Sebi has hosted a discussion paper on a Mandatory Safety Net Mechanism for wider public consultation. The proposal is an extension of Regulation 44 of Sebi Regulations, 2009, which addresses the concept of a safety net for investors in an IPO. As per the existing regulations, an issuer may provide for a safety net arrangement for the specified securities offered in any public issue, in consultation with its book running lead manager (BRLM) after ascertaining the financial capacity of the person offering the safety net arrangement. A maximum of 1,000 securities per original resident retail individual investor, in an IPO, is to be covered under the arrangement. The buyback will be at the issue price and is to be exercised within a period of six months from the date of dispatch of securities.
The fundamental change (from the said Regulation 44) now proposed is to make the safety net mandatory. Issuers will have to compulsorily offer a safety net, to all retail individual investors within a period of three months from the date of listing of equity shares, if the share price falls more than 20% of the issue price. As mentioned in the discussion paper, the proposal has been based on observed post-listing secondary market price trends of securities which were listed during 2008 to 2011. The proposal has been carefully drafted to eliminate effects of adverse price movements (below the issue price) due to abnormal market movements. The safety net is proposed to be made applicable only if the trading price falls more than 20% below the issue price. Further, the safety net is to be provided only after observing the trend in the broader index, for three months from the date of listing.
To be more effective in protecting retail investors, the details of the proposal may have to be revisited on two counts. First, it may be desirable to fix the mandatory safety net at the issue price, consistent with Regulation 44, as an observed depreciation in the post listing price of securities, over a period of time, may suggest a flaw in (issue) price discovery. Second, the aggregate buy-back offer may be suitably enhanced from the proposed 5% of the issued capital to protect the interests of retail investors. One may, perhaps, explore the possibility of linking the buy-back amount to the total premium collected, which could then take care of a larger number of small investors in the issue.
The Indian capital market has evolved today into a robust source of resources for companies. The market has become so ingrained in the financial landscape that it is difficult for any company/project to achieve financial closure without mobilising equity resources from the market. The market has been democratised and it is being increasingly accessed by a large number of companies/ projects. At par pricing of IPOs and a predetermined pricing formula, earlier stipulated by the Controller of Capital Issues (CCI), has been replaced by free pricing. In essence, the change is one from control to regulation. Any regulation-based system rests on three essential strands of monitoring, supervision and compensation. The transition from a fixed pricing to a free pricing regime and the depreciation in post-listing price in a large number of cases, as mentioned in the discussion paper, could lead to a crisis of confidence in the market and thereby jeopardise capital raising. Sebi now proposes to address this issue to bring forth a healthy market.
The author is MD & CEO, IDBI Mutual Fund
We come across these crossroads every few years. Some noble soul offers a magic potion to revive the equity markets. Unlike the comic book Asterix, though, there is no druid and no magic potion that will cure the Indian equity market of its torpor.
In short, the specialist advisory committee on primary markets and the Sebi board are testing the waters to introduce a scheme which will guarantee a minimum return on initial public offers (IPOs). To put it more accurately, the scheme mandates that the promoters should guarantee small shareholders, upto a money limit and time limit, that they will not lose over 20% of their capital. The 20% capital loss is to be calculated over and above any loss suffered by the broader index and the compensation is capped at 5% of the capital raised.
This is a wrong direction for several reasons. Broadly, this doesnt solve the problem of the depressed market, doesnt cure the malady of promoter rigging, and positively forces a legal manipulation of the market.
Risk is a factor which is intrinsic to the equity market. That is risk of market movement, rather than the risk of fraud. I sympathise with Sebi since I understand why it is trying to attempt this feat.
Over the recent past, Sebi has unearthed several IPOs where the promoters had set up financiers to rig the IPO with subscription money. After listing, these IPOs have tanked as the financiers take their money out of the capital raised by the company from the public, leaving a deflated balloon of a company in its wake.
The problems with the IPO market are not primarily caused by fraudulent promoters, but by an anaemic economy, repo-ing governmental policy, high volatility, a vast global crisis, mis-selling of various financial products, unreal investor expectations from the IPO market and finally, and not least importantly, a lot of bad luck. Sure some fraud has occurred in small nondescript companies, but that is not even a significant cause of the pain. Several blue chip companies have fallen by nearly 90% in the past 3 years alone.
The scheme is unlikely to discourage crooked promoters. These kinds of promoters pay upto 50% of the issue proceeds to illegal financiers and would be willing to pay an additional 5% to a Sebi-approved fraudulent scheme. They would still be net gainers, the way they look at it45% return rather than 50% return. The answer to such fraud is strict enforcement action, which Sebi has ably conducted over the past year, rather than this kind of scheme.
The mechanism is likely to backfire by bringing about a change in the attitudes of honest promoters who would seek to avoid IPOs altogether. You still would have the crooked promoters eager to do IPOs. The recommended rule will penalise patient and hard-working entrepreneurs who have spent decades building the company (promoters) or takers of a ten-year risk cycle (private equity) who must pay money to speculative investors who want free money in 1-2 weeks for doing no work and providing no long -term capital. Sebi must decide whose side it is on.
The author is founder, Finsec Law Advisors and visiting faculty, IIM-A