Preposterous ideas on retail reservation

Updated: Jul 26 2006, 05:30am hrs
Some thinkers are convinced that the small investors should be edged out of the IPO market as they are the beneficiaries of reservation and that all reservations lead to malpractices, as seen in other spheres. The debate actually started when the Economic Survey suggested doing away with reservation, arguing that multiple applications stem from the incentives offered by under- priced IPOs. This argument is untenable.

For one, QIBs and HNIs also get these incentives. For another, it is a myth that IPOs mean assured profits; IPOs can mean losses too, as the recent past has shown and therefore, this reservation is not much of a goodie. Besides, is it not a paradox that concerns about aggressive IPO pricing also exist simultaneously

Let me first put this reservation issue in its proper perspective. There is, in fact, no reservation for small investors; what they are getting are the leftovers. Until the late 90s, IPOs were available to all categories of investors, with no reservations. The big guys found this unacceptable because under the proportionate basis of allotment, they would get only a handful of shares, despite very large applications. It is they who demanded reservation for themselves, and under the new Sebi guideline in 2000, 60% of an issue was reserved for them, another 15% for the HNIs and a meagre 25% was left for the small investors. Thus, if the retail quota has to go, so must the 50% reservation for QIBs. In any case, unlike in other reservations where there is an opportunity to favour specific groups, the IPO retail quota is allotted only on an anonymous basis.

The arguments used by FIIs for demanding substantial reservation at that time was that retail lacked depth and with the IPO size becoming larger, issuers would have a comfort level with 60% of their issues subscribed to by the big guys. Who, incidentally, were willing to come in only with high reservation and with allotments on a discretionary basis. This argument was buttressed by another that did made sensecompulsory institutional participation would validate the issues for the small investors. Though in all fairness, this could have been achieved with, say, a 25% reservation.

This lobby also argues that the retail does not help an issuer realise the right price and, so, IPOs should be auctioned. This, however, will effectively shut out retail investors and convert a public market into a private one. Nevertheless, the auction system does have some merit. Presently, book-built and fixed price issues are alike, as the issue price in both cases is decided by the issuer (and not discovered by the market). The only difference is that instead of a single price, there is a price band.

Theres, in fact, no such reservation; small investors only get the leftovers
The suggested lock-in period on them, while FIIs run free, is discriminatory
Fortunately, Sebi does not subscribe to any of the lobbyists arguments
Under auctions, there should be no price indication for QIBs, and allotments should be done on a top-down bid price basis. This would help issuers get the best price for their shares from the institutional buyers, who too would be happy getting the desired quantity of shares at prices they are willing to buy.

What I am not for is the entire IPO being sold through auction. Only 25% of the IPO should be so reserved for QIBs. After completing the QIB portion, the balance IPO should be sold through the fixed price route to the retail, which presently uses only the cut-off option. Past over-subscriptions prove theres huge depth in retail. An argument may be offered that lower reservation may push the QIBs away. Not trueif an issue is good, QIBs will subscribe. They have subscribed to 50% of a Rs 100 crore issue and to 50% of a Rs 5,000 crore issue.

If the retail quota has to be continued, the lobby suggests that small investors should not be allowed to enjoy instant profits and, therefore, there should be a lock-in imposed on them for, say, one year (while FIIs be allowed a free run). There can be nothing more discriminatory than this. FIIs are already enjoying several favourslarger reservation, only 10% margin money and, until recently, discretionary allotments.

This lobby further argues that the small investor should be identified by his income levels, as opposed to his application money size, because several HNIs are usurping the retail quota. Their argument goes that a person investing Rs 1 lakh in, say, 50 IPOs in a year is, in fact, investing Rs 50 lakh and can surely not be called a small investor. The reality is that with the high levels of over-subscriptions, a small investor normally gets very little allotment. He uses the refund money to put an application in the next IPO and so on. At the end of a year, he may be fortunate to get allotments aggregating just a couple of lakh rupees.

On a more fundamental ground, I cannot figure out how a small investor can be defined by his income levels. First, we need an online tax system. Second, do we fix the criteria of current year income, or the past years, or an average of past three years or do we reckon the net worth of an individual A small investor can be defined only by the level of his participation, i.e. the application size.

The IPO scam happened only for one reasonlack of a unique identification number for investors. It was perpetrated by just a handful of fraudsters, and not by millions of small hapless investors; they should not be denied the opportunity of participating in IPOs. If the big goal is to move more household savings into the capital market, it is imperative that the domestic investor base grows to be able to counter the threat of instability often generated by foreign investors. IPOs have always expanded the investor base, as these are typically the best entry points. Bottom line: I feel redeemed that Sebi does not subscribe to any of the preposterous arguments.

The writer is the managing director of PRIME Database