Indian regulators have come up with a novel solution to the problem of failed initial public offerings: give small investors who lose money a refund. The proposal would appear to undermine the basic idea that common shares represent ownership rights - and risks. But unless company owners face consequences for ultra-aggressive pricing, they won't stop abusing their information advantage - and the market for IPOs will remain moribund.
The Securities and Exchange Board of India, which has floated the idea, is right to worry that small investors are being fleeced by insiders with superior information. Between 2008 and 2011, 55 out of 117 Indian IPOs traded at least 20 percent below the offer price after six months of listing.
Bankers have slammed the proposal as a draconian intervention in a free market. But SEBI is not seeking to eliminate the risk of underperformance altogether. Only small investors - those who had applied to buy less than $900 in stock - will be allowed to return their shares at the offer price. The option will only be triggered if both the absolute share price drop and decline relative to the broader market index are 20 percent or more within three months. And majority owners' repurchase obligation will be capped at 5 percent of the IPO size. Insiders will still have an advantage over new investors. But they will be discouraged from using it too blatantly.
Being responsible for ensuring positive trading in the secondary market might scare away a handful of IPO aspirants. But it will prompt those that remain to pay more attention to pricing their offers fairly. It will also put more pressure on investment banks to avoid dud issues.
There's no question that India needs to restore investor trust. Last financial year, households pulled out a net 93 billion rupees ($2 billion) from equities and mutual funds. In September, IPOs raised less than $7 million, while rights issues, where the market has already established a price, scooped up more than $1 billion.
It's not yet certain whether SEBI's proposal will be formalised: chairman UK Sinha recently hinted that a "milder form" of safety net might be introduced. But if the final rules are watered down too much, they might be ineffective. And that would defeat the whole point.
- The Indian market regulator plans to implement a safety net for retail investors in initial public offerings, UK Sinha, the chairman of Securities and