Sebi’s recent decision to make IPO grading optional instead of mandatory comes on the back of an analysis showing that the grades didn’t really play any role in investors’ decision-making.
If the Sebi analysis is anything to go by, investors, especially retail, were subscribing in droves to IPOs assigned a low grade by leading credit rating agencies such as Crisil, Care and ICRA, making the process futile. These agencies have a grading scale of 1 (poor) to 5 (strong).
Not surprisingly, Sebi’s board decided to make IPO grading optional last month — seven years after introducing it in 2006. The decision was based on two studies placed before the primary market advisory committee, which looks into the policy framework governing public issuances. Interestingly, industry players have been divided on the efficacy of the mechanism ever since it was introduced.
According to the study, even issues graded 4 by the rating agencies yielded losses when compared to the ones that were awarded lower grades. The PMAC, as part of its recommendations, submitted that “IPO grading may be made voluntary as against the current provision of the same being mandatory.”
The analysis found retail investors didn’t pay heed to the grading. “The retail investors for whom IPO grading was introduced subscribed fully or overwhelmingly to their portion in as many as 73 out of 86 'lower grade' IPOs,” says a Sebi paper.
But the indifferent approach towards IPO grading was not limited to retail investors — institutional entities didn’t pay much attention to grades either.
“...even QIBs have refused to acknowledge grades. The QIBs have subscribed fully their portion in as many 'lower grade' IPOs. This indicates that grading has been not a factor in investors' decision-making process,” says the Sebi document.