The Securities and Exchange Board of India’s (SEBI) marathon meeting on Wednesday evening yielded a rich harvest. As a result, tighter checks on insider transactions, tougher criteria for merchant bankers, and easier rules for investment trusts are on the way, most of which should help in improving investor protection and the efficiency of market participants. The biggest measure, of course, was reserved for initial public offerings (IPOs) of small and medium sized enterprises (SMEs), which were making headlines for all the wrong reasons. The best part is that while tightening the regulations, the regulator has balanced investor protection objectives with the needs of genuine SMEs. SEBI’s intentions anyway didn’t come as a surprise: A consultation paper in November this year had red-flagged some SMEs diverting issue proceeds, declaring manipulated numbers, and undertaking outsized related party deals.
The retail frenzy for SME IPOs and rising investor complaints about frauds have obviously forced SEBI’s hand. The point is that SEBI should have woken up much earlier. Some years ago, it had allowed unfettered freedom to issuers looking to list on SME platforms. They were exempted from filing their offer documents with the regulator and from announcing quarterly results or complying with most of the governance norms contained in the Listing Obligations and Disclosure Requirements Regulations. A course correction was required as a few rogues were spoiling the party. In that sense, Wednesday’s regulatory action can be termed as better late than never.
The changes are designed to ensure that only financially sound and operationally viable SMEs can raise capital through IPOs. That explains the criteria of a minimum operating profit of Rs 1 crore in at least two out of its three most recent financial years. The change of rules to limit the offer for sale by promoters makes eminent sense as this comes in the wake of instances of diversion of issue proceeds to shell companies controlled by promoters and inflation of revenue by circular transactions through related parties. It’s not clear, however, why the SEBI board did not approve the consultation paper’s proposal to increase the minimum application size for such IPOs from Rs 1 lakh to Rs 2-4 lakh. The hesitation in setting a Rs 4 lakh application size is understandable as it may have prompted retail SME punters to take even more concentrated bets. But a Rs 2 lakh application size should have been allowed.
Overall, the tightening of regulations was warranted as they come in the wake of the recent irrational exuberance witnessed in SME IPOs. Since the establishment of SME platforms, FY23-24 witnessed the highest number of SME issues and the highest SME fundraising. In the current financial year also, 159 SMEs have gone public so far, raising more than Rs 5,700 crore. As many as 29 out of 61 IPOs were oversubscribed over 100 times since September this year. The applicant-to-allotted investor ratio increased from four times in FY22 to 46 times in FY23 and 245 times in FY24, according to SEBI data.
SME listed entities are typically promoter-driven or family business companies with high concentration of shareholding among a few promoters. There is also limited presence of other shareholders who act as a check on the promoter’s influence. Regulations must ensure that unscrupulous elements don’t take advantage of the platform and that investor interests are adequately protected. In short, there can’t be any alternative to setting a higher governance bar.