Sucheta Dalal :Time For Regulators To Bust Bubble-Subsc<x>riptions (2 Feb)
Sucheta Dalal

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Time For Regulators To Bust Bubble-Subscriptions (2 Feb)  

Is the initial public offering (IPO) market being hyped up and overheated due to financing by banks and non-banking finance companies, in violation of Reserve Bank norms? And are such leveraged investors gambling on allotment for short-term gains? It is true. It is now established that easy finance for high networth, non-institutional buyers (NIBs) is encouraging them to gamble on allotment and cause artificial over-subscription of issues. NIBs have a specific reservation of the total IPO, which attracts the fastest and largest extent of over-subscription. This is sending false signals to companies and encouraging them to over-price IPOs or make larger issues in the mistaken belief that there is a greater demand for their stocks than really exists. It is also luring retail investors (classified as those applying for less than Rs 50,000 worth of shares) to subscribe to overpriced issues. The dangerous trend is also resurrecting the infamous grey market that existed in the 1980s and early 1990s and distorted the IPO scenario. With many large companies getting ready to raise a phenomenal Rs 25,000 crore through IPOs in the coming months, there is an urgent need to curb such leveraged speculation and short-term investment.

The Mumbai-based Investor Grievances Forum (IGF), headed by Kirit Somaiya, the BJP party Whip, has taken up the issue with both regulators — the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi). The investor group alleges that while commercial banks have restrictions on IPO financing and broker financing, they are circumventing RBI rules by lending large sums of money to non-banking finance companies (NBFCs) for on-lending to these segments.

Mr Somiaya says that four leading finance companies alone have a kitty of over Rs 2,000 crore, specifically for IPO financing. This has encouraged investors to gamble on allotment. If they receive a firm allotment of shares which list at a premium, they are immediately sold to book profits and pay off the lender. RBI chief general manager B Mahapatra has clarified to Mr Somaiya on December 17, 2003, that banks are allowed to finance IPO applications only to the tune of Rs 10 lakh per individual. He further says: “However banks are not allowed to extend finance to corporates for investment in other companies’ IPOs and to NBFCs for further lending to individuals for IPOs.”

This means that the central bank is clear that financing NBFCs to on-lend for IPO subscriptions is strictly illegal. But this rule is easily circumvented, because the money is not specifically lent for IPO funding, but routed as working capital finance or through instruments like Commercial Paper.

While this openly flouts the spirit of RBI guidelines, the central bank seems in no hurry to clamp down on such operations. Instead, Mr Mahapatra tells the MP that “we shall be glad if instances of violation of our guidelines are kindly brought to our notice to enable us to look into the matter” (emphasis added).

The Securities and Exchange Board of India (Sebi) has said that monitoring the financing of IPOs by banks and finance companies is the RBI’s responsibility. And it is unclear if the two regulators have either discussed the concerns expressed by Mr Somaiya, although they hold regular meetings. Mr Somaiya, a member of the Joint Parliamentary Committee, has openly accused the regulators of being silent spectators to the creation of an artificial atmosphere in the primary market.

He also makes the interesting but technical point that banks, as a matter of precaution, are listed as second applicants to IPOs funded by them. Each bank’s total applications, through NIBs, added up to well over 10 per cent of the issuing company’s capital. Incidentally, over-subscription in the retail category is low enough to indicate that small investors have not returned to the IPO market in a hurry. Hypothetically, if an issuer makes a firm allotment to all applicants, then banks will end up as joint owners of over 10 per cent of a company’s equity in violation of RBI norms. Such a scenario is not inconceivable given the choppy secondary market. The fact of NIBs causing market distortion is borne out by an analysis of IPO subscriptions last year and including Maruti Udyog and Indraprastha Gas. The numbers show that NIBs who are funded by finance companies cause the biggest over crowding of applications. They are also the fastest to dump the stock and exit after the listing. In each case, NIB shareholding has dropped dramatically within weeks of listing, since the buyers booked immediate profits. On the other hand, qualified institutional buyers (QIB), who are mainly mutual funds and institutional investors, have stayed with the company for the longer term; in most cases even longer than small retail investors. There has been a negligible change in their holding in most cases.

Until recently, QIBs were blamed for signalling fake over-subscription by overbidding for IPOs and there was a demand to impose margins on their applications. The analysis of IPO data suggests that they were more maligned than they deserved.

With several large IPOs from Gail, ONGC, Reliance Infocom, Tata Consultancy Services and Bharat Petroleum scheduled to offer anywhere between Rs 3,500 crore and Rs 6,000 crore each, it is only fair that regulators act now to correct distortions and clamp down on bubble-subscriptions.

Such action will give issuers time to re-assess the market and to moderate IPOs and their share premium. This is especially important in view of the steady erosion in secondary market values all through January. Ever since the latest bull market began in May 2003, January 2004 has been the first month when leading stock market indices have closed lower than in the previous month. This ought to ring loud warning bells for all companies planning IPOs on the strength of a booming secondary market.

-- Sucheta Dalal