review of ipo process in nepal and study of prerequisites ... · ii chapter five: stakeholder’s...
TRANSCRIPT
Submitted By
Deepesh Vaidya
15 July, 2012
Review of IPO Process in Nepal and Study of Prerequisites
for Introducing Free Pricing in IPOs in Nepal
i
TABLE OF CONTENTS
LIST OF ABBREVIATIONS III
LIST OF TABLES AND FIGURES V
CHAPTER ONE: INTRODUCTION 1
RESEARCH TOPIC 1
BACKGROUND 1
PREFACE OF THE RESEARCH 2
OBJECTIVES OF THE RESEARCH 3
RESEARCH METHODOLOGY 4
LIMITATIONS 5
CHAPTER TWO: LITERATURE REVIEW 7
CHAPTER THREE: REVIEW OF RELATED REGULATIONS REGARDING ISSUE OF SECURITIES AND
PRICING MECHANISM IN NEPAL 11
REVIEW OF REGULATIONS GOVERNING PUBLIC ISSUE OF SECURITIES IN NEPAL 11
THE COMPANIES ACT 2063 (2006) 11
THE SECURITIES ACT 2063 AND SECURITIES ISSUE AND REGULATIONS ACT 2065 12
A PROCEDURE FOR AN IPO PROCESS IN NEPAL 14
CURRENT PRICING MECHANISM IN NEPAL 18
EMPIRICAL STUDY OF IPO PERFORMANCE UNDER PREVAILING PRICING MECHANISM 18
OVERVIEW OF SOME DIFFERENT PRICING MECHANISM USED IN NEPALESE CAPITAL MARKET 22
CHAPTER FOUR: REVIEW OF FREE PRICE DISCOVERY MECHANISM / BOOK BUILDING
MECHANISM IN NEIGHBORING COUNTRIES 26
BANGLADESH 26
CHINA 31
INDIA 33
MALAYSIA 40
ii
CHAPTER FIVE: STAKEHOLDER’S VIEW ON THE FREE PRICING MECHANISM IN IPO IN NEPAL 52
COMPANIES (ISSUERS) 53
INVESTORS 54
MARKET INTERMEDIARIES 59
REGULATORS 60
CHAPTER SIX: RECOMMENDATIONS AND APPROPRIATE MODEL FOR NEPAL 64
CHANGE IN REGULATION AND CAPACITY BUILDING OF STAKEHOLDERS 64
METHODS OF GOING PUBLIC 68
PAR VALUE METHOD 69
MARKET PRICING METHOD 69
PROCEDURE REQUIREMENTS 70
PAR VALUE METHOD 70
MARKET PRICING METHOD 70
CHAPTER SEVEN: CONCLUSION 75
BIBLIOGRAPHY 77
ANNEXURE I
ANNEX I: ILLUSTRATION OF PRICE DISCOVERY THROUGH BOOK BUILDING MECHANISM II
ANNEX II: ELIGIBILITY CRITERIA FOR INQUIRY OBJECTS IN CHINA III
ANNEX III: QUESTIONS ASKED TO CONCERNED STAKEHOLDERS REGARDING FREE PRICING SYSTEM IN IPO IN NEPAL IV
iii
List of Abbreviations
AGM Annual General Meeting
BFI’s Bank and Financial Institutions
BRLM Book Running Lead Manager
BSE Bangladesh Stock Exchange
CA Chartered Accountants
CCI Controller of Capital Issue
CHCL Chilime Hydropower Company Limited
CSRC China Securities Regulatory Commission
DIP Disclosure and Investor Protection
DSE Dhaka Stock Exchange
EII Eligible Institutional Investors
FII Foreign Institutional Investors
FPO Further Public Offerings
ICDR Issue Capital and Disclosure Requirement
IPO Initial Public Offering
NBER National Bureau of Economic Research
NBFIs Non-Banking Financial Institutions
NEPSE Nepal Stock Exchange
NTC Nepal Telecom
QIBs Qualified Institutional Buyers
SCBNL Standard Chartered Bank Nepal Limited
SEBI Securities Exchange Board of India
iv
SEBON Securities Board of Nepal
SEC Securities Exchange Commission of Bangladesh
v
List of Tables and Figures
List of Tables
Table 1: Subscription and aftermarket pricing of some of the largest IPOs, 2063/64 – 2067/68 .............. 18
Table 2: Overview of SCBNL, NTC and CHCL issue under different pricing mechanism ............................. 22
Table 3: Allocation of shares under Book building in Bangladesh .............................................................. 29
Table 4: Restriction in IPOs in China ........................................................................................................... 32
List of Figures
Figure 1: Movement in Price of Ordinary shares after listing in NEPSE, 2063/64-67/68 ........................... 21
Figure 2: IPO value chain ............................................................................................................................. 51
1
Chapter One: Introduction
Research Topic
To review the current system of pricing of securities offered to public through Initial Public Offerings in
Nepal; to assess the need for free pricing mechanism in IPOs in Nepal; and to provide recommendation
on pre-requisites in terms of regulations/infrastructure necessary to implement system of free pricing of
securities in the Initial Public Offerings of securities in Nepal.
Background
Capital Markets of Nepal can be taken as ordinary shares dominated market, further skewed by the
ordinary shares of financial institutions and insurance companies. 80% of all listed securities in Nepal
Stock Exchange Ltd., the only stock exchange in Nepal, are ordinary shares. 78% of all listed ordinary
shares, in terms of listed value, are ordinary shares of financial institutions comprised of Commercial
Banks, Development Banks, Finance Companies, Insurance Companies (hereinafter referred to as BFIIs).
If government owned portion of Nepal Doorsanchar Company Ltd. (91.50%) is omitted, ordinary shares
of BFIIs comprises 89% of total listed ordinary shares. Due to overweight of the ordinary shares of BFIIs,
the stock market, which should have been an economic barometer of the country, is predominantly
influenced by the performance of financial sector rather than the performance of overall economy of
the country. The dominance of capital market by securities of BFIIs is largely explained by regulatory
requirements where companies established under Bank & Financial Institutions Act and Insurance Act
are mandatorily required to offer their shares to general public and list the shares in stock exchange.
Hence, such companies come to public by compulsion whereas companies from other sectors, besides
BFIIs, have no compulsion and generally have not shown eagerness to enter the capital markets in
Nepal.
In order to make the capital market deep and more diverse, it is necessary to bring companies from
various economic sectors of the country into capital markets by facilitating them to offer securities to
the public and by ensuring that such shares are continuously priced in the secondary market. Going
public is also beneficial for companies as they will have access to needed capital through broad base of
public fund, in addition to banks and private market. However, companies have simply shied away from
the market and have not shown interest to vie for the market. Ironically, except for few, most of the non
2
financial sector companies listed in the Nepal Stock Exchange have not performed well, both in terms of
financial return and also in terms of regulatory compliances, vis-à-vis BFIIs. One of the main reasons
pointed out for such lax compliances by such non BFIIs was the absence of strong regulatory body to
oversee them that would require them to follow proper corporate governance as a public limited
company. At the same time investors are also fragmented and non-institutionalized to form a united
and strong force to demand compliances from such listed companies. Such experience has developed a
negative sentiment among the Nepalese capital markets investors toward securities of such non BFIIs
companies. The tasks would be hence not only to attract companies from the various sector of the
economy to capital market for access of funds but also to attract general investors’ to participate in
those offers knowingly and willingly.
Further, attracting companies from different sectors entails not only attracting existing and established
companies to issue their securities in the capital markets but also developing the market where fairly
new companies are able to issue their securities in the market. Existing companies will be interested to
come to the market only if there is an incentive for them to issue their shares to the public. One of such
incentives is being able to make existing shareholders’ investment liquid at market value. For fairly new
companies, the incentive would be an opportunity to collect much needed capital from the market at
right price. For both to happen, the market requires a mechanism under public offerings that allows
market to determine prices of securities. For market to determine prices in IPOs, the market needs to be
capable of doing so.
To heal the negative sentiments of public investors towards non BFIIs companies, the first responsibility
would be that of the Securities Board of Nepal (SEBON), the regulator of the capital market of Nepal,
followed by Company Registrar's Office (CRO), to ensure regulatory environment that regulates and
supervises such issuers; assures regulatory compliances by such issuers; and if needed takes necessary
actions against companies defaulting on compliances willfully. Further, concerned authority also need to
ensure proper capital markets ecosystem by encouraging emergence of various other market
intermediaries who brings long term capital, investment sophistication, professional advices/facilitation,
negotiating power with the issuers, and market intelligence to be a reference for the retail investors.
Preface of the Research
Capital markets channelizes funds from surplus group to deficit entity through direct undertaking of
agreed upon sharing of risk and return between two parties. The process of raising required capital from
3
the capital markets can be done through private placement or offering securities to public at large
through public offerings. Initial Public Offerings is the first offerings of the company's securities to the
market to raise required capital by the company. Simultaneously, fund raising from the public can be
done through Further Public Offerings (FPO) or Right Offerings. One of the major issues in public
offerings is ensuring fair price of securities. Internationally, three difference approaches have been used
to price the securities: fixed pricing, book building and auction. Book building and auction comes under
free pricing method in IPO.
In the fixed pricing method, price is fixed by the issuer in consultation with the issue manager, whereas
in both the book building and the auction, price is set after obtaining feedback from the investors. In the
case of Nepal, fixed price is set by the regulatory regime whereby, BFIIs cannot offer shares at price
more than the par value and for other companies price cannot exceed more than the per share net
worth, after complying with prerequisites in the Company Act and Securities Regulations. Fixed pricing,
practiced internationally, bestows the responsibility of determining the price to the issuer and the issue
manager. The market price is determined in the aftermarket. However, in the context of Nepal, fixed
pricing has been set at not more than per share net worth value. Because of such provisions, it is very
likely that the securities are underpriced, which is commonly known as leaving money on the table. This
is a cost to the issuer and if such cost is high, the incentive for the issuer to take such cost without any
other offsetting benefit would be null. This has been one of the reasons pointed out why companies,
which are not mandatorily required to come to public, are not eager to come to public in Nepal.
Hence, to bring companies beside BFIs to the market willingly, the capital market needs to address the
issue of letting the companies issue their shares at fair price. But, for this to happen we need to assess
the current status of capital markets of Nepal and work towards creating an ecosystem where the
market is fully equipped to subscribes such issues where investors have the ability to make informed
investment decisions and also be assured that the market they are investing are well regulated with
proper supervision by the concerned authority.
Objectives of the Research
The objectives of this research are:
1. Review the prevailing IPOs mechanism in Nepal at fixed price (face value) or at premium (limited
to per share net worth value) and its limitation to attract companies from other sectors of the
economy to the market.
4
2. Assess required changes in pricing mechanism in IPO to attract companies from the real sector
into the capital markets to raise capital.
3. Assess if investors are ready to invest in IPO under free pricing and highlight their concerns
4. Assess prerequisites required to allow/implement IPOs on free pricing in Nepal.
Research Methodology
Research Design The nature of the study is an exploratory study. An exploratory study is undertaken since not much is
known about the situation at hand and no information is available on how similar problems or research
issues have been solved in the past in the context. Since very few studies have been conducted and
knowledge is scant in the area of free pricing in Nepal, exploratory studies has been used to better
comprehend the nature of the problem.
Instruments Used Formal and informal communications (interviews and email correspondence) have been used for the
research. Some of the questions asked during the interviews and email correspondence are shown in
Annex III. The different questionnaire was prepared for different stakeholders such as potential
companies (10 questions), (representative) retail investors (10 questions), institutional
investors/potential to be institutional investors (13 questions), and Merchant Bankers (12 Questions).
Data Collection Procedure Because of the time and resource limitation only in-depth interview was used for data collection
procedure.
Sample and Sampling Being an exploratory research, non-probabilistic sampling has been used. The sampling method used for
the research is judgment sampling. This method is used since subjects are chosen to be part of the
sample with a specific purpose in mind. It is believed that subjects are better fit for the research
compared to other individuals. Some of the samples are listed in Annex IV.
Research Report Structure This research will cover five broad segments:
1. The first segment will review literatures to make a case for free pricing in IPOs.
5
2. The second segment will highlight existing process of public issues of securities in Nepal. This
will start from reviewing the current regulatory provisions, securities pricing mechanism and
process followed to complete the IPO process. This segment will also analyze historical IPOs and
secondary market transaction to substantiate prevalence of under pricing of securities in IPOs in
Nepal. This segment will also highlight few non-traditional public issue processes tested in the
capital markets of Nepal.
3. The Third segment will highlight IPO processes in neighboring countries which include
Bangladesh, China, India and Malaysia. The segment will also look into regulatory environment
in the respective countries in brief.
4. The fourth segment reviews the ecosystem of capital markets in Nepal through interviews with
stakeholders of the capital market namely: Regulators; Market intermediaries; Individual
Investors; Institutional Investors; and companies' potential to go public. The basic mode of
collecting data would be through interviews or through review of published data. (Refer to
Annex III for the list of questions asked during the interview for different stakeholders).
5. The fifth segment will provide a suggestive free pricing model for Nepal. This segment will also
provide suggestions on the prerequisites needed to develop an ecosystem to promote free
pricing in IPOs in Nepal based on comments received from stakeholders and regulatory review
of such processes in neighboring countries.
Limitations
The comprehensiveness of this report may be limited by resources available to the researcher to
conduct in-depth research of each and every segment of the issue. An in-depth study in specific issues
may be required to complement the report. Some other factors that may have limited the research are:
The research is based on expert opinion of various stakeholders such as regulators, market
intermediaries, investors, and companies' potential to go public; hence, the report may suffer
from biasness of such experts.
Due to researcher's constraint, the research may also have not covered views of all the
stakeholders.
Stakeholders are highly dispersed and hence may not have been accommodated in the research
Data about the primary and secondary markets in Nepal are not easily available.
6
Interviewee may not have been fully aware about the research topic hence their opinion may be
incomplete or wrong.
However, the report depicts views of selected representatives from each stakeholder group; refers
to the similar initiative in the neighboring countries; and the experience of the researcher in the
field. Hence, the report will serve as a basis to initiate discussions on free pricing system in IPOs in
Nepal and also serve as the framework for implementing free pricing system in IPOs in Nepal.
7
Chapter Two: Literature Review
Why go public?
The term ‘going public’ refers to the process whereby a privately held company issues or makes a
provision to issue its shares to the general public. Initial public offerings (commonly known as IPOs) are
offering shares to the general public for the first time by going public companies or newly established
public companies. The decision to form a public company or the decision to convert a private company
to a public company marks a significant strategic decision as it not only increases its access to capital
market for required capital but also exposes the company to public scrutiny.
Going public entails both pros and cons to the issuing company. Public offerings invites large but
fragmented individual/institutional investors that buy the offered shares to share risk and reward based
on disclosed information and with a mandate to safeguard their interest through sending a
representative director/s from the public investors to the board of directors of the company. Hence, the
process of public offerings requires public companies, as compared to private companies, to be more
transparent and credible and have a process of meeting all the obligations towards all the stakeholders.
This requirement of corporate governance is the cost to the company, but the benefit of being a public
company also allows to access vast pool of public funds at comparatively low cost.
An article published in Chartered Accountants of Canada talks about the issues that need to be
considered before deciding to go public. The article highlights the need to analytically weigh both pros
and cons of going public. The benefits of going public are access to capital beyond which is privately
available, facilitation of mergers and acquisitions, access to secondary equity financing through FPOs,
increased publicity and improved financial status and most importantly, provision of an exit strategy for
original investors, including venture capitalists and angel investors, as well as owners (Deazeley, 2008).
On the flipside, the downside of going public include dilution of ownership, legal hassles, high auditing
and legal fees and increased scrutiny by regulators and public.
The decision of making public issues of securities depend upon different factors and situations and the
issues are timed accordingly (Ritter & Welch, 2002). Firstly, the life cycle theory explains that a company,
which becomes a potential target, will be better off if it is public as it will fetch higher value in the
market. Secondly, market timing theory explains that the decision to go public is affected by the market
8
sentiments. Companies postpone equity issue if the market sentiment is against it and the issue is
delayed until the market is bullish. From the capital markets perspective, companies from various
industries going public bode well for the overall economy since it makes the capital market more
diversified and robust for investors to make informed investments.
IPO Pricing Mechanism
The most important, and also one of the difficult aspects in going public, is the price discovery in IPOs.
Fair price discovery is important to both investors and issuers because underpriced securities translate
to cost to issuers whereas overpriced securities are cost to investors. If offering are under priced, the
issuer will not be able to realize the true value of the offering and thus, investors benefit at the cost of
the issuer. On the contrary, overpriced securities means that investors are paying more for the securities
than their actual worth and their value will decline in the secondary market.
Despite of the costs incurred because of mispricing, there is a general agreement that some money has
to be “left on the table” by intentionally offering securities at a discount to the fair value, so as to entice
investors in the issue at the beginning. A study by Chen, Hong and Wu attributes IPO positive initial
returns to two factors: deliberate under-pricing and market misevaluation based on the estimated fair
price. The study states because of noisy trading, the securities are traded at higher prices, which is the
primary reason, instead of deliberate under-pricing, for initial high returns (Chen, Hong, & Wu, 1999).
While deliberate under-pricing may serve the interest of the issuer, the unanticipated under-pricing is
not desirable. In both cases, fair price discovery is important either to determine the extent of
discounting (in case of deliberately under-pricing) or to issue securities at their market value.
Various mechanisms are widely used in IPO pricing. Broadly, the pricing mechanism can be categorized
into fixed pricing method, where issue is made at a fixed price without soliciting market demand; and
free pricing method, where pricing is done as per the market demand. Under fixed pricing mechanism,
pricing at premium based on net worth, pricing based on P/E ratio and pricing at face value are the
common methods employed, where the issue price does not necessarily reflect the market price. On the
other hand, in order to ensure fair price discovery, some issuers undertake costly methods to evaluate
the value of the firm, which include free pricing mechanisms like auction and book building method.
Book building involves the submitting of (legally) binding bids by relatively exclusive groups of
institutional investors. The book manager, in consultation with the issuing company, uses this crude
9
approximation of the market demand curve to establish the price at which the share offering is sold and
exercises considerable discretion in the allocation of shares (Wilhelm, 2005). The author explains that
book building is a process of building a market, where no market exists.
Under book building, the underwriter arranges a road show and then collects indications of interest,
which are used to build the order book, based on which, the offering price is set (Jagannathan, Jirnyi, &
Sherman, 2010). SEBI, Disclosure and Investment Protection Guidelines, 2000 defines “book building” as
a process undertaken to elicit demand and to assess the price for determination of the quantum or
value of specified securities or Indian Depository Receipts, as the case may be, in accordance with these
regulations.
Another widely practiced method under free pricing mechanism is the auction method, which may take
various forms. Uniform price auctions, also called Dutch auction, are multi-unit sealed bid auctions in
which all winning bidders pay the same price, whereas, ‘dirty’ IPO auction is a uniform price auction
where they leave “something on the table” by pricing below market clearing price (Jagannathan, Jirnyi,
& Sherman, 2010). A discriminatory auction is another variation of auction method, where the issue
price is based on pay-what-you-bid.
The major difference between book building method and auction is that book building has discretionary
power in securities allocation. While some studies explain the discretionary power as a tool to reward
investors who help in price discovery process, others have claimed that it hinders the transparency of
pricing and allocation process under free pricing mechanism.
SSS Kumar (2010) makes a case of the significance of discretionary allocation in book building
mechanism. Under price discovery in book building mechanism, the article claims that investors need
some sort of compensation to disclose the fair price under free pricing (Kumar, 2010). Citing the work of
Benveniste and Wilhelm (1990), Kumar (2010) illustrates how book building can lead to efficient price
discovery, if investors are provided incentive to reveal information regarding the fair price. However, in
Indian context, the discretionary power of the book runner in allocation of shares to investors was
removed and it was mandated that the allocation must be made on the pro-rata basis to all categories
of investors.
The allocation discretionary power, made available to underwriter (or book runner as the case may be)
under book building mechanism, has also been a subject of criticism as the discretion has been abused
10
(Jagannathan & Sherman, 2006). It states that book building mechanism has been criticized mostly
because underwriters exclude small investors from the bidding process, which allows them to use their
discretionary power to award their favorite clients (Sherman & Titman, 2002). The goal of discovering
fair price will not be achieved if access to participation is limited.
Book building, known as firm commitment in the US, has been extensively used in over forty countries.
The book building is preferred to other alternative options, auction and fixed price method, because it
helps to gather and report the optimal level of information required for fair price discovery of the
offering. In the context of India, relevant reference for Nepal, few empirical studies have been
conducted that depicts the efficiency of book building mechanism in India. In a study of 463 companies
from 54 industries, whose IPOs were issued during the ten years span of time and used either fixed price
offer or book building mechanism for the issue, it was found that book building mechanism is preferred
to the fixed price offer for price discovery (Bora, Adhikary, & Jha, 2012).
Complimentary to the benefit of price discovery, another advantage of book building mechanism is that
it gives the issuer an option to withdraw IPO when the demand is weak. Referring to the IPO mechanism
in the USA, Busaba (2006) sheds light on this feature of book building mechanism, which is generally
overlooked by the issuers to a large extent. The values of the option offsets, or even outweigh, the
possible costs of soliciting information from investors and costs of under pricing of securities which
might exist even if book building method is used.
11
Chapter Three: Review of related regulations regarding Issue of
Securities and Pricing Mechanism in Nepal
Review of Regulations governing Public Issue of Securities in Nepal
The Company Act 2063 (2006)
A public company is a company other than a private company. There has to be a minimum of seven
promoters for the incorporation of a public company. A public company that is listed on the stock
exchange is called a “Listed company”. The number of shareholders in a public company has to be at
least seven in minimum and of any number in maximum. A public limited company should have a paid
up capital of at least Rs 10 million.
The Company Act, 2063 has the provision to convert private company to public company. Such provision
is essential and is a precursor even to talk about bringing real sector companies to the public market and
is pivotal to talk about free pricing of securities in IPOs.
Provisions for the conversion of private company into Public company
1. If a special resolution of a private company through its general meeting decides to convert a
private company into a public company
2. If twenty five percent or more stake of a private company has been taken by one or more public
companies then that private company has to convert into public company. Provided any bank or
finance companies holding shares as trustee does not count as taking stake in that private
company.
3. If a private company buys twenty five percent or more shares of a public company.
4. Upon the conversion of private company into public company, subsidiaries of the private
companies shall Ipso facto be converted into a public company
Procedure to be adopted for the conversion of a Private company into a Public company
Upon the passing of the mandate through special resolution for the conversion of private
company into public company, the company has to make an application with a copy of
resolution within thirty days to the Office of registrar. Company registrar shall give the
certificate for conversion of private company into public company within six days of application
12
Upon the conversion of private company into public company through either of points 2 and 3
above, the company has to make an application to the office of registrar within seven days of
the occurrence of such a circumstance.
Pricing of securities as per the Company Act
Company Act, 2063 states the par value/ face value of shares of a private company shall be as specified
in its Article of Association whereas face value of shares of a public company should be at least Rs. 50 or
any amount above it divisible by ten as mentioned in the Memorandum of Association and Article of
Association but it does not restrict the public offering price. However, under the heading of ‘Shares and
Debentures’, Chapter 4 of Companies Act, 2063 it states that a company can issue shares at premium
upon fulfilling the following criteria.
o The company has been making profits and distributing dividends for three consecutive
years,
o The company’s net assets (net worth) exceeds its total liabilities
(Net worth in Company Act, 2063 means “the assets of a company remaining after
deducting all liabilities other than goodwill, if any, of the company along with
accumulated loss excluding the paid up capital, reserves, cumulative profit or free
reserve of whatever designation to which shareholders have right, from the total assets
of the company as of any date”)
o The company’s general meeting has decided to issue shares at a premium.
The existing regulation in the Company Act, 2063 allows company to issue shares at premium. But, the
act has not talked about the provision for existing shareholders of the private or public company to issue
shares to the public by divesting the shareholding of the existing shareholders. And also the Act has not
talked about if allowed, can such shares be issued in premium.
The clause 64 of Company Act, 2063 restricts company to go to public at discount.
The Securities Act, 2063 and Securities Issue and Regulations, 2065
Securities Act, 2063 defines incorporated public company as any company established with the provision
to issue its shares to general public. Clause 27 of the Act requires such company to register its shares
with Securities Board of Nepal before the issuance of the shares to the general public. Clause 29 of the
13
same Act states that if the company wishes to sell its shares to more than 50 investors in a single
process, the company needs to do public offerings otherwise; the shares may be sold under private
placement.
In Public offerings, Company should mandatorily publish a Prospectus. The Act identifies that initial
offering of shares to general public is an act of issuing new shares to raise new capital. The Act does not
specifically states the provision of divestment by the existing shareholders of a company as initial public
offering. However, the Securities Registration and Issuance Regulations, 2008 (formed under the
Securities related act) talks about the different category of shares that could be sold to general public.
Some of the important criteria of the Regulations are:
Unless otherwise stated by any specific laws, any public limited company should have set aside
at least 30% of its issued capital to the general public. But, not less than 51% of the issued
capital should be held by the promoters of the company.
Promoter shareholders and any other shareholders of the company, beside the general public
shareholders, will not be allowed to sell their shares for the period of 3 years from the allotment
of shares to the general public, after the public issue.
Once the company has offered its shares to general public, promoter shareholders and other
shareholders beside general public, shall be able to sell their shares to general public by issuing
Offer Document instead of Prospectus.
Under the regulation 10.3.Kha. of the above referred Regulation, 2008, if promoters and other
shareholders, beside public shareholders, want to sell their shares to general public following
criteria need to be fulfilled
o Out of last five years, company should be operating in profit for three years and per
share net worth value should be more than per share paid up capital
o Conducted Annual General Meeting and has updated audited financials
o Required amendments in chartered documents of the company have been duly
approved by the Annual General Meeting
o If the issue price of the shares are more than the par value, then validation of the
process and assumptions used to fix the price
o In complete compliance with the governing Acts and Regulations and the directives
issued by regulators of the country
14
Rule 11, of the above referred regulation, 2008 allows company that has issued shares to
general public and listed its shares in Stock Exchange, to issue further shares to general public, if
o Company has earn net profit in recent two years out of last five years and per share net
worth is more than the per share paid up capital
o Further public offering decisions have been made by the AGM
o If offered price is more than the par value of shares, need to provide basis of calculation
to validate the premium on shares to be issued
Rule 24 of above referred regulation, 2008 also allows company to issue its shares to general
public in the initial public offerings at premium, but
o The premium price that the company can charge has been pegged to net worth value
per share
o If securities are to be issued at premium, the methodology of fixation of price and basis
and justification of the premium must be mentioned.
The face value of securities has to be Rs 100 per unit for share, Rs 1000 per unit for debenture
and Rs 10 per unit for Collective investment scheme.
Provisions related to the issue of securities in Nepal
The Securities Registration and Issue Regulations, 2008 states that a public limited company has to
allocate at least thirty percent of the issued capital to public for public subscription. If a corporate body
is using natural resources/raw materials from the area for its business, it has to allocate 15 % of the
issued capital to general public and 10% of the issued capital to people residing in that area. Unless
otherwise stated, a public issue can be up to 49% of the issued capital, promoters must be holding must
be at least 51% of the issued capital.
A Procedure for an IPO Process in Nepal
1. Issuing company going public approaches merchant banks
Issuing company approaches the merchant banks, licensed to provide public issue services as per
Merchant Banker Regulations, 2008. Merchant banks submits written proposal accompanied by
tentative budget of the issue management process. After the terms and conditions are met, issuing
company appoints an issue manager and a formal agreement is signed.
15
2. Registration of securities
A company incorporated as a public limited company to offer securities to public has to register its
securities to Securities Board of Nepal. For the purpose the company has to make an application to the
SEBON in a prescribed format given in Schedule 1 of Securities registration and Issue Regulation, 2008
along with the cash receipt voucher charged as securities registration fee. SEBON would issue a
securities registration certificate as part of approval of registration of securities
3. Preparation of prospectus
Upon signing of the agreement, issue manager acts on behalf of the issuing company and drafts a
prospectus in a format specified by the Securities Registration and Issue Regulations, 2008.
4. Agreement with the underwriters
Fifty percent of every issue has to be mandatorily underwritten by a qualified underwriter or group of
underwriters. After the approval of underwriters list, a separate MOU has to be made and signed by the
issue manager on behalf of issuing company with the individual underwriters, underwriting the
securities issued.
5. Obtain letter from Stock Exchange Ltd.
The issuing company via issue manager should submit one set of documents (prospectus and other
documents being registered in SEBON) to Stock Exchange Ltd. to obtain its letter stating that the
securities to be issued is qualified to be listed on Stock Exchange as per prevalent listing bylaws. The
stock exchange is required to submit its rebuttal against the proposed issue to the board within 7
working days from the submission of documents if any in reference to existing exchange by laws. If no
such response is received by the Board within the stipulated time, Board assumes the consent of Stock
Exchange to list the securities being offered to the public from the applied prospectus.
6. Registering Prospectus with SEBON
After preparing the prospectus, the prospectus with the required documents and fees need to be
registered in the SEBON for the consent and registration. The prospectus registered needs to be signed
by all the board of directors implying their responsibility as matters written in the prospectus to be true.
16
7. Finalizing the approval of issue
Issue managers should update any changes as directed by SEBON in the prospectus. Upon completion of
all the disclosure needed as per the Securities Registration and Issue Regulations, 2008, the SEBON
grants the registration of prospectus and approval to issue shares based on the information provided in
the prospectus. After receiving registration letter from the SEBON, issue manager should get the
prospectus registered with the company registrar’s office and if the company has a separate regulatory
authority, get the prospectus registered with the same as well. All registration has to be completed
before the orientations of the intermediaries and publicity being carried out.
8. Orientation of intermediaries
The issue manager/s in the mean time should appoint bankers to the issue and the collection centers.
Issue manager should make sure that intermediaries selected for the issue process know the job
assigned to them. For this, issue manager might require to prepare and give proper guidelines to them.
In short, issue manager should make sure that they work as directed by the issue manager.
9. Finalizing the date of issue opening
The issue manager should communicate the approval of prospectus to the issuing company and the
Issuing Company should decide on the date on which they wish to open the public offerings process and
inform the same to the issue manager.
According to Securities Issue Guidelines 2008, the issue has to be publicly sold within two months from
the date of receiving approval from SEBON.
10. Publishing announcement letter
After all the provisions have been made, issue manager willing to publish offer document or prospectus
has to publish announcement in the format prescribed by Securities Registration and Issue Regulations,
2008 Schedule-12 in at least one daily newspaper minimum one week prior to the opening of the issue
and the board has to be informed regarding it.
17
11. Opening of the Issue
The issue has to be opened for at least five working days from the date of opening. Issue can be opened
for only four days if the issuing company has at least a total of 10 collection centers in 5 development
regions
12. Share Allotment
Under former Securities Allotment Guidelines, 2051, more weight was given to small applicants.
However, the new directive (Share Allotment Directive, 2068) has made provisions to allot shares under
proportionate basis to ensure equal weight to all applicants irrespective of amount of application or
volume of oversubscription. The change in the allotment guideline is expected to encourage application
by institutional investors or high net worth individual for large number of shares in one name. Such
investors were largely discouraged under previous allotment model where applicants applying for large
number of shares were used to be allotted relatively less number of shares. After the change in the
allotment guidelines, Janata Bank made the first major IPO in the country.
Under the current allotment guideline, Investors applying for shares less than NRs. 50,000 are
categorized as retail investors, and 40% of the issued securities have to be mandatorily allocated for
them. Remaining 60% are to be allotted under pro rata basis of allotment. However, if total applications
by the retail investors represent more than 40% of total applications received all shares will be allotted
proportionately.
13. Refund of non allotted share application money
According to Securities Issue Guidelines 2065, Issue manager should start the process of distributing
allotment slips and refunding within five days of allocation of shares.
14. Distribution of Share Certificate
As per clause 33 of The Company Act, 2063 the share certificate has to be issued to the share holders
within 2 months from the date of allotment of shares
15. Listing of shares with Nepal Stock Exchange Ltd.
The issuing company should apply for the listing of the issued securities with the stock exchange through
an application within 30days from the date of allotment of shares. The shares can be traded only after
18
the application is approved by NEPSE, which might require further time. Securities could be traded in
the secondary market only after 7 days of the listing of securities on NEPSE.
Current Pricing Mechanism in Nepal
Par Value of NPR 100
– for companies registered under Bank & Financial Institution Act and Insurance Act
– for other companies who have not met condition to issue shares at Net worth
Net worth – for other public limited companies who comply with the terms and condition stated
in the clause 29 of the Companies Act, 2063 and Chapter 5 Clause 24 of Securities Registration
and Issue Regulation 2008.
As per clause 64 of Companies Act, 2063 shares are not allowed to be offered at discount (below
the par value). Securities Registration and Issue Regulation, 2008 does not cover the provision
related to issuing shares at discount.
Empirical study of IPO performance under prevailing pricing mechanism
Efficient price discovery mechanism is important to both issuers and investors because it ensures fair price
discovery. Underpriced and overpriced securities offering, in effect, are the cost to the issuers and the
investors respectively. IPO pricing mechanism in Nepal limits the role of market in determining the price.
Consequently, the issue price does not reflect the true price and the prices are corrected only in the
aftermarket. Table 1 depicts the aftermarket trading of some IPOs of selected companies, which verifies that
because of the restrictive pricing mechanism, the issue is mispriced to a large extent.
Table 1: Subscription and aftermarket pricing of some of the largest IPOs, 2063/64 – 2067/68
Name of the Issuer Listed
Amount
(Rs. In
millions)
Issued
Amount
(Rs. In
millions)
Issue
price
(Rs.)
Post IPO
Volume
weighted
price (Rs.)*
Post IPO
Percentage
gain
Subscription
(times)
FY 2067/68
Agricultural Development
Bank Ltd.
3,037.5 960 100 121.51 21.51% 2.97
Manakamana Dev. Bank Ltd. 1,000 300 100 120.71 20.71% 5.42
Jyoti Bikas Bank Ltd. 740 292 100 143.35 43.35% 6**
19
Surya Life Insurance Co. Ltd. 360 108 100 146.83 46.83% 4.22
FY 2066/67
Sunrise Bank Ltd. 1250 375 100 432.87 332.87% 26.75
Prime Com. Bank Ltd. 1000 300 100 641.46 541.46% 31.34
Vibor Bikas Bank Ltd. 680 265.20 100 384.46 284.46% 7.19
Prime Life Insurance 360 108 100 176.07 76.07% 10.17
FY 2065/66
Nepal Doorsanchar
Company Ltd.
15000 1500 600 1095.39 82.57% 0.35
Global Bank Ltd. 1000 300 100 596.78 496.78% 34.25
Citizens Bank International
Ltd.
1000 300 100 548.09 448.09% 20.54
Bank Of Asia Nepal Ltd. 1000 300 100 457.62 357.62% 18.90
FY 2064/65
Siddhartha Insurace Ltd. 100 25 100 302.06 202.06% 60.63
Infrastructure Development
Bank Ltd.
80 24 100 871.67 771.67% 93.55
ICFC Bittiya Santha Ltd. 75 22.40 100 846.55 746.55% 35.06
Annapurna Bikas Bank Ltd. 60 29.40 100 219.92 119.92% 21.94
FY 2063/64
Sanima Bikash Bittiya
Sanstha Ltd.
320 96 100 457.55 357.55% 40.31
Gurkha Dev. Bank Ltd. 320 96 100 420.04 320.04% 108.32
Sikhar Insurance Com. Ltd. 125 25 100 237.54 137.54% 43.75
Siddhartha Vikash Bank Ltd. 50 20 100 146.10 46.10% 2.22
* Post-IPO price refers to average of 14 trading days price after IPO weighted by number of shares traded in each day. **Source: http://businessjournalist.blogspot.com/2010/08/jyoti-bikas-bank-primary-issue.html
Source: SEBON Annual reports, NRB Previous daily prices and researchers own calculation
A study of four largest IPOs (all ordinary shares) over the last five fiscal years depicts that the
aftermarket price is much higher than the issue price. The selected 20 institutions include five
commercial banks, nine development banks, one finance company, three insurance companies, one
20
hotel and one Telecommunication Company. The secondary trading data (closing price) of the
companies for the first 14 days of trading were taken into account in order to find out the price move.
Nepal Stock Exchange determines the range for first day trading price at 1 to 3 time of net worth of
securities. Brokers are allowed to trade on their discretion within that range. The volume-based
weighted average price shows that the securities are traded in excess of 273% of the issue price in
average. It indicates that an IPO of Rs. 100 is traded at an average price of Rs. 373 in the secondary
market in the first two weeks, which reflects that the IPOs are highly underpriced during the public
issue. Thus, such jump of share price in first two weeks of trading in the secondary market signals a flaw
in the IPO pricing mechanism in Nepalese capital market and also explains the issue of IPOs being
oversubscribed in most cases, more notably in commercial banks, which are mispriced by a large extent.
This also explains the complain made by few private companies regarding the pricing of shares in the
IPOs as not issuer friendly, as the current system requires them to sell their shares at huge cost to the
issuer. In order to avoid such mispricing of securities, different efficient mechanisms for price discovery
of IPOs are introduced and practiced worldwide.
21
Figure 1: Movement in Price of Ordinary shares after listing on NEPSE, 2063/64-67/68
0 200 400 600 800 1000 1200
Agricultural Development Bank
Manakamana Dev. Bank Ltd.
Jyoti Bikas Bank Ltd.
Surya Life Insurance Co. Ltd.
Sunrise Bank Ltd.
Prime Com. Bank Ltd.
Vibor Bikas Bank Ltd.
Prime Life Insurance
Nepal Doorsanchar Company Ltd.
Global Bank Ltd.
Citizens Bank International Ltd.
Bank Of Asia Nepal Ltd.
Siddhartha Insurace Ltd.
Infrastructure Development Bank Ltd.
ICFC Bittiya Santha Ltd.
Annapurna Bikas Bank Ltd.
Sanima Bikash Bittiya Sanstha Ltd.
Gurkha Dev. Bank Ltd.
Sikhar Insurance Com. Ltd.
Siddhartha Vikash Bank Ltd.
Issue price Post-IPO gain
22
Overview of some different pricing mechanism used in Nepalese Capital
market
Except for IPO issue at fixed price at par, which has been the norm in Nepalese capital market, few
issues have been made under different method, both in the primary issue and secondary market. Closed
auction bidding method, with predetermined floor price, was used in case of IPO of Nepal Doorsanchar
Company Limited (referred to as NTC) and cross holding share transaction of Standard Chartered Bank
Nepal Limited (SCBNL) held by Nepal Bank Ltd. The IPO of NTC was done under privatization of public
entity by Government of Nepal whereas, shares of SCBNL held by Nepal Bank Ltd. were traded in the
market based on then prevailing market price. Chilime Hydropower Company Limited (CHCL) became
the second hydropower company to make IPO at a premium, based on its net worth. The first company
to do so was Arun Valley Hydropower Development Co. Ltd. Further, auction method is currently used
to sell unsubscribed ordinary shares issued by listed companies during the right offerings. Further public
offering (FPO) has also been tried by one company which sold its shares at market price to public. Table
2 gives a detail picture of these companies, where primary issues and secondary trading were priced
under different mechanisms.
Table 2: Overview of SCBNL, NTC and CHCL issue under different pricing mechanism
Company SCBNL NTC CHCL
Type of Issue Sell of Cross holding
share through offer
documents
IPO IPO
Date of Issue 2061/3/4 (June 18, 2004
– July 2, 2004)
2064/10/9 (January
23,2008 – February 26,
2008)
2068/2/17 (May 31,
2011 – June 3, 2011)
Modality of
Issue
Closed bid auction Closed bid auction Open invitation
Par Value of
offerings
NPR 31,248,800 NPR 1,500,000,000 NPR 134,400,000
Net worth per
share at the
time of
NPR 403.15** NPR 178.63* NPR 476.72 (based on
annual reports
2066/67)
23
offering
Trading price NPR 1600 (June 15, 2004) - NPR 900 (May 31,
2011)
Issue price NPR 1500 (floor price) NPR 600 (floor price) NPR 408.36
Basis of
premium
Secondary market price N/A Secondary market price
of promoters share
Number of
shares issued
312,488 15,000,000 1,344,000
Number of
shares
subscribed
551,221
(1.76 time subscribed or
76% oversubscribed)
5,299,690
(0.35 times subscribed or
65% undersubscribed)
1,344,000
(7 times subscribed or
591% oversubscribed)
Average bid
price
NPR 1548 NPR 612 -
Weighted
average bid
price
NPR 1621 NPR 678.84*** -
First day
closing price
(Next trading
day after
issue closure)
NPR 1720
(July 5, 2004)
NPR 900 NPR 845
(June 5, 2011)
* as of Ashad end 2064 ** as of Ashad end 2060 ***Calculated from Economic Survey 2008/09
Standard Chartered Bank Nepal Limited (SCBNL)
The ordinary shares of SCBNL under the ownership of Nepal Bank Limited (3,12, 488 ordinary
shares including 10% bonus shares) was offered to public, under closed bid auction, the floor
price being set at the prevailing market price of NPR 1500 per share.
The shares were bid in the range of NPR 1500 – NPR 1900, the weighted average bid price being
NPR 1621. Despite of its relatively high offer price, the issue was 1.76 times subscribed, which is
an oversubscription of 76%.
24
Nepal Telecom (NTC)
In April, 2004, Nepal Telecommunications Corporation was converted into a public limited
company, and its name was changed to Nepal Doorsanchar Company Limited (commonly known
as Nepal Telecom). However, the government continued to retain its full ownership. On January
23, 2008, NTC launched an IPO of 15 million shares, under auction method, worth about 10%
stake of the company at a premium price of NPR 600 per share as floor price.
The minimum number of shares to bid was set at 100 shares, worth Rs. 60,000. The restriction is
assumed to have discouraged retail investors from participating in the bid. No individuals or
institutions were allowed to buy more than 5000 shares.
The IPO auction of NTC faced several controversies like the basis for determining the premium
was not justified and use of auction system has unnecessarily drove the price higher, thereby
marginalizing the retail investors.
The IPO issue, although being the largest issue in Nepalese capital market history, received a
subdued response from the investors. Only about 35% (slightly more than 5 million) of the issue
was subscribed.
Formerly, the company has sold 7.5 million shares or 5% stake of the company to the
employees.
Chilime Hydropower Company Limited (CHCL)
CHCL issued its shares to public at premium. CHCL first issued its shares to the employees of
Nepal Electricity Authority and the employees of the company itself and then to local resident of
area affected by the project and finally to the general public. Shares sold to employee were sold
at par. shares sold to locals of affected area were sold at two different prices: i) NPR 100 for
locals of three VDCs and ii) NPR 324 per share, with the premium of NPR 224 per share to locals
of 15 other VDCs'. However, the price of the IPO of CHCL shares to general public was set at
NPR 408.36, involving a premium of NPR 308.36. The price is determined adhering to the
companies Act, 2063 and Securities Act which allows company to issue shares at premium to the
extent of net worth per share (Securities Board of Nepal (SEBON)). The minimum quantity to
apply is 20 shares, instead of 50 shares. Another hydropower company Arun Valley Hydropower
Company had also issued its shares to public at NPR 184 per share.
25
The IPO of CHCL was approved by SEBON on May 18, 2009 and the company announced to
release 2,304,000 shares worth Rs. 230.4 million on June 15, 2009. The IPO, however, was
withheld as per the notice by Supreme Court as a case was filed against the company by the
people from the affected areas as they were allocated just 5% of the total issue instead of 8% as
agreed upon earlier. The company launched its IPO later on May 31, 2011.
Out of the total issue, only 1,344,000 shares were offered to the public after allocating 960,000
shares to the local resident. The issue, despite being made at premium, was hugely
oversubscribed (by 591%).
Above-mentioned cases illustrate that different forms of pricing mechanism have been tried in the
Nepalese market and the market response to such issues have been fairly positive, as depicted by their
enthusiastic participation both in the auction method and IPO issue under fixed price at premium. Both
SCBNL and CHCL issue were highly oversubscribed, whereas, NTC shares received a lukewarm response
as the issue was undersubscribed. To make a note here, in all three cases, the prices were fixed by the
issuer. But, the offering of SCBNL shares by Nepal Bank Ltd. was a secondary offering and market price
had been determined. Though, CHCL offering was primary to the public, it had already listed its shares
sold to its employee in the Stock Exchange and hence secondary market price had been determined.
But, in the case of NTC, the price had not been determined by the market and was fixed by the issuer
and there were no reference point to the investors to compare or rely on.
The references of these issues reflect that market demand has been considered, albeit only partially, in
the auction process. The auction price used is comparable to the discriminatory auction, where the
bidders have to pay the price that they have bid. However, no attempt has been made in understanding
the market and determining the issue price completely on the basis of the market demand.
26
Chapter Four: Review of Free price discovery mechanism / Book
Building Mechanism in neighboring countries
Bangladesh
Securities and Exchange Commission (Public Issue) Rules, 2006 and Securities and Exchange Ordinance
1969, governs the process of public offering in Bangladesh. The regulation has gone through numerous
amendments especially on the book building method of public offering. According to the regulation,
company going public has to adopt either of the two pricing methods, Fixed Pricing or Book Building.
Review on Fixed Pricing Method
If a company is planning to float ordinary shares to public through fixed price method , various
factors affecting the pricing decision has to be clearly stated in the prospectus
This generally means that if company issues shares through fixed price model in premium , it
has to be justified in reference to following criteria:
o Net Asset value per share at historical or current cost
o Earning value per share (as per weighted average net profit after tax) for five preceding
years or such shorter period during the commercial operation of the company.
o Projected EPS for the next three years as per rational assumption of the issuer which has
to be certified by the auditor.
o Average market price per share (MPS) of similar stocks for the past one year, if it’s a FPO
then MPS of common stock of the issuer in the aforesaid period. All of the factors that
have been considered in fixing the premium price of the shares.
(Note: the amount of premium charged on the public offering under this method should not exceed
the amount of premium charged on share issued within the immediately one preceding year
(Premiums on bonus shares are excluded))
Review on Book Building Method
In regard to Securities and Exchange Commission (Public Issue) Rules, 2006 (Amended) following are
the criteria for issuer to be eligible to go into book building process in Bangladesh
Must have at least Tk. 30 crore net worth
27
Must offer at least 10% share of paid up capital (including intended offer) or 30 crore face value
offering whichever is higher.
Must be in commercial operation for at least past 3 years
Should be in profit for immediate past two years and should not have any accumulated losses at
the time of application
Should have regularly held AGM and should have audited its latest financial statement from a
registered CA.
Price discovery for determining indicative price
According to Securities and Exchange Commission (Public Issue) Rules, 2006 “indicative price” means
the price which the issuer indicates in the draft prospectus taking input from the eligible institutional
investors on which the bidders bid for final determination of price.
Eligible Institutional Investors
Merchant bankers except the issue manager concerned to the proposed issue;
Foreign institutional investors registered with or approved by the Commission;
Recognized pension funds and provident funds;
Bank and non-bank financial institutions under regulatory control of Bangladesh Bank;
Insurance companies regulated under Insurance Act, 1938 (Act No. IV of 1938);
Institutional venture capital and institutional investors registered with or approved by the
Commission;
Stock Dealer registered with the Commission; and
Any other artificial juridical person permitted by the Commission for this purpose.
Asset Management Companies
“Any Eligible institutional investors where Directors/Promoters/Sponsors of Issuer Company
have interest under related party definition of International Accounting Standard (IAS), shall not
be eligible to participate in the bidding process.”
“Issue manager in which sponsors/directors of Issuer Company have ownership interest cannot
be eligible to act as issue manager because of conflict of interest.”
28
Procedure followed while determining price under book building process
The issuer/ issue manager shall be responsible to issue an invitation to Eligible Institutional
Investors both in writing and in at least five widely circulated national dailies, at least ten days
before the road show/ presentation/ seminar clearly indicating time and venue of such event.
The invitational letters to EII’s should also have an Information memorandum containing all the
financial statement of the past five years or such shorter period during which the issuer was in
operation. CEO and Financial Analyst should jointly sign and submit indicative price to issuer/
issue manager by stating out all the rationale behind the price within the three working days of
said road shows or presentation.
Representatives from stock exchanges shall participate in road shows as observers.
Issuer in consultation with issue manager should quote its own indicative price in its draft
prospectus based on quotation received from EII’s. The Information memorandum send to EII’s
should be without the indicative price. The indicative price should be disclosed to the EII’s after
the quotations have been received. This indicative price has to be supported by at least 20 EII’s
including at least three quotations from each of the following categories :
o Merchant Bankers, Commercial Banks, Asset Management Companies, Non-Banking
Financial Institutions (NBFIs), Insurance Companies and Stock Dealers. EII’s who have
supported the indicative price should participate in the electronic bidding system at
least with their intended quantity and indicative price. The intended quantity by the
EII’s who support the indicative price should be at least 10% of total issue size for that
indicative price to be discovered.
The draft prospectus shall be simultaneously submitted to stock exchange and commission
along with the due diligence report by all concerned. The rationale behind the indicative price
has to be clearly stated in the draft prospectus.
Formal price shall be within the band of 20 per cent (both upward and downward) of the
indicative price within which EII’s have to bid.
EII’s bidding shall commence after getting a go from the commission
The hard copy of Information memorandum without the indicative price shall physically be sent
to the following institutions/associations at least 5 (five) working days prior to the Road Show:
Stock Exchanges, Bangladesh Merchant Bankers’ Association (BMBA), Bangladesh Association of
Banks (BAB), Bangladesh Leasing & Finance Companies Association (BLFCA, Bangladesh
Insurance Association (BIA), Association of Asset Management Companies.
29
Associations shall ensure dissemination of hard copy of draft prospectus among their respective
members.
Institutional investors are not permitted to apply for more than 5% of total security offered for
sale to institutional investors; they are subject to maximum of five bids.
Bidding Period for institutional investors will be (forty eight) hours which may be changed with
commission’s approval.
The Company and The Issue Manger shall submit the status of bidding and the cut off price
along with the final draft prospectus, simultaneously to the Commission and the stock
exchanges within 5 working days from the closing day of the bidding.
There should be 15 days gap between the closure of subscription for the institutional investors
and opening of bidding for general investors.
Table 3: Allocation of shares under Book building in Bangladesh
In face value Institutional
investor
Mutual
Fund
Non Residential
Bangladeshi
Public Portion
Tk. 30 to Tk. 50
crore
40% 15% 10% 35% or balance
amount
Over Tk. 50
Crore to Tk.100
crore
50% 15% 10% 25% or balance
amount
Over Tk. 100
crore
60% 15% 10% 15% or balance
amount
The lock-in period of securities held by institutional investors should be 4 (four) months from
the first trading day.
Amendments of various clauses under Book building Process in Bangladesh
In January of 2011, Book Building system in Bangladesh was suspended amid share market debacle that
caused equity market in Bangladesh to plummet. The wrong doings of foul players in the system was
attributed to market crash. The current regulations in book building were also blamed for breeding
ground for collusion in pricing of offering. So SEC made amendments to the book building process in
30
Bangladesh in October 2011. A review above showcases all the new amendments made to the book
building process in Bangladesh. The reasons for the new amendments are discussed below:
In order to ascertain more transparency and disclosure, representatives of Dhaka Stock
Exchange (DSE) and Bangladesh Stock Exchange (BSE) should participate in road shows/
presentation. These are the stock exchanges where security will eventually be listed.
Parties have been blamed in fixation of prices of securities, in order to combat it; SEC has
included a clause to not allow issuer’s subsidiaries or any EII’s with interest of promoters/
directors /sponsors of the issuer to participate in the bidding process.
In order to expedite the process of IPO , SEC has reduced the institutional bidding time to 48
hours.
Asset Management Companies were not previously included in the EII’s category , new clause
includes these institutions ; inclusion of AMC is said to assist in the discovery of indicative price
as these institutions will have very good research team.
In order to ascertain the commitment of EII’s to quote indicative price, SEC has made a new
clause that while submitting price they also have to submit the intended quantity of security
that they are willing to purchase. For an indicative price to be said discovered, the quantity
demanded by EII’s who support the indicative price should be at least 10% of total issue size.
EII’s need to deposit 20% of the bid amount at the time of bid submission to the designated
bank account and the rest amount has to be settled within five working days prior to the
opening of the issue to the retail investors ; if EII’s fail to do so 50% of the advance money would
be confiscated.
Quotas for institutional investors have been increased by SEC so as to support better price
discovery through proper valuation. If more institutional investors are allowed to participate
there will be better chance of price discovery.
Lock in period for EII’s has also been increased from 15 days to 4 months.
In the newer version of the regulation issuer / issue manager and EII’s are not collectively
allowed o fix the indicative price. The detailed of the clauses have previously been explained,
this will check on the degree of collusion in price setting by different parties (Institutional
investors) involved.
31
China
Evolution and Development of pricing mechanism
The establishment of China Securities Regulatory Commission (CSRC) in 1992 is a key milestone in capital
market development of China. In October 1992, State Council Securities Commission (SCSC) was
established to oversee the securities market and was responsible to draft relevant laws, rules and
regulations for securities market, develop long-term strategies, deliver guidance and coordinate among
central and local governments, conduct supervision and inspection of market activities (China Securites
Regulatory Commission (CSRC), 2008). SCSC merged with CSRC in April, 1998 and it has been operating
with the core objective of facilitating listing and trading of securities in public, developing market rules
and regulations, supervising the securities firm and ensuring development of capital market as a whole.
Regarding the pricing of IPOs, different methods have been tried and tested in the capital market. Prior
to the establishment of stock exchanges, shares were issued at par and there were no mechanism as
such to determine the issue price. Afterwards, the IPO issue pricing was determined on the basis of a
fixed price-earnings ratio, taking into account the profit after tax. Fixed pricing method was used
because of immaturity of both issuers and underwriters and lack of institutional investors. However,
with the increasing capacity of institutional investors and maturity of the market, market driven pricing
gradually replaced government driven pricing. At the end of 2004, CSRC enacted the Circular on Several
Issues concerning the Book-building Procedures for IPOs, which marked the introduction of free pricing
mechanism in Chinese securities market. Further, the Administrative Measures for Securities Issuance
and Underwriting, issued in September, 2006 explained the pricing and share allotment under book-
building.
Prevailing Pricing Mechanism in China
The prevailing IPO pricing mechanism is a market-oriented one, which has been preceded by fixed
pricing and controlled P/E ratio-based pricing. Inquiry pricing system was introduced on a trial basis
from 1 January, which, in essence, is a book-building pricing system involving two stages. Initial price
band is discovered by soliciting price offers from institutional investors in the first phase while final price
of the offering is determined on the basis of second-round feedback from the institutional investors.
Previously used IPO Pricing methods: Fixed price method, price based on P/E ratio, criticized for
lack of flexibility and depriving underwriters from pricing freedom
32
IPO pricing of securities is governed by Chapter II of Administration Measures on Securities Issuance and
Underwriting, CSRC Decree No. 37 (effective from September 19, 2006), under the heading ‘Inquiry and
Pricing’. The key highlights of the chapter are as follows:
Specified institutional investors, referred to as inquiry objects, are solely responsible for
determining the issuance price of an IPO stock. Inquiry objects refer to the securities investment
fund management companies, securities companies, trust and investment companies, financial
companies, insurance institutional companies, and qualified foreign institutional investors that
meet the conditions prescribed in the Measures, and other institutional investors approved by
the CSRC.
The basis for making inquiry is a research report on investment value provided by lead
underwriter to the inquiry objects. The issuer, underwriter and the inquiry objects should not
publicly disclose the information contained in the report in any form.
A research report, based on certain analyses, should help predict the reasonable investment
value of an issuer’s stock by using valuation methods generally recognized in the industry.
Inquiry process is divided into initial inquiry and accumulative tenders and bid inquiries. Through
initial inquiry, an issuer and its lead underwriter determine the issuance price range and
subsequently the issue price is determined through the accumulative tenders and inquiries.
Any institutional investor, who does not participate in the initial pricing inquiry, or who
participates but does not make valid quotation, are not eligible to participate in the
accumulative tenders and inquiries.
After the initial inquiry, if less than 400 million shares are publicly offered and less than 20
inquiry objects provide valid quotations, or if more than 400 million shares are publicly offered
and less than 50 inquiry objects provide valid quotations, the issuer and its lead underwriter
shall not determine the issuance price and shall suspend the issuance.
Table 4: Restriction in IPOs in China
Date Reasons
February 2005 - May, 2006 ‘to halt a four-year market slump and to allow more than USD 200 billion
of mostly state-owned equity to be converted into tradable shares’
September 2008 – 19
June, 2009
To reduce pressure on the liquidity by a large number of IPOs
China halted IPOs on September 2008 after the Shanghai index tumbled 60
33
per cent from its high the previous year. At that point, 37 companies had
received regulatory approval for IPOs.
India
Evolution and Development
Before the decade of 1990, the primary issue market of India was governed by the Controller of Capital
Issue (CCI), which determined the issue price of IPO. In 1992, the Indian capital market moved to a freer
capital market with the SEBI taking over as the new market regulator. Subsequently, the control over
price and premium was removed and companies were able to raise funds by filing an offer letter with
SEBI, thereby ensuring a more liberal capital market. The Disclosure and Investor Protection (DIP)
Guidelines, 2000, Chapter III, states that an unlisted company eligible and desirous of making public
issue can price freely its equity shares or any securities convertible at a later date into equity shares.
Therefore, the prevalent pricing mechanisms in India are based on fixed price method, book building or
the combination of both.
The book building mechanism in India was introduced by SEBI on the basis of recommendations of an
expert Committee under the Chairmanship of YH Malegam in October, 1995. The purpose of the
committee was to “to review the (then) existing disclosure requirements in offer documents” and two of
the terms of references were “the basis of pricing the issue” and “whether substantial reduction was
possible in the time taken for processing applications by SEBI”. The proposed recommendations were
accepted by SEBI in November, 1995 (Gangadhar & Reddy, 2005).
The book building method in India has evolved to be quite different from other countries like the US, the
most notable distinctions being in the retail participation and discretionary power of lead managers. In
Indian market, retail investors are also allowed to participate in the book building process, unlike in the
US and they have the option to place either market bids or limit bids. Likewise, the Book Runner Lead
Manager (BRLM) do not have the allocation discretionary power to allocate securities, which is regarded
to be the basis for discovering the efficient price of offerings.
34
Amendments
The book building mechanism has constantly evolved in India since its inception in the mid 90s. Initially,
the book building mechanism was available only to the issues exceeding IPO of 100 crore. Because of
the stringent restrictions, book building did not have a good start and no companies adopted book
building mechanism in issuing IPOs. The restriction was later changed and the issue requirement was
reduced to 25 crore in 1998-99 (http://www.citeman.com/6075-book-building-guidelines.html). In July,
2001, the restriction of minimum public issue size of 25 crore was removed from the guidelines.
Various changes were brought by SEBI on March 29, 2005. Allocation of securities to Retail investors
under book built issue was increased to at least 35% from 25% earlier. Likewise, allocation to non
institutional investors was decreased to 15% from 25% earlier. As per the DIP Guidelines, 2000, the
category of ‘retail individual investors’ was redefined to ‘an investor who bids for securities of or for a
value not more than Rs. 1,00,000’, which is an increase from Rs. 50,000 on March 29, 2005.
Likewise, formerly, both the allocations (to institutional investors) as well as determination of the issue
price were under the discretion of the BRLM and issuer respectively (Allocation was made on a
proportionate basis to retail and non-institutional investors, whereas discretion could be used by BRLM
in case of allocating securities to institutional investors). However, from November, 2005, SEBI
mandated that the allocation should be made on pro-rata basis to all investor categories. The regulatory
change has been under scrutiny as some of the studies suggest that the discretionary power in the
allocation of securities under book building method helps in efficient price discovery of the offering,
which is the inherent objective of the mechanism.
SEBI also introduced the concept of Anchor Investor in public issues through book building route in July
9, 2009. Anchor investors are from the investor category of Qualified Institutional Buyers (QIBs), for
whom the minimum application size will be Rs. 10 crore and subscribe to the maximum of 30 percent of
the proportion allocated to QIBs. SEBI required issuers to have at least two anchor investors for issue
size upto 250 crores and five for issue size exceeding 250 crore. The intention of introducing the concept
was to boost investor confidence as availability of buyers with prior commitments will enhance the
issuer’s ability to sell.
35
Book building mechanism in brief
The Book building process is described in ICDR (Issue of Capital and Disclosure Requirement) under
Schedule XI. The process is explained as under:
The issuer company appoints a lead merchant banker as Book Runner Lead Manager (BRLM).
BRLM is given a definite period of time to conduct awareness programs like campaigns and road
shows.
The BRLM appoints syndicate member, which is a SEBI registered company, to underwrite the
issue to the extent of ‘net offer to the public’. The syndicate member creates demand in the
market by asking for the bid price and quantity of the issue to be offered.
The BRLM builds up an order book, based on the feedback from the syndicate members about
the price and quantity of the bids received, which depicts the demand for shares at various
price.
Based on the order book, the issuer company in consultation with the BRLM, determines the
issue price, which is also known as market clearing price. (See Appendix)
After determining the final price, allocation is made based on several factors like earliness of
bids, investor’s quality etc. The allocation is entirely under the discretion of the issuer company
and the BRLM.
Allocation on fixed price method commences only after the placement portion is closed (one
day after the closing).1
Types of Book Building process
As per Securities Exchange Board of India (Disclosure and Investor Protection) Regulations, 2000, an
issuer company proposing to issue capital through book building can do so in the following methods:
75% Book Building Process
Offer to Public Through Book Building Process
o 100% of the net offer to the public through the book building process, or
o 75% of the net offer to the public through book building process and 25% at the price
determined through book building
1 The issue of securities through book-building process shall be separately identified/ indicated as ‘placement portion category’.
36
The 75% book building process allows bids to be submitted only by institutional investors and
underwriters, excluding retail investors. The mechanism is adopted as an alternative to firm allotment,
which provides for allotment to institutional investors and permanent/regular employees of the issuing
company. Remaining 25% of the total public issue is reserved to be offered exclusively to individual
investors who have not participated in the bidding process at fixed price (the price determined by the
book building method).
In contrast, the 100% book building process allows all investor category (retail investors, institutional
investors and QIBs) to participate in the bidding process and allocation is made accordingly (discussed in
the later section). Both retail and institutional investors are allowed to bid in the issue. Retail investors
have option of market bids or limit bids whereas institutional investors are required to place limit bids
only.
A modification of the 100% book building process is the 75% of the offering to be made through book
building process and 25% at the price determined through book building. Under this system, both
institutional as well as individual investors are allowed to participate in the bidding process, from which
the issue price is determined. The remaining 25% of the issue is made on fixed price basis (at the price
determined by the book building method) and shall be available to those who have either not
participated in the bidding process or have not received any allocation in the book built portion.
The 2nd method of book building allows reservation to be made so that book building shall be for the
portion other than the promoters’ contribution and the allocation made to permanent employees of the
issuer company, shareholders of the promoting companies and persons who have business association
with the issuer company.
Pricing process under Book Building
The pricing process under book building mechanism starts once the book running lead manager
prepares a Red Herring Prospectus which contains an indicative price range. As required by Issue of
Capital and Disclosure Requirement Guidelines, if the floor price or price band is not mentioned in the
red herring prospectus, the issuer is required to announce the floor price or price band at least two
working days before the opening of bid (in case of IPO) and at least one working day in case of FPO, in all
the newspapers in which the pre issue advertisement was released. The indicative price range (or price
band) is determined jointly by the issuing company and the book running lead manager, on the basis of
37
the valuation effort of the BRLM and the minimum acceptable (floor price) stipulated by the issuer. The
cap on the price band shall not exceed to 120% of the floor price as per the guidelines. As per DIP
guidelines, 2000, Chapter XI, 11.3.1 viii (b), the price band can be revised up to the extent of 20% up or
down of the floor price disclosed in the red herring prospectus and the upper limit will be adjusted
accordingly.
The issue price is determined by the issuer company and the BRLM based on the bids received through
the ‘syndicate members’ (See Appendix I). The bids above the cut-off price are valid and subject to
allocation as per the guidelines.
As per the circular published on September 3, 2009, 75% book building route has been omitted.
However, it is still mentioned in the DIP Regulations, 2000. Likewise, the requirement to disclose price or
price band in the draft prospectus was omitted. Total issue period could not exceed 10 days, including
any revision in the price band as per the new guidelines.
Application
As per the DIP guidelines, the broker/syndicate member shall submit at least ten percent of the
application money as margin money in respect of bids placed by qualified institutional buyers. However,
investors other than QIBs are required to pay the full amount as advance payment at the time of
application.
Allocation Procedure
The allotment procedure under book building method is explained under 11.3.5 of DIP Guidelines, 2000.
The provisions for allocation as per the guidelines are as follows:
1. In case of 100 per cent of the net offer to the public through 100% book building route
Not less than 35% of the net offer to the public shall be available for allocation to retail
individual investors;
Not less than 15% of the net offer to the public shall be available for allocation to non
institutional investors i.e. investors other than retail individual investors and Qualified
Institutional Buyers;
Not more than 50% of the net offer to the public shall be available for allocation to Qualified
Institutional Buyers.
38
2. In case an issuer company makes an issue of 75% of the net offer to public through book
building process and 25% at the price determined through book building
In the book built portion, not less than 25% of the net offer to the public, shall be available for
allocation to non Qualified Institutional Buyers and not more than 50% of the net offer to the
public shall be available for allocation to Qualified Institutional Buyers.
the balance 25% of the net offer to the public, offered at a price determined through book
building, shall be available only to retail individual investors who have either not participated
or have not received any allocation, in the book built portion.
Out of the portion available for allocation to QIBs, 5% shall be allocated proportionately to
mutual funds and up to 30% to anchor investors.
As per Chapter XI, 11.3.5 (iii) of the guideline, allotment to retail individual investors, non-institutional
investors and qualified institutional buyers shall be made proportionately in case of oversubscription.
(Refer to Schedule XVIII of DIP Guidelines, 2000, Illustration of allotment to QIBs ICDR is mentioned in
Schedule XI, Part C of DIP Guidelines.)
Allotment shall be made not later than 15 days from the closure of the issue failing which
interest at the rate of 15% shall be paid to the investors.
In case of public offering as stated in 2 above, the offer of 25% of the net offering to the public
must be made within 15 days from the date of closure of the bidding.
IPO Grading
As per Chapter II, 2.5A.1, no unlisted company shall make an IPO of equity shares or any other security
which may be converted into or exchanged with equity shares at a later date, unless the following
conditions are satisfied as on the date of filing of Prospectus (in case of fixed price issue) or Red Herring
Prospectus (in case of book built issue) with ROC:
The unlisted company has obtained grading for the IPO from at least one credit rating agency;
Disclosures of all the grades obtained, along with the rationale/description furnished by the
credit rating agency or agencies for each of the grades obtained, have been made in the
Prospectus (in case of fixed price issue) or Red Herring Prospectus (in case of book built issue);
and
39
The expenses incurred for grading IPO have been borne by the unlisted company obtaining
grading for IPO.
Underwriting
In case of public issues under book building, the issue must be underwritten by book runners or
syndicate members. The issuing company needs to enter into an underwriting agreement with the
book runner who in turn enters into an underwriting agreement with syndicate members.
In event of syndicate members failing to fulfill their underwriting obligations, the lead book runner
shall fulfill the underwriting obligations.
Other than for fulfilling the underwriting obligations, the book runner and syndicate members shall
not subscribe to the issue in any manner.
The ‘syndicate members’ shall enter into an underwriting agreement with the Book Runner
indicating the number of securities which they would subscribe at the predetermined price.
The process, in effect, is a firm commitment underwriting where the lead book runner shall be
responsible for bringing in the amount devolved in the event that their respective syndicate members
do not fulfill their underwriting obligations.
Eligibility for Underwriting
As per SEBI (Underwriters) Regulations, 1993, Chapter II (7), the capital adequacy requirement for
applying to the board should not be less than net worth (paid-up capital and free reserves) of rupees
twenty lakhs. Likewise, As per Chapter V (5.5), DIP Guidelines, the outstanding underwriting
commitments of a merchant banker shall not exceed 20 times of its net worth at any point of time.
As per Section 76 of the Companies Act, 1956, the underwriting commission payable to the underwriter
cannot exceed five per cent of the price at which underwritten shares are issued, or the amount or rate
authorized by the article of association of the issuers, whichever is less.
Extent of underwriting
As per SEBI (Merchant Bankers) Regulations, 1992, Chapter III (22), the lead merchant banker shall
accept a minimum obligation of five percent of the total underwriting commitment or rupees twenty-
five lakhs, whichever is less.
40
As per Chapter XI, DIP Guidelines, in case the book-building option is availed of, underwriting shall be
mandatory to the extent of the net offer to the public. In case of 100% of the net offer to the public
through book building process, 100% of the net offer to the public is to be underwritten. In case of 75%
of the net offer to the public through book building process and 25% at the price determined through
fixed price, 75% of the net offer to the public is to be underwritten.
Refund
Brokers are required to refund the margin money collected, within 3 days of receipt of basis of
allocation, to the applicants who did not receive allocation.
Lock in period
In case of public issue, three years for promoters (starting from the date of allotment in the
public issue)
For securities issued on firm allotment basis, one year from the date of commencement of
commercial production or the date of allotment in the public issue, whichever is longer.
For anchor investors, lock-in period of 30 days from the date of allotment in the public issue.
Malaysia
Capital Markets and Service Act, 2007
The Act defines issue and issuer as
“issue” means–
(a) in relation to securities, to bring or cause to be brought into existence those securities; and
(b) in relation to a notice, prospectus or other document, to circulate, distribute or disseminate such
notice, prospectus or document;
“issuer” means–
41
(a) in the case of shares or debentures, the corporation whose shares or debentures are being
issued, offered for subscription or purchase or in respect of which an invitation to subscribe or
purchase has been made;
(b) in the case of units of a unit trust scheme or prescribed investment scheme, the management
company; and
(c) in the case of any other securities, the person making available, issuing, offering for subscription
or purchase, or making an invitation to subscribe for or purchase, such securities;
“securities” means–
(a) debentures, stocks or bonds issued or proposed to be issued by any government;
(b) shares in or debentures of, a body corporate or an unincorporated body; or
(c) unit trusts or prescribed investments, and includes any right, option or interest in respect
thereof, but does not include futures contracts;
Equity Guideline, 2009
The guideline defines,
Offer for sale: means an invitation by, or on behalf of, an existing securities holder to purchase
securities of the issuer already in issue or allotted.
Offer for subscription: means an invitation by, or on behalf of, an issuer to subscribe for securities of
the issuer not yet in issue or allotted.
Requirement for an Issue
An applicant must have an identifiable core business of which it has majority ownership and
management control.
The core business of the applicant must not be the holding of investment in other listed
corporations.
An applicant must qualify whose core business is not that of infrastructure project must satisfy
either the profit test or market capitalization test.
42
An applicant whose core business is that of infrastructure project must satisfy the infrastructure
project corporation test.
a) Profit Test
i) Profit requirements: The applicant (either at the corporation or group level) must have an
uninterrupted profit of three to five full financial years based on audited financial statements prior
to submission to the SC, with an aggregate after-tax profit of at least RM20 million and an after-tax
profit for the most recent financial year of at least RM6 million. In fulfilling the profit requirements,
contributions from associated companies must not exceed those of subsidiary companies.
(ii) Pro forma accounts: Where a listing of a corporation is sought based on the strength of its
group, at least one corporation (which is the qualifying corporation) within the group must be able
to fulfill the profit requirements. If no single corporation is able to fulfill the profit requirements,
listing based on the strength of the group’s pro forma accounts may be considered provided that
the corporations within the group which collectively fulfill the profit requirements –
are involved in the same core business; and
have common controlling shareholders,
over the profit track record period.
(iii) Operating history: The applicant or the qualifying corporation must have been incorporated
and operating in the same core business over at least the profit track record period prior to
submission to the SC. Where listing is sought based on the strength of group pro forma accounts,
the corporation which is the single largest contributor to the after-tax profits of the group on an
average basis for the most recent three full financial years, must satisfy the operating history
requirements.
b) Market capitalization test
(i) Market capitalization: The applicant’s ordinary shares must have a total market capitalization of
at least RM500 million based on the issue or offer price as stated in the listing prospectus and the
enlarged issued and paid-up share capital upon listing.
43
(ii) Pro forma accounts: Where a group of corporations is seeking listing based on the strength of
the group, the corporations within the group must have common controlling shareholders for at
least one full financial year prior to submission to the SC.
(iii) Operating history: The applicant or the corporation within the group representing the core
business must have been incorporated and generated operating revenue for at least one full
financial year prior to submission to the SC.
(c) Infrastructure Project Corporation Test
(i) The applicant, either directly or through its subsidiary company, must have the right to build and
operate an infrastructure project, whether located in Malaysia or outside Malaysia–
with project costs of not less than RM500 million; and
for which a concession or license has been awarded by a government or a state agency, in or
outside of Malaysia, with a remaining concession or license period of at least 15 years from
the date of submission to the SC.
(ii) The SC may consider the listing proposal by an applicant with a shorter remaining concession or
license period from the date of submission to the SC, if the applicant fulfils the profit requirements
under the profit test.
d) Management continuity and capability
An applicant must have had continuity of substantially the same management for at least three full
financial years prior to submission to the SC or, in the case of an applicant seeking listing under the
market capitalisation test or the infrastructure project corporation test, since the commencement of
its operations (if less than three full financial years).
In complying with the requirement on continuity of substantially the same management, the
applicant must demonstrate that, throughout the relevant period–
(a) the current executive directors of the applicant have had direct management responsibilities
for, and played a significant role in, the applicant’s business; and
(b) the senior management of the applicant has not changed materially. Where the
requirements of paragraph 5.06 are not met, the applicant must demonstrate to the SC the
44
expertise and capability of its management in ensuring that its operations are managed
effectively.
e) Financial position and liquidity
An applicant must have a healthy financial position, with–
(a) sufficient level of working capital for at least 12 months from the date of the listing
prospectus;
(b) positive cash flow from operating activities, if listing is sought under the profit test and
market capitalisation test; and
(c) no accumulated losses based on its latest audited balance sheet at the time of submission to
the SC, if listing is sought under the profit test.
Underwriting Arrangement
According to Equity Guidelines sections 5.25 and 5.26:
Any underwriting arrangements in relation to an offering of securities are at the discretion of
the applicant and its principal adviser.
The principal adviser must be part of the syndicate of underwriters for the securities offered
under the initial public offering if there is an underwriting arrangement.
An applicant seeking listing on Bursa Securities (Stock Exchange) must disclose in its listing
prospectus the following things –
(a) The minimum level of subscription and the basis for determining the minimum level based
on factors, such as the level of funding required by the applicant and the extent of the
shareholding spread needed; and
(b) The level of underwriting that has been arranged, together with justifications for the level
arranged.
If the minimum level of subscription is not achieved, the offering of securities must be
terminated and all consideration received must be immediately returned to all subscribers.
45
The price at which the underwriter should subscribe the unsubscribed issue will be at the IPO
price, Securities Commission of Malaysia does not specify the price at which underwriter should
subscribe such shares.
Allocation Made to Investors
According to section 5.12 of Equity Guidelines, The methods of offering of securities chosen by an
applicant should enable the applicant to have a broad base of shareholders and comply with the
shareholding spread requirement of Bursa Securities.
An applicant must, as part of its listing scheme, undertake an offering of securities to the general
public and the allocations for such securities have to be made through a balloting process. The
balloted portion must constitute the following:
Enlarged issued and paid-up capital Minimum offering to the general public
Below RM 200 million At least 5% of the enlarged issued and paid-up capital
or an aggregate of RM 3 million in nominal value,
whichever is the higher.
RM 200 million and above At least 2% of the enlarged issued and paid-up capital
or an aggregate of RM10 million in nominal value,
whichever is the higher.
Shareholding Spread Requirement
According to the section 8.02 of Listing Requirements in Bursa Malaysia
A listed issuer must ensure that at least 25% of its total listed shares (excluding treasury shares)
are in the hands of public shareholders. The Exchange may accept a percentage lower than 25%
of the total number of listed shares (excluding treasury shares) if it is satisfied that such lower
percentage is sufficient for a liquid market in such shares.
46
Categories of investors
Bumiputra investors are defined and categorized by MITI into three sub categories: individual,
company and cooperative
Retail and institutional investors (Bumiputra investors fall as either retail or institutional
investors )
Other institutional investors beside the Bumiputra institutional investor are: Malaysian
institutional investors and Foreign institutional investors
Bumiputra Equity Requirement
At least fifty percent of public spread requirement should be allocated to Bumiputra investors on
the best effort basis.
Pricing of securities
As per equity guidelines section 5.23, the issue price of equity securities (other than warrants and
convertible securities) offered for subscription or sale, for which a listing is sought, must be at least
RM0.50 each.
Moratorium
Guideline 5.29 states that a moratorium will be imposed on the shares held by the promoters of all
applicants, as follows:
(a) For listing under the profit test or market capitalization test, the promoters are not allowed to
sell, transfer or assign their entire shareholdings in the applicant as at the date of listing, for six
months from the date of listing on Bursa Securities; and
(b) For listing under the infrastructure project corporation test, the promoters are not allowed to
sell, transfer or assign their entire shareholdings in the applicant as at the date of listing on Bursa
Securities, for six months from the date of listing.
The moratorium will be lifted immediately at the end of the six months if the infrastructure project
has generated one full financial year of audited operating revenue. For infrastructure project
corporation, which has yet to generate one full financial year of audited operating revenue, the
promoters must retain their shareholdings amounting to 45% of the issued and paid-up share capital
47
of the applicant. Upon achieving one full financial year of audited operating revenue, the
moratorium on the 45% shareholding will be lifted.
Prospectus Guideline, 2009
Basis for Pricing of Securities
Examples of factors that are commonly cited in pricing determination may include, but are not
limited, to the following:
48
From a published Prospectus
Mechanism of Price determination
Retail price: Retail price is stated in the prospectus and is the price at which retail investor would
make their bid for the shares
Basis for the fixation of the retail price
Based on the financial performance and operating history of the company
Based on competitive strengths, business strategies and future plans of the company
Based on net asset of the company after including the effect of the upcoming IPO
Reference is also given above as Prospectus guideline for determination of price
Institutional pricing: the price at which institutional investors would bid for the shares under the
book building process
Final retail price: this is generally lower than institutional price and retail price. If it is lower than
retail price then the difference in amount so collected from retail investors would be refunded back
to them.
A traditional book building process is not followed in Malaysia as institutional and retail bids take
place simultaneously. The price at which institutions and retail investors subscribe the given
quantity of shares may be different from each other. The shares allocated to institutional investors
49
are sold through book building process to institutional investors. The price determined through this
process is used as the basis for final retail price. The final retail prices at which the retail investors
subscribe the given quantity of shares may be lower than the retail priced fixed while drafting the
prospectus. In such cases, the retail investors get the refund of the excess subscription amount.
Critical Assessment
Referring to regulations pertaining to public issues in the neighboring countries, it is evident that the
capital markets regulation has been amended, largely after 1990's, to attract companies to come to
public by allowing the pricing of the securities to be fairer to the issuer. The regulation has allowed
issuer to issue shares both at the fixed pricing and free pricing mechanism, both the mechanism allows
selling the securities at the intrinsic value of the securities being offered rather than at par value.
Though the data has not been gathered, it can be referred that the effect of such changes has positively
impacted the growth of the capital markets in those reference countries. However, it is also evident that
such regulations have gone through several changes to accommodate the taste and the maturity of the
market. The above study also reflects that by having regulations that allows companies offer securities
to the public at market price will not be sufficient, there will also be a need to develop an ecosystem of
stakeholders that can subscribe intermediate or vet such offerings. Stakeholders, like institutional
investors, underwriters, credit rating agencies, merchant bankers, active brokerage houses, independent
researchers, comprehensive regulations against defrauding auditors by governing chartered accountants
authorities etc to name a few, needs to be promoted and nurtured. In presence of such strong
ecosystem we can develop a capital market that can embrace securities being offered in IPO at market
price or free pricing of IPOs.
The review of regulations in neighboring countries also indicates the need to have regulation that
safeguards the interest of the investors through requirement of proper disclosure as well as creating an
ecosystem that is mature to evaluate any offerings independently. Different control measures like profit
history, standardized tests, rating of securities, mandatory requirement to have institutional investors,
lock period of the promoters or institutional investors etc. have been established. Such control
measures are required not only to build confidence of the investors but also to safeguard investors from
disclosure fraud.
50
However, the need for the capital market to be friendly for the issuer to attract them to come to the
market and the capital market being friendly to entrepreneurs looking for fund at right price is
fundamental to the development of the capital markets and the economy as a whole.
The IPO value chain can be depicted as under which summarized the process of the IPO under both fixed
pricing and book building mechanism:
51
IPO pricing
Fixed Pricing
Face Value
Premium based on different criteria
Free Pricing
Book Building
Auction
Road Shows
Collection of Institutional Bids
Determination of Price Bands
Bid Opening
Collection Centers
Market Cut Off Price
Institutional
Investors Retail
Investors
Prospectus
Mode of Offering
100% Book Building
Partial Book Building
Fixed Price Offering
Company (Both Private and Public Company)
Private Company
going Public
Public company
going public
Decision
for an IPO
Appointment of Issue Manager/ Underwriter / Lead Manager/ Book Runner
Compliance
Allotment of Shares
Listing
Price Stability
Mechanism
Lock Up Period
Figure 2: Typical IPO value chain
52
Chapter Five: Stakeholder’s view on the free pricing mechanism in IPO in
Nepal As evident from previous chapters, not only the developed economies but also the neighboring
developing economies are moving towards allowing IPOs through free pricing mechanism. In Nepal's
context as well, the discussion has been initiated that the capital markets in Nepal should allow IPOs
through free pricing mechanism (In this research report, market pricing and free pricing has been
referred interchangeably). The jump of share price in the secondary market compared to the public issue
offering price has indicated that the companies have been issuing their shares to public during public
offerings at discount. In an environment, where private companies are reluctant to be public companies
due to various reasons, requiring them to sell shares to public at discount is a deterrent. From the
securities issuers' perspective, being able to issue/sell shares to public at perceived market price would
definitely be a positive move to attract such potential issuers to opt capital markets as a source of
capital raise. Hence, to make capital markets a broad and effective market to serve its basic objective of
being a platform of efficient capital mobilization, the pricing of shares needs to be free and transaction
should happen at the perceived market price by the party at the both side of the transaction. However,
for such transactions to be successful, the markets need to have an ecosystem where all the
stakeholders are aware and equipped to play their role effectively. Hence, the concern of most of the
stakeholders is "Is the market ready?"
Among various methods used, book building has been widely adopted as a means of market pricing/free
pricing of shares in many countries including our neighboring countries. The prospect of introducing
book building as free pricing mechanism to derive at fair price discovery sounds enticing but several
factors need to be considered to ensure its successful implementation. Some of the prerequisites are
like market readiness, infrastructural capacity, regulatory capacity for supervision, investors' sentiment
and issuers' concerns. Unless the prerequisites of introducing free pricing mechanism are fulfilled, the
effort for introducing book-building mechanism or any other form of free pricing mechanism will be
futile.
In this regard, the research attempted to understand and reflect the perception of different
stakeholders in the capital markets about the free pricing mechanism in general and book-building
mechanism in specific in the IPOs in Nepal. The key stakeholders included were regulators, issuers
(companies), intermediaries (merchant bankers and underwriters) and investors (both individual and
53
institutional). The views were collected through interview covering the questions as presented in the
annexure as a reference.
Companies (Issuers)
Issuing companies have direct interest in introducing market pricing of securities in IPOs. Among
available market pricing mechanism, issuing companies have considered book building mechanism to
determine the offer price in IPOs as favorable. They have a view that under the prevailing restrictive
pricing mechanism, well-performing private companies are discouraged to go to public because such
companies cannot realize their true value while selling their shares to the public.
Listed below are specific comments received from the respondent representing potential private
companies going public.
There should be enough incentives for companies to go public. Going public entails both direct
costs and indirect costs. Direct costs include cost of managing IPOs while indirect costs include
the cost incurred while ensuring governance to maintain transparency in operations, accounts
and other regulatory compliances which is stringent to public companies than to private
companies. They are of view that, even though being a public company benefit in the long run in
accessing the required fund, converting private company into public company should be
completely a voluntary decision lured by some short term incentives to the issuers. Some of the
proposed recommendation by respondents are:
o Tax rebates/tax holidays for certain years to recoup cost of managing IPOs.
o Incentive on capital gain tax in case of public issue through divestment of owned shares.
o Regulation and regulator overseeing public limited company should burden the
company through legal hassle to comply with bureaucratic process and unclear policies
rather should facilitate the compliance process by laying out processes that are
standardized and that can be easily followed.
Public offerings should also be allowed by the means of divestment and not only by increasing
the share capital. The Securities Act, 2063 defines "Issuance" as a proposition and a process
undertaken to issue additional shares in order to increase the capital of the company. Such
definition should also include an act of offering already existing shares owned by the existing
shareholder of the company however complying with the condition to be set by the regulators
in regards to the minimum shares to be offered to the general public.
54
Issuing companies will be interested to come to public if they are allowed to issue shares at
perceived market price. Determination of market price is of concern to the issuers in two ways,
if the price is underpriced then it is in effect leaving money on the table but if it is overpriced
then the issue will not be subscribed. Hence, issuing company would like to obtain the market
feedback before deciding on the issue price.
In IPOs of companies from real sector where direct regulatory insight is not stringent as in the
case of BFIIs, companies are also reluctant to come to market because they feel that the
investors don't have trust in their corporate governance practices. Public will simply not apply in
their IPOs. Hence, it is also in the best interest of companies that there should be a strong
regulator to oversee public companies. However, the role of regulatory body should be more of
a supervisor or overseer who does not interfere in the operating of business but ensures that
the regulations governing public companies are being complied with and company follow proper
corporate governance.
As investors are weary about the corporate governance of the companies beside BFIIs. In this
regard, SEBON should play an instrumental role to disseminate confidence of strong oversight
on the listed companies for proper corporate governance and timely disclosure of accounts and
other corporate affairs. Hence, may be the prudent way to go would be to take few interested
companies willing to go public as cases for public offerings and play an instrumental role to
disseminating public confidence in such public offerings through the assurance that SEBON will
play as a strong role as a regulator.
There are many cases of public companies from real sectors, which have attributed in eroding
public confidence in listed non BFIIs companies. In order to heal such negative sentiments of
investors, a strong regulatory body should oversee the performance of such listed non BFIIs
companies.
Investors
It may look like investors are better off with the prevailing pricing system of requiring company to issue
shares at regulated price, where investors get to invest in underpriced securities. It also explains the
excessive oversubscription in IPOs in Nepal. However, it is the issuers who bear the burden of the
underpriced securities and therefore private companies, which are not compelled to go public, will
remain private companies (and apparently companies from real sectors are reluctant to go public). From
55
investors’ perspective, this will limit the assortment of securities available in the capital markets, which
will ultimately hinder the growth of capital market and the investment opportunity available to the
investors. Therefore, introducing a mechanism that attracts better performing companies from all wake
of economy is in line with the investors’ benefit as well. The research found both institutional and retail
investors felt the lack of investment opportunities to invest in good real sector companies and they are
comfortable with the idea that such investment opportunities may come at higher price than the par
value or the net worth value.
As per Securities Allotment Guidelines, ‘Investors’ are broadly categorized into two categories: retail
investors and ‘other investors’. Investors who apply for securities worth less than NPR 50,000 are
categorized under retail investors, whereas all investors who apply for the amount greater than NPR
50,000 are categorized under ‘other investors’. It is however a need to have different categories of
clearly defined investors in order for market pricing mechanism to work. For the research, we have
taken feedback from two investors' group namely Institutional Investors, represented by institutions
that are in existence and perceived to be investors, and Investors forum to represent by retail investors.
Institutional investors: The term ‘institutional investors’ has not been well-defined by any related
regulations in Nepal. For the purpose of the study, Employees Provident Fund (EPF), Citizens Investment
Trust (CIT), life and non-life insurance companies, mutual funds and potential other institutions formed
with the objective of investments are regarded are institutional investors in general and their opinions
on introducing market pricing mechanism (book-building method in specific) are summarized as follows:
Government controlled entities are guided by their independent acts and regulations. Existing
mandates regarding investment policies in their regulations restrict their investment in equity
market either partially or completely. EPF is allowed to invest only in promoter shares of BFIIs,
up to the extent of 25% of their paid up capital (however such investment are practically limited
to 15% only). Thus, equity investment by EPF in real sectors companies are not allowed by its
regulation.
In case of CIT, there are no restrictive regulations that hinder it from investing in primary and
secondary market. CIT has an Investment Guideline that mandates its investment operation.
However, being a government run institution, CIT opts to invest in equity market specially as
promoter shareholder and in secondary market but it seems that CIT does not have a clear
mandate about investing in the shares in the IPOs at market price. In absence of clear mandate
56
CIT may not be in a position to act as an institutional investor and play instrumental role in
determining the price of IPOs under free pricing mechanism.
Insurance companies internationally are active player in the capital markets. In Nepal, Insurance
companies are regulated by Beema Samiti, which does not allow them to invest more than 5%
of their total investible fund in equity market. Further, their investment in one particular
company is restricted to 2% of the total investment amount or 10% of the paid up capital of the
company, whichever is less. The allowed percentage of the fund to be invested in the equity
market is very low for insurance companies to play instrumental role in free pricing mechanism.
Further, insurance companies are not allowed to issue equity market linked units to investors
which has been practiced by insurance companies internationally.
Regardless of the constraint, the research found that insurance companies are willing to
participate in the IPOs given under the free pricing mechanism provided good companies come
to the market and price discovery is a well thought methodological process. Investment return is
one of the main revenue streams for insurance companies. However, such investments have
been largely subjected to government bonds and BFIs’ deposits. It is of view that if the capital
markets become diversified, robust and efficient, insurance companies may participate actively.
Bank & Financial Institutions can be influential institutional investors in the Capital Markets of
Nepal. BFIs' have the capital strength and the resources to be informed and professional
institutional investors. BFIs' may not only be an active player as the institutional investor in the
Public Issue market but they can also play a major role in venture promotion that will help
entrepreneurs get long term funds. However, the current regulation governing the BFIs' seems
to be a bottleneck. The current regulation promotes BFIs' to be a secondary market player but
does not incentivize in promoting new ventures or give flexibility in applying for new issues. The
current regulation, allows BFIs to invest in listed shares but for such institutions to invest in non
listed shares there are conditions, namely i) if BFIs' invest in non listed shares and such shares
are not listed within one year of investment, then additional 100% of the investment amount
should be deposited in non usable investment adjustment account; ii) if BFIs' invest in new
establishment, then if shares of such institution are not listed within 2 years of establishment or
2 yrs from the date of establishment, whichever is earlier, then additional 100% of the
investment amount should be deposited in non usable investment adjustment account.
57
In the other hand, the current regulation has allowed BFIs' having maximum of 10% of its
primary capital invested in the single company and maximum of 30% of its primary capital in
total of securities investment portfolio. Further, there is a cap, in terms of the primary capital, to
invest in the single company. This provides an opportunity to bring huge source of fund to
capital markets from well regulated institutions that can be assured to follow methodological
investment process. The task is to lure such BFIs' to the market and regulators allowing BFIs' to
make an investment of longer horizon.
Regardless of the regulations regarding investment decisions, the major concern for institutional
investors to participate in bidding process under book building mechanism is the issue of poor
corporate governance and credibility of companies besides BFIIs. In case of companies other
than BFIIs that are well governed by respective regulators, institutional investors perceive a lack
of a strong regulatory body to ensure strong compliance by the companies, beside BFIIs, to the
existing regulations and accounting standards needed by public companies.
Institutional investors’ base in Nepal is not strong to support free pricing mechanism. Eligibility
criteria and other requirements for being qualified as institutional investors for free pricing
mechanism and the limit on investment to be made by such investors are not defined by any
regulations in Nepal. Besides, the institutions which are likely to be institutional investors in
Nepal currently are not equipped to be an influential player for fair price discovery of an issue
under free pricing mechanism.
Mandate to be institutional investor needs to be defined. The regulation should allow even
market intermediaries like merchant bankers, brokers be institutional investors.
There has been emergence of institutional investors, beside BFIs’, Insurance companies in the
capital markets of Nepal. With the change of allotment model in IPOs of Nepal to pro rata
allotment, some private investors have found the benefit of channeling the investment through
companies formed to make investments in the capital markets. Upcoming mutual funds will be
influential force in the capital markets and they can also be influential under free pricing
mechanism. If companies from real sector are attracted due to free pricing mechanism, it is also
better for mutual funds as diversified investment will be available to mutual funds to create a
portfolio.
Currently, due to unavailability of diverse investment opportunities, lack of clear mandate of
institutional investors and lack of incentive for institutional investors, their role in the capital
markets have been very minimal. But, when contacted such institutions, they do have objective
58
and zeal to be an active player in the capital markets including in IPOs, but the benefit for doing
so has to be mandated.
Merchant bankers/brokers/dealers/market markers are also potential institutional investors.
But, the current regulatory provision should be amended to allow them to facilitate investment
as well as invest on their own.
Retail Investors: As per the Securities Allotment Guideline, any investors investing below NPR 50,000
are taken as retail investor. For the purpose of this research, retail investors pertain to any natural
person who is not institutional investor. The feedback received from the representative of retail
investors shows the interest of the investors in diversifying the capital markets in Nepal with the entry
of real sector companies for which they are even ready for the free pricing mechanism. However, they
have represented few concerns, which are as follows;
With sufficient and effective promotion as well as counseling investors can be attracted to
invest in real sectors. They should also be made aware that unless and until real sector
companies come into stock market, the market will not have stable growth.
Need to educate investors as they think investment in IPO is the easiest way of making money
but with stock market coming down last few years proved they were wrong and are now getting
cautious to invest in only performing companies.
For retail investors to be interested in offerings of real sector companies only if they can depend
on the disclosed information. Hence, information made available during the IPO values most
and for which information disseminating institutions should be made liable, that includes,
issuing company as well as the issue manager.
Initially investors may shy off with premium issue as they are not used to it. This is when the role
of institutional investors becomes pivotal. After successful 2/3 issues, the investors, at large, will
be more apt to take the initiative.
Proper due diligence by Issue Manager or professional institutions, like Credit rating agencies
are to be done. A clear regulatory framework needs to be in place that ensures authorities
involved in intentional mal practice of miss utilizing public fund are personally made responsible
liable to face legal consequences.
Investment process needs to be made easy as many investors are avoiding IPOs because of all
the requirements like photo, copy of citizen and also to present original, and bank account of
each member of family applying for the shares every time they apply for shares. Besides, after
59
allotment, investors' have to go to get the refund even though bank accounts have been
mentioned and again certify. It is a hassle that needs to be eased.
Pre requisite for free pricing IPOs are competent Issue Managers, credible Credit Rating
Agencies and presence of credible and multiple Institutional Investors.
Existence of mutual funds, unit funds or even investment through portfolio managers can be
credible source for making investment in IPOs at market pricing.
Market Intermediaries
The market intermediaries in issue management are merchant bankers appointed by SEBON. Under free
pricing mechanism, the role of market intermediaries include, managing issues, underwriting the issue,
conducting road shows to market the issue and understand the market demand, helping issuing
company to come up with the price band, etc. However, the role of merchant bankers in Nepal is highly
limited and it only includes functions of issue management, underwriting, Registrar to Shares (RTS) and
portfolio management.
Considering the level of market maturity and lack of institutional investors, merchant bankers
are of a view that a controlled form of pricing mechanism in the initial phase is good rather than
going for total free pricing. The proposed mechanism is a fixed pricing mechanism in essence
whereby internationally practiced valuation methods are used to determine the issue price
rather than leaving it totally up to market.
Instead of requiring companies to go to public forcefully, encouraging steps like tax rebates
should be provided to entice companies from realty sectors to convert into public companies.
The reservation of merchant banker to go for book building mechanism is that there is a lack of
strong regulatory body that ensures compliance by the issuing company to the proper
accounting standards and corporate governance.
Merchant bankers play a vital role in bringing companies from real sector to the capital markets.
There has been demand from other stakeholders for the merchant bankers to play a crucial role
in not only bringing the issue to public but also in enabling investors make informed investment
decisions. For this, even merchant bankers need to be well equipped with the understanding of
the issuing company, its business and the industry the issuing company is part of, before
bringing the issue to the public. This entails making merchant bankers earn such experience and
learn by allowing merchant bankers perform multiple of services to its customers and thereby
enable merchant bankers be resourceful.
60
The scope of merchant bankers should be widened from the existing work mandate of merchant
bankers and allow them to provide comprehensive services to the client which does not limit
but also includes financial consulting and financial advisory services. In order to boost public
confidence and ensure the quality of an issue, IPO grading and providing advisory services to
investors should be included in the scope of merchant bankers, who have the capacity to assess
these aspects with professional expertise.
The role of credit rating agencies in qualifying different ratings to the issues needs to be initiated
and strengthened, which can act as a barometer to general investors. The market should
encourage multiple credit rating agencies for ratings by multiple companies for minimizing
errors.
Regulators
All public companies are regulated by Company Registrar’s Office. Besides, there are specific regulators
for different categories of institutions. Banks and financial institutions come under the supervision of
Nepal Rastra Bank, securities related companies like merchant banks and brokerage houses come under
the supervision of Securities Board of Nepal (SEBON) and insurance companies are regulated by Beema
Samiti (Insurance Board). However, in case of companies from other real sectors, there is a lack of
strong regulatory body. Hence, SEBON is required to play a role of an ultimate regulator for all public
companies in regards to compliance to norms of public limited companies.
Currently, capital markets regulation allows companies to issue only new shares to the market.
If the company had been allowed to issue its shares to public through divestment of existing
allotted shares, most of the private companies would be incentivized to come to the market.
Regulatory environment should be conducive to encourage ecosystem and promote different
stakeholders of the markets. Further, allowing the existing market intermediaries to deepen its
expertise of the market by allowing them to provide wide array of services rather than limiting
them to limited services.
Enacting regulatory environment where capital markets supports not only established
institution but also promotes new initiatives, allowing venture funds, private equity funds to
play role in promoting such ventures and allow them to divest their shares by taking such
companies public. In a way, need to promote an environment where public issue can be a
mechanism for the exit strategy.
61
As per the Investment Directives issued by Beema Samiti, insurance companies are allowed to
invest only up to 5% of their total investible funds in equity market. Further 5% of the total
investment amount can be invested in equity market with permission from Beema Samiti. The
rationale is that financial strengths and performance of insurance companies are not too strong,
thus should not be exposed to high risks. Such, provision may need to be revised if we want to
build stronger capital markets by bringing companies from real sector to the market.
If Insurance companies issue policy targeting the investment in the capital markets, then the
regulator should also develop capability to understand risk of such product and hence be in a
position to regulate the same.
Similarly, BFIs' regulation should allow certain portion of BFIs' funds to be invested in the capital
market with less stringent conditions. Further, BFIs' should also be allowed to promote new
ventures through venture funds which has longer investment horizon than traditional
investment in listed securities.
Critical Assessment
All the stakeholders point towards the need of market pricing in IPOs as a necessary reform in order to
attract companies from real sector to offer their shares in the capital markets. It is necessary to have
representation from diverse economic sector in the capital markets for the market to be strong and be
able to play its role in the economic development of the country. However, there are also concerned
that if the Nepalese capital markets have a mechanism that can check any mal practice in such IPOs or
mechanism to safeguard interest of investors. Such concerns are unanimous as Nepal has history where
public have lost their money in IPOs of companies who are not governed by concerned regulatory
authority.
Companies who are potential to go to public view free pricing mechanism in IPOs are must for them to
be interested to go for IPO. They think that the decision to go for IPO should not be forced but should be
a choice. Further, in the context, going public is considered as a cost rather than eminent financial
benefit, such companies are looking for incentives for them to take the initiative. Incentives like tax
holidays; allowance of divestment as means of offering shares to public; reduction on capital gain tax on
such divestments; and a support from the regulatory regime to support initiation by such companies if
such companies decide to go for IPO; would definitely pave a way for potential real sector companies to
come to IPOs.
62
While talking about free pricing in IPOs, we also need to assess its importance in promoting
entrepreneurship in Nepal. For any entrepreneurship to flourish there has to be an idea and also
complementing capital. Complementing capital has been scarce in Nepal and has been limited to friends
and family. There is no organized sector as venture funds to promote such initiatives. One of the reasons
why venture capital (VC) funds are not developed is the problem of exit and price of exit. For VC funds to
exist, they would require an exit provision whereby they can sell their investments at market price in the
public market. Hence, if the IPOs at market price are allowed, such move will promote multiple
enterprises to invest in enterprising institutions with the aim of nurturing such enterprising and taking
public at market price. Such would be a new era of entrepreneurship.
Existing investors in the capital markets also support the idea of letting companies offer shares in IPO at
market price with the view that such provision will incentivize companies from different sector to offer
their shares to the public and the capital markets will be deep and diversified for investors. Some of the
concerns of the investors are i) concerned regulators should be resourceful to assure proper disclosure
of information at the time of IPO and effective supervision of such issuers after IPOs; ii) intermediaries
like merchant bankers, credit rating agencies, auditing firms should perform their fiduciary duty without
any compromise; iii) existence of institutional investors to take a role of a leader and work in the best
interest of the shareholders; and iv) existence of effective brokerage house, securities research
agencies, professional fund managers etc to provide independent advice to investors.
Role of institutional investors is very crucial in the development of capital markets in Nepal. Their role is
pivotal in the case of IPOs at market price not only because they will have money to invest but also will
have capability to evaluate each deals and suggest/negotiate a fair price for such securities. Institutional
investors are largely lacking in Nepal in the current context. With the establishment of mutual fund, it is
encouraging but not enough. Capital markets have seen investments in the name of the companies but
they are yet to become institutional investors in the capital markets that have established brand and
infrastructure to lead the market. Some of the potential institutional investors are financial institutions
and insurance companies. But, they are limited by the concerned law to take the role of an institutional
investor or have not shown interest to be one. Other potential institutional investors are merchant
bankers, brokers, market makers, corporate house, pension funds etc. The regulatory environment
should be conducive enough for such companies to take the role of institutional investors.
63
Market intermediaries have been demanding for such provisions for long and are the advocate of such
change in the IPO market. They strongly believe that free pricing in IPO will change the landscape of the
capital markets in Nepal. But they fear that that market may not have enough control mechanism in the
regulatory system and in the ecosystem of the capital market to check and balance pricing of securities
in IPOs as well as do periodic review to inform investors on timely manner. They strongly believe that
the market intermediaries will have a major role to play and hence they need to be well equipped. One
of way of being equipped is being able to know the industry better by being able to serve clients in that
industry through various services besides traditional merchant banking services as stipulated in the
Merchant Banking Regulations, 2063.
In terms of regulations, Nepal does not have regulation that allows company to go to public offerings at
market price or have free pricing IPOs. Concerned regulator of capital markets, SEBON, has not issued
any regulation regarding free pricing of IPOs. The current regulation allows company to issue shares at
the price up to its net worth value, after complying with pre conditions, stated previously. However,
SEBON has realized the need to move further to free pricing in IPOs and this research being conducted is
the result of the realization. But, for free pricing of IPOs to be successful other regulators also need to
participate. Other regulators like Nepal Rastra Bank should have a provision for financial institutions
under its supervision to be allowed to play an active role in the capital markets. Actually, developed
capital markets is good for the banking industry as it provides fall back when companies get distressed
and cannot repay its fixed obligations. The current problem in the real estate sector is the perfect
example where banking sector has considerably high exposure but there is no capital market that can
pump in equity capital to replace the limited risk taking capacity of the debt. Similarly, Insurance Board
has a major role to play in letting insurance companies take major exposure in the capital markets. Being
able to invest in capital markets also allows insurance companies to utilize the available capital
resources in productive sector and contribute in economic growth of the country.
Hence, feedback of all stakeholders point to the need to implement a system that attracts companies to
go public willingly and for economic reason. One of such policy would be allowing companies to offer
shares, both new and existing (divestment), under free pricing mechanism.
64
Chapter Six: Recommendations and Appropriate Model for Nepal
Change in Regulation and Capacity building of stakeholders
Capital Markets should be a broad platform where enterprises: established, start ups or newly
established, should be able to look for required capital. For this to happen, a conducive and robust
ecosystem needs to be built which requires strengthening of different market stakeholders with the
coherent effort to develop the market. Much of the effort has been in promoting the Capital Markets
that support established institutions, which is also the focus of this study. However, the study also
emphasis on the need to expand the capital markets, that is, able to embrace the need of new and
upcoming enterprising ideas to be a successful enterprise.
In terms of IPO market, different stakeholders are in consensus regarding the need of luring real sector
companies in the capital markets of Nepal and using free pricing mechanism in the IPOs as the mean of
attracting such companies to the capital markets. Hence, the concept of market pricing, possible
through various mechanisms like book building or fixed pricing or auction method, needs to be
implemented soon as a catalyst to attract companies from real sector into capital markets. However, the
question "is the Nepalese capital markets mature to accept free pricing in IPO" is wide spread. Even with
this concern, most of the stakeholders believe, such mechanism of IPO under free pricing is eminent and
needed for the growth of current capital markets.
As discussed in the report too, some of the key ingredients for the success of this module are the strong
regulatory supervision and assurance of strong regulatory oversight, effective and efficient market
intermediaries, availability of diverse and well equipped institutional investors, conducive tax related
provisions to lure company to go public, interest of the retail investors etc. Book building mechanism
has been successfully operating in neighboring countries like India and Bangladesh under the backdrop
of above mentioned key improvements.
For the success of free pricing in general and book building system in specific in Nepal, an ecosystem is
necessary that involves roles of each of the stakeholders.
Developing capital markets that facilitates the availability of capital to entrepreneurs at right
price and availability of investment opportunity to investors should be in the priority list of the
policy makers. The policy makers should identify the capital markets as an important platform
65
for mobilization of investments and should work in institutionalizing the same so that the
opportunity gets well dispersed to everyone with skills and ideas.
Securities Board of Nepal needs to strengthen itself in terms of the regulatory realm for dynamic
capital markets, prompt response to new issues arising with the development of capital
markets; resources to vet the public information; educate public regarding the capital markets
through training, workshops; resources to conduct constant supervision; and unrestricted power
to enforce regulatory provision to all the stakeholders. SEBON needs to be an advocate, active
facilitator and strong supervisor to develop this market. The current infrastructure and the
number of human resource available may have been inhibiting SEBON to play the role even
though the regulatory environment provides SEBON an autonomous power to develop the
capital markets in Nepal.
Securities Board of Nepal has to assure investors that it stands ready to impose regulatory
compliance by all public companies who have issued their shares to the public, including
companies from real sector who are not regulated by any specific regulatory body, and ensure
proper corporate governance by such companies. Such assurance is very important in current
market where investors are suffering from lack of proper corporate governance issues by
companies beside BFIIs'.
Regulators should work toward creating an environment where capital markets play a vital role
in mobilization of capital for economic growth and investment opportunities. This includes
allowing concerned stakeholders be robust to intermediate the process. In other words,
allowing merchant bankers be resourceful and be more responsive as an issue manager. For
merchant bankers to be resourceful, merchant bankers should be allowed to put their hands on
different services thereby they can understand the industry and companies better. One of such
services is advisory services. Through advisory services, merchant bankers can work closely with
companies or have an understanding of the industry. Knowing the industry/company is a crucial
element required to do proper due diligence for preparing prospectus and providing correct
information to public. Such requirement is even more pronounced if free pricing is allowed, as
investors price securities based on disclosed information. Further, if making merchant bankers
responsible for information disclosed is important, then allowing merchant bankers understand
the industry/company through other means of services is also pivotal.
Market intermediaries such as credit rating agencies, financial audit agencies, financial advisors,
brokers with the mandate to advice investors etc needs to promoted as they can be an advocate
66
for investors or entrepreneurs. They can be an independent force to advice investors about the
pricing of securities especially in the market where shares are allowed to be sold at market price
or free pricing of IPOs.
Public Issue should be allowed by issuing fresh shares or by divestment of the shares of the
existing shareholders, ensuring the minimum required percentage of shareholding to be
maintained by the promoters/existing shareholders till the specified time. This entails allowing
company that does not have set aside shares to the public, as required by the Securities
Registration and Issue Regulations, 2065 but willing to offer the shares under the provisional
basis, where the existing owners offer the subscribed shares to the public so that after the
allotment of the subscription, the minimum percentage set aside for public would be met.
Institutional investors need to be promoted. Institutional investors can play the role as the
benchmark in the free pricing mechanism and can play significant role to safeguard retail
investors' investments. Institutional investors have the capacity and zeal to work as the
compelling force for the public companies to follow proper corporate governance. Institutional
investors are yet to find its significance in the capital markets of Nepal, hence they needs to be
promoted or give incentives like
o tax rebate on capital gains on long term investments.
o tax holidays or tax subsidy for first few years
o allowing interested insurance company/BFIs' to have larger role to play as institutional
investors with capital markets friendly regulations
o allowing establishment of venture funds, private equity funds or even widen the
investment arena of portfolio manager to invest in new ventures as well
Encourage private companies to go public by allowing tax rebates / tax holidays for certain years
after going to public. Tax rebates and tax holidays are to be given to cover up the expenses
incurred to go to public. This should not be a major reason for company to go public, but should
be an incentive for companies willing to go public.
The need to have various institutional investors is the key ingredient for the success of book
building system. We can categories major institutional investors as : Employees Provident Fund
(EPF), Citizens Investment Trust (CIT), life and non-life insurance companies, BFIs’, mutual funds
and potential other institutions formed with the objective of investments are regarded as
institutional investors. These categories of institutional investors are too narrow compared to
that of India and Bangladesh.
67
Even this narrow base of institutional investors has many restrictions in investment. EPF is
allowed to invest only in promoter shares of BFIIs, up to the extent of 25% of their paid up
capital (however such investment are practically limited to 15% only). So equity investment in
realty sector companies seems not permitted by the regulation. If EPF is to act as an institutional
investor, flexibility in the regulation is a must.
Similarly CIT does not have clear mandate in investing in shares at the market price this makes it
difficult to participate in the price discovering process under book building.
These restrictions are also there with other major institutional investor i.e. the insurance
companies. They are not allowed to invest more than 5% of their investible fund in equity
market with the limitation of 2% of the total investment amount in one particular company.
These restrictions in part of major/ available institutional investors will raise questions regarding
the presence and role of institutional investors in Nepal if book building system were to be
introduced.
BFI's should be allowed to set aside portion of their distributable funds for investment in capital
markets with long term investment horizon. Investment in the capital markets should be
allowed not only in the secondary market but also in the primary market and in venture funds to
promote entrepreneurship. All these investments entail a longer gestation period hence the
regulation should allow BFIs' to hold such investment for longer period than allowed in the
existing regulations.
Merchant bankers/brokers/dealers/market markers should also be given mandate to be
potential institutional investors. The current regulation requires them to invest with prior
disclosure which might prohibit them to be effective institutional investors.
Under the free pricing mechanism the role of issue management, underwriting, facilitating road
shows, finding price bands etc becomes very important. These are some of the significant
functions that issue managers / merchant bankers should carry out. It is the responsibility of
Securities Board to help develop merchant bankers' capability to be able to conduct proper due
diligence before the formal free pricing system is introduced.
The role of merchant bankers in Nepal is highly concentrated on issue management,
underwriting, Registrar to Shares (RTS) and portfolio management. They should also be
encouraged to carry out financial consulting and financial advisory services. This will help
merchant bankers develop skills beyond traditional merchant banking services. Skills like
68
valuation and project grading can be developed with the financial advisory services which are
essential for price discovery in book building process.
The role of credit rating agencies in qualifying different ratings to the IPO’s should be
strengthened, these ratings would play significant role in boosting general investors' confidence.
However, selection of credit rating or assessing the need to have the issue rated by the Credit
Rating agencies may be voluntary decision of the issue manager and the issuing company.
The current requirement in the Company Act to be eligible to issue shares at premium, as net
worth of the company should be more than the total liability of the company, needs to be
amended to make it more tune to international practice of requiring net worth more than the
paid up capital or company with accumulated profit with recent years of positive net profit.
The current provision under of Securities Registration and Issue Regulation, 2065 which limits
the premium issue price up to the net worth per share value, should be removed and allowed
for free pricing provision under prescribed terms and conditions.
Methods of going Public
The capital market of Nepal is in its initial development stage. Hence, proposing the method of Public
Issue should consider the interest of investors as well interests of Issuing Companies. We can fairly say
that we do not have enough retail investors who are well equipped to make informed investment
decisions on their own. Hence, there is a likely chance such investors may not be able to judge the
startup companies. As for the institutional investors, we are yet to see a clear emergence of institutional
investors, even though some institutions do buy and sell securities in the market. Considering the
maturity of the investors, the Securities Issue regulation of Nepal should provide a flexibility to the
Issuing Company in terms of selecting the securities issue option and similarly the pricing option.
On the other hand, the Securities issue regulation should be embracing enough to attract companies at
different level of development to opt for capital markets as a source of raising funds. For this,
companies should have an option to select different mode of Securities issue as per their need and the
regulatory requirement of the Public Issue regulations.
Hence, it is recommended that by continuing the current provision of allowing companies to issue their
securities at par value, the Securities Issue regulation should also allow companies to offer their
securities to public at market price.
69
Par Value Method
Company that does not qualify to issue their securities at market pricing should be allowed to issue their
shares at par value as per the existing regulation in the Securities Registration and Issue Regulation,
2065. Regulation 7.5 and 7.6 of the above mentioned regulation stipulates the condition to issue shares
at par value.
Market Pricing Method
For the company to be allowed to issue securities at market price there should be pre conditions that
the issuing company should comply with. For which, the existing condition in the Company Act, 2063
regarding premium issue may be relevant, except the condition that the net worth of the company
needs to be more than the total liability of the company (as discussed previously). Further, the provision
under the Securities Registration and Issue Regulation, 2065 that requires the premium offer price to be
limited to the net worth of the shares, be amended to allow for free pricing.
There are different prerequisites in different country which can be the basis for determination of
conditions for the company to be able to issue shares at premium. The example can be taken from the
Bangladesh and Malaysia (as explained in Chapter Four).
Market pricing is recommended to be done in two different ways:
a. Fixed Pricing Method
Fixed pricing method is proposed for companies offering shares to raise small capital or
companies who opt for fixed pricing method than book building method. As book building
method is a long and a costlier process, it might not be economically feasible for the companies
to adopt this method.
b. Book Building Method
Book building method should be allowed to companies offering shares to raise capital more
than threshold amount (threshold determination is the beyond the scope of this research and
hence has not been stipulated). The book building process should include portion set aside for
institutional investors and for retail investors. Similar to the process followed in India and
Bangladesh, the ratio of allocation to institutional investors and retail investors need to be
determined. However, the method should allow the issuer/issuing company in determining the
70
issue price to the institutional investors at the market clearance price decided via bids received
during the book building process. Further, the offer price to the retail investors may be, at the
discretion of the issuing company, be the offer price to the institutional investors or lower. The
condition for such differences needs to be stipulated in the prospectus beforehand.
Procedure Requirements
Par Value Method
The IPO process under the Par Value Method would be same as per the existing regulation under
Securities Registration and Issue Regulations and respective directives.
Market Pricing Method
Fixed Pricing Method
Fixed pricing method bestows the responsibility of finding the price of the offer to the issuing company
and the issue manager. The regulator will have to stipulate the metrics for determination of price. The
price fixed has to be justified to the regulatory authority regarding the determination of price. Referring
to provision in Bangladesh, the justification for such pricing can be in reference to following criteria:
o Net Asset value per share at historical or current cost
o Earning value per share (as per weighted average net profit after tax) for five preceding years
or such shorter period during the commercial operation of the company.
o Projected EPS for the next three years as per rational assumption of the issuer which has to be
certified by the auditor.
o Average MPS of similar stocks for the past one year, if it’s a FPO then MPS of common stock of
the issuer in the aforesaid period.
Application
The regulation should stipulate the subscription amount to be submitted along with the application
form. The clause 27.3 of Company Act, 2063 has stipulated the condition for the submission of the
subscription amount with the application form. The same can be made applicable for the offer under
the fixed pricing method.
71
Requirement of performance history
The regulation should stipulate the requirement of performance history of the Issuing Company before
allowing for market pricing mechanism for the IPO of their shares.
Underwriting
In case of public issues under fixed price mechanism, the issue must be underwritten. The process of
underwriting and the eligible list of underwriters need to be stipulated. Further, the role,
responsibility, terms of the underwriter needs to be clearly stipulated.
The underwriting regulation should clearly stipulate the eligibility criteria to be a licensed
underwriter.
The underwriting regulation also should clearly stipulate the extent of underwriting requirement for
different type of offering namely: par value, fixed price and book building process.
Refund
The regulation should clearly stipulate the time frame within which the intermediaries are required to
refund the margin money collected to the applicants who did not receive allocation.
Allotment
The regulation regarding the allotment of shares to the applicants can be made similar to the existing
Securities Allotment Guideline, 2068.
Lock In Period
The regulation should stipulate the Lock in period for
promoters
For investors made preferential allotment, if any
For insiders of the issuing company including management and staff of the issuing company
72
Book Building process
Issuing company proposing to issue share capital through book building should clarify whether the issue
is
100% of the net offer to the public through the book building process, or
Prescribed portion of the net offer to the public through book building process and balance at
the price determined through book building. (Percentage allocation of share to institutional and
retail investors has not been specified as it is beyond the scope of the research)
Pricing process under Book Building
The pricing process under book building mechanism starts once the book running lead manager
prepares a draft Prospectus with an indicative price range. If the floor price or price band is not
mentioned in the draft prospectus, the issuer is required to announce the floor price or price band
before the opening of bid. The indicative price range (or price band) is determined jointly by the issuing
company and the book running lead manager, on the basis of the valuation effort of the Book Running
Lead Manager and the minimum acceptable (floor price) stipulated by the issuer.
Application
The regulation should require submission of advance money by the broker/syndicate member as margin
money in respect of bids placed by institutional investors during the book building process. However,
investors other than institutional investors are required to pay the full amount as advance payment at
the time of application.
Allocation Procedure
The allotment of the book building process shall be stipulated ensuring that the minimum amount of
shares to be allotted to the retail investors. However, the allotment procedure should look into ways to
entice institutional investors in participating in such book building process by allowing confirmed
allotment to institutional investors who participated in the price discovery process.
Further, the allotment procedure should also consider maximum time after the issue closure by which
the allotment has to be completed. As well as, the maximum time period after the closing of the bidding
process within which the public offering must be made.
73
IPO Grading
In order to gain confidence of the investors and ensure proper due diligence from the independent
agency, there needs to be a provision for any unlisted company to make an IPO of equity shares or any
other security which may be converted into or exchanged with equity shares at a later date, should
mandatorily have the following conditions satisfied as on the date of filing of Prospectus (in case of fixed
price issue) or Red Herring Prospectus (in case of book built issue) with CRO:
The unlisted company has obtained grading for the IPO from at least one credit rating agency (in
case of Nepal, currently we have only one credit rating agency);
Disclosures of all the grades obtained, along with the rationale/description furnished by the
credit rating agency or agencies for each of the grades obtained, have been made in the
Prospectus (in case of fixed price issue) or Red Herring Prospectus (in case of book built issue);
and
The expenses incurred for grading IPO have been borne by the unlisted company obtaining
grading for IPO.
Underwriting
In case of public issues under book building, the issue must be underwritten. The process of
underwriting and the eligible list of underwriters need to be stipulated. Further, the role,
responsibility, terms of the underwriter needs to be clearly stipulated.
The underwriting regulation should clearly stipulate the eligibility criteria to be a licensed
underwriter.
The underwriting regulation also should clearly stipulate the extent of underwriting requirement for
different type of offering namely: par value, fixed price and book building process.
Refund
The regulation should clearly stipulate the time frame within which the intermediaries are required to
refund the margin money collected to the applicants who did not receive allocation.
Lock in period
The regulation should stipulate the Lock in period for
74
promoters
For securities issued on firm allotment basis
For institutional investors and other investors like anchor investors
Requirement of performance history
The regulation should stipulate the requirement of performance history of the Issuing Company before
allowing for market pricing mechanism for the IPO of their shares.
Definition of segregation of Institutional investors
Definition of institutional investors is crucial for book building process. Definition is required so as to
open the business opportunities for various prospective institutional investors. Existence of multiple
institutional investors lowers the risk of price collusion between the institutional investors and hence
helps in protecting the interest of the retail investors.
In reference to regulation in Bangladesh, eligibility of institutional investors can be as follows:
Merchant bankers except the issue manager concerned to the proposed issue
Foreign institutional investors registered with or approved – such provision needs to be
stipulated in concerned regulation
Recognized pension funds and provident funds –operation scope of current pension fund and
provident fund needs to be enhanced and the regulatory environment should promote
emergence of such funds from the private sectors as well
Bank and other financial institutions under regulatory control of Nepal Rastra Bank – the
investment horizon of such BFIs' need to be made longer than allowed by the existing concerned
regulation and directives
Insurance companies regulated under Beema Samiti - the investment horizon/total amount
available for investment by such Insurance companies need to be made longer/increased as
allowed by the existing concerned regulation
Institutional venture capital and institutional investors registered with or approved by the
SEBON – such provision needs to be added in the existing Securities Law
Stock Dealer registered with the SEBON – need to promote stock dealer and, referring to current
regulation, should be allowed to operate in the primary market as well
Asset Management Companies - need to be identified as a business by securities law or by Bank
& Financial Institution Acts
75
Chapter Seven: Conclusion
Capital Markets of Nepal can be taken as ordinary shares dominated market, further skewed by the
ordinary shares of financial institutions and insurance companies. In order to make the capital market
deep and more diverse, it is necessary to bring companies from various economic sectors of the country
into capital markets by facilitating them to offer securities to the public and by ensuring that such shares
are continuously priced in the secondary market.
Going public is also beneficial for companies as they will have access to needed capital through broad
base of public fund, in addition to banks and private market. However, companies have simply not
shown interest to vie for the capital markets. On the other hand, except for few, most of the non
financial sector companies listed in the Nepal Stock Exchange have not performed well, both in terms of
financial return and also in terms of regulatory compliances and disclosures, vis-à-vis BFIIs. One of the
main reasons pointed out was the absence of strong regulatory body to oversee them that would
require them to follow proper corporate governance as a public limited company. At the same time
investors are fragmented and non-institutionalized to form a united and strong force to demand
compliances from such listed non BFIIs companies. This has developed a negative sentiment among the
Nepalese capital markets investors toward securities of such non-BFIIs companies. The tasks are hence
to attract companies from the various sector of the economy to capital market for access of funds and
also to attract general investors’ to participate in those offers knowingly and willingly.
Attracting companies from different sectors entails not only attracting existing and established
companies to issue their securities in the capital markets but also developing the market where fairly
new companies are able to issue their securities in the market. Existing companies will be interested to
come to the market only if there is an incentive for them to issue their shares to the public. One of such
incentives is being able to make existing shareholders’ investment liquid at market value. Another
incentive can be the opportunity to sell their shares at market price.
Internationally, three difference approaches have been used to price the securities: fixed pricing, book
building and auction. Book building and auction comes under free pricing method in IPO. In terms of IPO
market, different stakeholders are in consensus regarding the need of luring real sector companies in
the capital markets of Nepal and using free pricing mechanism in the IPOs as the means of attracting
such companies. Hence, the concept of free pricing, possible through various mechanisms like book
76
building or fixed pricing or auction method, needs to be implemented soon as a catalyst to attract
companies from real sector into capital markets. However, the question "is the Nepalese capital markets
mature to accept free pricing in IPO" is wide spread. Even with this concern, most of the representatives
from the different stakeholders group believe that IPO under free pricing is a must.
For the free pricing to be taken positively by the market, a conducive and robust ecosystem needs to be
built. This requires strengthening different stakeholders in the market and making a coherent effort to
develop the market. The market development entails not only putting effort to promote the capital
markets that support the established institution, which is also the focus of this study, but also expanding
the capital market that can embrace the need of new and upcoming enterprising ideas.
Hence, it is required that all the stakeholders of the capital markets ecosystem be facilitated and
supported by regulatory environment and market opportunities. The market requires a strong regulator,
interested issuer, qualified intermediaries, interested and informed investors and other facilitating
institutions that provide professional and independent services to help dissemination of fairer
information for making investment decisions.
Hence, the study recommends that even with continuing the current provision of allowing companies to
issue their securities at par value, the Securities Issue regulation should also allow companies to offer
their securities to public at market price or allow free pricing of IPOs. The market price offer can be via
fixed price method or book building process.
The research has highlighted the need to implement market pricing mechanism to lure performing
companies from the real sector to come to the capital markets. The research has seen that such
opportunities are available. The research also highlights that the capital markets be ready to address the
issue of not only the established enterprises but also support entrepreneurial initiatives. The market is
also ready to think in that line. However, for this to happen, the market requires the enhancement of all
the stakeholders in the ecosystem. This may seems an immense task, but a lot of effort has already been
made in this regard. The need is to coherently decide on the comprehensive plan that can impact the
ecosystem at the same time. The development of the ecosystem is however, a gradual process, and such
gradual improvements will happen only when the regulatory framework allows for such changes to
occur.
77
Bibliography
Bora, B., Adhikary, A., & Jha, A. (2012). An Empirical Perspective on Book Building as Effective Tool for
Price Discovery. 2012 International Conference on Economics, Business and Marketing Management (pp.
168-172). IACSIT Press, Singapore.
Busaba, W. Y. (2006). Bookbuilding, the option to withdraw, and the timings of IPOs. Journal of
Corporate Finance , 159-186.
Chen, A., Hong, C., & Wu, C.-s. (1999). The Underpricing and Excess Return of Intial Public Offerings
Based on the Noisy Trading: A Scholastic Frontier Model.
China Securites Regulatory Commission (CSRC). (2008). China Capital Markets Development Report.
China Securities Regulatory Commission (CSRC). (September, 2006). Measures for the Administration of
the Offering and Underwriting of Securities .
Deazeley, B. (2008). Deciding to Go Public. Canadian Institute of Chartered Accountant.
Gangadhar, V., & Reddy, G. N. (2005). Book Building Process: An Efficient Mechanism for Management
of Mega Public Issues in India. The Chartered Accountant , 676-683.
Government of Nepal. The Companies Act, 2063 (2006).
Jagannathan, R., & Sherman, A. E. (2006, March). Why Do IPO Auctions Fail? NBER Working PaperSeries .
Jagannathan, R., Jirnyi, A., & Sherman, A. (2010). Why Don't Issuers Choose IPO Auctions? The
Complexity of Indirect Mechanisms. National Bureau of Economic Research .
Kumar, S. S. (2010). Is Bookbuilding An Efficient IPO Pricing Mechanism? - The Indian Evidence.
International Research Journal of Finance and Economics , 173-188.
Ritter, J. R., & Welch, I. (2002). A Review of IPO Activity, Pricing and Allocations. Journal of Finance ,
1795-1828.
SEBI. (2000, updated August 20, 2009). Securities and Exchange Board of India (Disclosure and Investor
Protection) guidelines, 2000.
SEBI. (2009). Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements)
Regulations, 2009.
Securities and Exchange Board of Nepal (SEBON). Securities Registration and Issue Regulations, 2008.
Securities and Exchange Commission, B. Securities and Exchange Commission (Public Issue) Rules, 2006.
Securities and Exchange Commission, Bangladesh. (2009, March 11). SEC Notification.
78
Securities Board of Nepal (SEBON). Securities Act, 2063 (2007).
Sherman, A. E., & Titman, S. (2002). Building the IPO order book: underpricing and participation limits
with costly information. Journal of Financial Economics , 3-29.
Wilhelm, W. J. (2005). Bookbuilding, Auctions, and the Futuer of the IPO Process. Journal of Applied
Corporate Finance .
I
Annexure
II
Annex I: Illustration of Price Discovery through Book Building Mechanism
In book building process, bids are called from different investor category within the given price range,
stating the bid price and number of issues. The indicative price range (or price band) is determined
jointly by the issuing company and the book running lead manager, on the basis of the valuation effort
of the BRLM and the minimum acceptable (floor price) stipulated by the issuer. Based on the bids
received from investors, the issuing company and lead manager determine the issue price. Given below
is a hypothetical example, illustrating the process of determining the issue price in determining the issue
price:
Category Bid Quantity Bid Price Cumulative Quantity Subscription
A 500 275 500 16.67%
B 1,000 272 1,500 50.00%
C 2,000 270 3,500 116.67%
D 750 266 4,250 141.67%
E 2,200 265 6,450 215.00%
Let us assume a price band of Rs. 265 - Rs.275 and the proposed issue size is of 3,000 shares. As
depicted in the above table, the offer is fully subscribed at point C, where the cumulative quantity is
3,500 shares. The highest price at which the company is able to issue the desired quantity of offerings
here is Rs. 270. If the issuer decides to issue at Rs. 272, only 50% of the offering will be subscribed. The
issuer can determine a lower price but not higher, to ensure the full subscription of the offerings. The
issuing company, with consultation with the book running lead manager, will determine the cut-off
price, i.e. Rs. 270. All the bids above the cut-off price are regarded valid and considered for allocation in
the respective categories.
III
Annex II: Eligibility Criteria for Inquiry Objects in China It is established according to law, and has not been subject to any administrative penalty,
regulatory measure or criminal penalty by relevant regulatory departments because of any
significant violation of laws or regulations during the recent 12 months;
It may conduct stocks investment according to law;
It has good credit record, and has necessary institutions and personnel for independently
engaging in securities investment;
It has sound internal risk evaluation and control systems which can be effectively implemented,
and the risk control indicators comply with relevant regulations; and
It has been 12 months since the date of removal if the inquiry object has been removed from
the list of inquiry objects by the SAC according to the regulations of the Measures.
IV
Annex III: Questions asked to concerned stakeholders regarding free pricing
system in IPO in Nepal
Questionnaire for Potential Companies
1. From where did you source the required capital to start your company?
2. From where do you resource needed capital for continuous upgrade?
3. Have you raised capital from the private market? Have you faced problems doing so?
4. What is your view regarding going public?
5. What kind of hindrance do you see regarding going public in Nepal?
6. What kind of regulation, provisions would promote you to go to public?
7. Would you be interested to see developed capital markets that can supplement the
dependencies on traditional bank for needed capital?
8. If the capital markets in Nepal allows you to offer your shares in public at market price, would
you be interested to go to public?
9. What kind of regulation changes would you prefer if you are a public limited company?
10. What kind of service you expect from capital markets in Nepal?
Questionnaire to retail investors/representatives of retail investors
1. Why retail investors are not attracted towards IPOs in recent days?
2. Will retail investors be interested to invest in companies from different economic sectors (with
inclusion of realty sectors), if available?
3. Are retail investors ready to subscribe securities issued through free pricing system?
4. What kind of information do retail investors require to make decision about share price in IPOs?
5. Retail investors do buy and sell shares in secondary market at market price. But will they be
ready to do so in IPOs, especially when the market determined price exceeds the face value?
What will be the likely effect on investors’ sentiment?
6. What kind of market facilitation is required to facilitate investors to buy shares at market price
in IPOs?
7. What are problems faced by retail investors regarding investment in IPOs?
8. Are there any institutions that support retail investors in making decision regarding investment
in IPOs?
V
9. What kind of institutions would, in your opinion, help retail investors participate in IPOs with
free pricing system?
10. Would you be interested to invest in mutual funds/unit funds that invest in IPOs?
Questionnaires to Institutions who are institutional investors/potential to be institutional investors in
IPO
1. What are your mandates/restrictions regarding investment in securities issued in capital
markets through IPOs and transaction in securities through secondary markets? Are you bound
with any kind of regulations regarding your investment policy?
2. Would you be interested to have an investment portfolio of securities issued in capital markets
of Nepal?
3. As an institutional investor, what would attract you to invest in securities issued in the capital
markets?
4. Would you be interested to be institutional investor if you are assured of shares allocation?
5. If capital markets in Nepal allows for free pricing of securities in IPOs, would be interested to
participate? If yes, what would be your condition for participation?
6. Are there any regulatory changes that need to be done for you to participate as investor
through free pricing system in IPOs?
7. What kind of institutions do you think will be interested to participate in free pricing of
securities in IPOs? Is the institutional investors’ base strong enough to support the free pricing
system?
8. Would you be interested to be part of venture fund if free pricing system in IPOs is allowed?
9. Would you be interested to run funds/units that specialize in investing in securities of
companies?
10. What should be the basis for quoting price if institutional investors are allowed to participate in
the bidding process under free pricing mechanism? What degree of diligence and analysis would
have to be carried out to understand the issuing company?
11. If there is a lock- in period for institutional investors, would that be a deterrent for investing in
securities issued in capital market?
12. How do you perceive the need of underwriting under free pricing system?
13. If free pricing is adopted, what measures can be adopted to ensure fair price discovery without
any collusion among institutional investors or other forms of manipulations?
VI
Questionnaire to Merchant Bankers
1. Can Merchant bankers market IPOs under free pricing to investors?
2. What kind of infrastructure is required to implement free pricing IPOs?
3. Can merchant bankers be institutional investors in IPOs?
4. What can attract merchant bankers to be an investor in securities issued in the capital markets?
5. If capital markets in Nepal allows for free pricing of securities in IPOs, would merchant bankers
be interested to participate?
6. If Yes, what would be the condition for participation
7. Are there any regulatory changes that need to be done for you to participate as investor
through free pricing system in IPOs?
8. What kind of institutions, beside merchant bankers, be interested to participate in free pricing
of securities in IPOs?
9. If free pricing system were to come to Nepal, what degree of diligence and analysis would have
to be carried out to understand the issuing company?
10. Do the existing capital markets of Nepal have enough varieties / categories of institutional
investors to go into book building process? What should be the backdrop of price discovery?
Who might be the eligible institutional participants in Nepal? (In terms of research and resource
capability?)
11. What could be the mechanism of road shows? Issue related to the use of online system and
process of bidding?
12. Module that could be followed for discovering indicative prices? In case of Nepal, time duration
between the institutional bid opening/ closing and bid opening for public.