indicates stronger fundamentals. The general fundamental areas of rating are the issuer’s management information, market conditions and potential growth factors. An IPO assessment carried out by an independent credit rating agency gives professional and independent assessment of the IPO. The assessment provides vital information about the company and also creates awareness about the fundamental strengths and weakness among the investors. The information provided by the rating agencies will help the investor in allocating his resources better and maintaining a good portfolio of stocks in his pocket. According to Sebi, the IPO grading will be expressed on a five-point scale and is a relative comparison of the assessed fundamentals of the graded issue to other listed equity securities in the country.
IPO Grading Vs. Investment Recommendation An IPO grading is different from an investment recommendation. In an investment recommendation, brokers or analysts express their opinion to ‘buy’, ‘hold’ or ‘sell’ a share based on performance indicators like business prospectus, financial positions and market factors, taking into consideration the price of the security. Whereas while grading an IPO, the cognizance of the price of the security is not taken into consideration and it is only one of the inputs for the investor to consider the share in their decision-making process.
Speaking to the press, a Sebi spokesperson said, “The IPO grading does not take cognizance of the price of the security, it is not an investment recommendation. Rather, it is one of the inputs for the investor to aid in the decision-making process. All other things remaining equal, a security with stronger fundamentals would command a higher market price.”
The Need for Rating
IPO rating comes in handy, as it has often been proven and observed that when an investor considers investing in an IPO, he/she approaches a broker and generally goes through the information given by the company in the application form. The investor seldom reads or hardly gets access to the prospectus as these are generally sent to brokers and qualified institutional buyers. Even after having got access to the prospectus, retail investors do not go through the entire document containing about 150 pages or more. And even if they do, they may not be able to comprehend the disclosures made in the document for the decision-making. The ratings disclosed by the independent credible agencies,
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therefore, will be welcome, as they will help the investor in making decisions against risky IPO issues.
The success of IPOs in the market in the past two years has encouraged several companies to enter the market (see Table 1), and the opportunities to invest in them are bound to be manifold. The grading of IPO on a five-point scale reflecting the fundamentals of the IPO and the dissemination of information will be a boon for the investor, as it will help investors to allocate their resources better.The IPO grading report, like a credit rating, which is very useful for a debt investor, will also be of use to the retail investors. The grading of IPO will give an improved quality of information which can result in stratification of the market in the hope of raising easy capital. The grading of IPOs will also enable an investment banker to market a high rated IPO issue, at the same time a poorly rated IPO will come under the scanner when it is heavily oversubscribed.Market circles and analysts entrust that institutional investors collude with brokers and company managements to organize a variant of the pump-and-dump scheme by engineering over subscription of public offers at inflated prices. They aim to dump these shares in the secondary market after orchestrating a flare up in post-listing prices. Grading IPOs could prevent this vicious circle.
Table 1: IPOs in 2006Issues in January 2006 IPO/FPO Issue Dates1. Andhra Bank2. Bank of Baroda3. Dynamic Products Ltd.4. Entertainment Network (India)
Ltd.5. Gujarat State Petronet Ltd.6. Inox Leisure Ltd.7. Jagran Prakashan Ltd.8. Nitin Spinners Ltd.9. Raj Rayon Ltd.10. Royal Orchid Hostels Ltd.
FPOFPOIPOIPOIPOIPOIPOIPOFPOIPO
16/01-20/0116/01-20/0118/01-25/0123/01-27/0124/01-28/0127/01-02/0225/01-31/0106/01-12/0112/01-18/0112/01-17/01
765.001633.0015.44213.84372.60198.00369.4440.0015.25112.53
Issues in February 2006 IPO/FPO Issue Dates1. Gitanjali Gems Ltd.2. GVK Power &
Infrastructure Ltd.3. Indo Tech Transformers
Ltd.4. K Sera Sera Productions
Ltd.5. Pratibha Industries Ltd.6. Sadbhav Engineering Ltd.7. Sakuma Exports Ltd.
IPOIPOIPOFPOIPOIPOIPOFPOFPO
16/02-21/0202/02-21/0210/02-16/0216/02-22/0216/02-22/0203/02-08/0208/02-14/0210/02-15/0215/02-21/02
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8. The South Indian Bank Ltd.9. Union Bank of India.
1405.28Source: www.primedatabase.comThe grading of IPOs will pave the way for providing an independent and informed opinion on the fundamental analysis of the company towards making a quality decision and at the same time taking steps towards establishing a scientific manner of setting up procedures in the issue of IPOs.
Complexity in Rating IPOs
But the rating of equity issues is more complex than rating debt instruments. It is obvious that when RBI made the rating of the schemes floated by the Non Banking Finance Companies (NBFC) and other deposit-taking firms mandatory, they did not get satisfactory ratings, and this caused a shake in the NBFC segment. Moreover, there are complexities in rating equities. The general valuation metrics applied to companies are market value, price-to-sales, price-to-earning, price-to-book value, profit margin and the expected utilization of IPO proceeds (percentage offered in IPO). Also, with the choice of rating the IPO being optional, issuers are not forced to rate their IPOs at all. Or there could be a bias in rating; a low-rated IPO could turn into a good issue and the reverse may also happen. As the cost of grading is borne by the investor protection fund or IEPF, and the rating agencies normally will have the IPO rating done for a fee without accountability, the regulator cannot consider this grading system as foolproof.
Sebi’s notion of rating stockbroker is equally dubious. Stockbrokers are known for changing their trading positions frequently; which could be very difficult for credit rating agencies to deal with. The real time risk management systems of the exchange alone will know the default probability of the stockbroker. Unless the mechanism is perfectly installed, there is no meaning to the credit ratings of stockbrokers-even if the stockbroker is doing a bond issue. It is to be observed that the YES Bank IPO scam revealed how brokers, unscrupulous traders and investors beat the audit trails created by automated trading systems. The IPO scam showed how easy it was for an individual retail investor to open thousands of demat accounts in collusion with depository participants and banks.
Lessons to be Learnt from SEC
Doubts are being raised about Sebi bringing in the optional grading of IPOs by credit rating agencies. It is a known fact that there is a nexus between the brokers, investment bankers and credit rating agencies. The experiences in the US are lessons to be learnt from.
The Securities and Exchange Commission (SEC) before implementing the Sarbanes-Oxley Act of 2002 had scrutinized the nexus between the brokerage and investment banking houses and the promotion stocks by them in order to
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gain lucrative investment-banking fees. Sec’s scrutiny of credit rating agencies found a lack of diligence in identifying credit problems. The cases of Enron and WorldCom were well-know for fraudulent grading before they went bankrupt. The well-know credit rating agencies like Standard & Poor’s (S&P) and Moody’s did not reduce Enron’s credit ratings from investment grade to junk level until four days before Enron’s doors were shut and WorldCom had been rated investment grade only months before it went bankrupt.
In view of Sebi announcing its plan of voluntary grading of IPOs, it is to be kept in mind that the regulator has to safeguard investors from the nexus between credit rating agencies and investment bankers, as it is possible that the regulator cleared companies with dubious background for raising public money. It remains to be seen how Sebi’s ambitious plan succeeds in safeguarding investors’ interest.
Investment decisions in IPOs are becoming increasingly difficult, given the flurry of public offers that hit the market these days. Differentiating a good offer from a bad one, assessing the company fundamentals and verifying the credentials are becoming more complex. In this backdrop, the Securities and Exchange Board of India's decision to make IPOs (initial public offers) grading by credit rating agencies mandatory, is likely to provide some respite to retail investors. However, the rating is unlikely to throw much light for short-term investors or traders seeking to make a quick buck from the `listing gains’. We take a look at what the grading system proposes to do and what changes, if any, it is likely to bring in.
In a move, which does not appear to have any precedence elsewhere in the world of capital markets, the SEBI has introduced compulsory grading of initial public offers that will hit the market from now on. Credit rating agencies such as the CRISIL and ICRA will grade the various forthcoming IPOs on a five-point scale from grade 5 (indicating strong fundamentals) to grade 1 (indicating poor fundamentals).
This grading, which will be based on the agencies assessment of company fundamentals, will consider the following five parameters — earnings per share, financial risks, accounting quality, corporate governance and management quality. Thus, the rating awarded to an IPO will mirror the company's general health in terms of these qualitative and quantitative factors. The IPO pricing, however, is not factored in for the purpose of rating. These ratings, apart from being available in the respective offer documents of the companies, can also be viewed on the respective rating agency's Web site.
Grade 1
For instance, a company X decides to tap the primary market for raising capital. The rating agencies will now be required to grade the company. This process will include market checks, plant visits and practice of due diligence apart from studying the other already-specified macro factors. At the end of the
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process, say, X is awarded grade 1 (indicating poor fundamentals). This would mean that the company is fundamentally weak and investments in that company could be risky. However, the rating does not go on to say whether such an offer is to be avoided or not.
In a similar manner, if X gets a grade 5 (the highest one possible), it does not mean a blanket approval from the rating agency to invest in the public offer. It only means that X is fundamentally sound on the basis of metrics used by the rating agency.
Thus, in general, the grading process that has been introduced is meant to make the retail investors aware of the health of the company's business. It cannot be interpreted as a recommendation to invest or avoid any offer that is so rated.
Advantages IPO grading, a hitherto optional exercise, has been made compulsory to encourage only serious companies. Over the long-term, it is likely to help SEBI regulate the IPO market by helping it protect the investors from cases of vanishing companies. The rating will also facilitate the not-so-well known companies in tapping the primary market for capital. Retail investors, on the other hand, stand to benefit the most. The grading system that purports to give a professional perspective of the company's fundamentals is likely to help investors establish the credentials of the company they plan to invest in. Neutral agencies can be more objective in their evaluation of a public offer compared to other market participants. This apart, it is likely to help investors weed out companies with poor fundamentals or those with a spurious background at the preliminary stage itself.
Disadvantages More often than not, the pricing of any IPO is what influences the decision of any investor. The rating agencies, in this case, will not talk about ``what price'' and ``what time'' aspects of the offer. Given that the decision to invest or avoid investments in any IPO is most often a function of the pricing, the lack of this aspect in the present IPO grading system could make the whole process an unfinished task. Also, rating agencies (experienced in debt rating) could face trouble with rating the equities, which, unlike debt rating, is more dynamic and cannot be standardized. Further, IPO grading mechanism is a globally-unique initiative; it could increase the cost of raising capital in India and urge companies to seek capital overseas. Markets, in the short term, can be price-driven and not purely motivated by company fundamentals. That is to say that, at times, even good companies at a higher price could be a bad investment choice, while the not-as-good ones could be a steal at lower prices.
Despite having disclaimers, a higher graded IPO may well tempt small investors into falsely believing that a high premium would come about on listing. Similarly, investors may get deluded by a low-graded IPO, which could become a `missed opportunity' in the future. The purpose of introducing
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grading, thus, might get defeated if it leads to a false sense of buoyancy or alarm among investors.
Till such time the utility of the IPO grading system is unraveled, it is advisable for investors to use the grades only as an additional input to make an informed decision. Investors need to be convinced about the business potential, pricing and valuations of an IPO, together with the grading, to make a final choice.
2. Circuit Limits
Few days back SEBI shows his intention to put circuit limit on listing of IPO. Like Parsvanath Developers Ltd it issued share at 300 Rs and on listing date it went up 650 Rs. Similarly in recent IPO of ICRA it was issued at 330 and it went to 880 Rs 266% up on its listing day and close at 798 Rs 242%. SEBI for investors benefit sooner or later will come with this Circuit limit to stop price volatility.
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Recommendations:
1) I think more of the customized professional personal consultant kind of the move is required for the group to move ahead to tap the niche market for the personal portfolio management.
2) To increase and retain the customer base from the existing one, try to focus more on retail clients.
3) Value added services are the next leg ahead, which could provide the impetus for the growth for the financial services, is the next big thing for the broking houses.
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References www.bseindia.com
www.nseindia.com
www.bloomberg.com
www.ey.com
www.moneycontrol.com
www.primedatabase.com
www.rbi.gov.in
www.ey.com
Google Search.
Prime Database Directory 2006.
Study Material BSE/NSE.
INDIA-An Investor’s Guide to the Next Economic Superpower.
By Aaron Chaze
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