India must learn to ignore foreign opinion and structure appropriate rules to suit our market
The embarrassment caused to the government by the allotment mess in the six public sector disinvestment offers of March 2004 have triggered off the overdue process of modernising India’s primary market.
The secondary market has grown aggressively after large-scale automation in the mid-90s, but the primary market lags far behind. This is partly because it never quite recovered from the excesses of 1992-95 and the few good Initial Public Offerings (IPOs) that enthused investors, did not warrant a change in systems and processes.
All that changed in March 2004. The six mega PSU offerings revived investor interest and the enthusiasm of foreign investors not only ensured their success but also opened the doors to large private sector IPOs such as Biocon and TCS.
The Securities Market Infrastructure Leveraging Expert Task Force (SMILE Task force), in its first report, has come up with an interesting plan to automate the IPO process. And although it provides the outline for a very sophisticated system, it also recommends a workable short-term plan that will not shut out small investors with too much automation and restricted access.
The SMILE proposal focuses on ensuring data integrity, especially in book built issues, by eliminating repetitive punching of data by different intermediaries.
• Recent allotment mess has triggered modernisation of the primary market
• The SMILE proposal focusses on ensuring data integrity
• Google’s IPO will hopefully cause our regulators to rethink
The investor requires to provide just a name and depository number at the time of filing an application, which can by verified and a physical confirmation obtained. The data then goes into a composite database created by depository with additional information available with it.
This database will go to the registrars and bankers for adding payment details and a software-based computation will examine valid bids and prepare a list of successful applicants. This will streamline the issue process, minimise errors and halve the time from issue closing to actual trading.
This new format can only be adopted after a detailed infrastructure audit, and the SMILE committee correctly suggests a third-party infrastructure scrutiny of covering technological capability, operating systems and processes of all intermediaries and the prescription of certain minimal standards.
Having strengthened the process flow, the committee recommends key changes in the chain of responsibility to ensure successful issuance and effective handling post-issue investor grievances.
It wants the Book Running Lead Manager (BRLM) to be empowered to pick their team (of investment bankers, registrars and bankers to the issue) and to assume fiduciary responsibility for the entire process with proper contractual arrangements with other intermediaries. Although the report mentions that this suggestion has been strongly opposed by investment bankers, it is only correct that lead manager must be made jointly and severally liable along with the issuer for the entire IPO process. The SMILE recommendation of a cap on the financial liability of investment bankers, to three times the fees earned from the issue also seems fair.
On the issue of retail participation, the SMILE report says that 97.3% of retail applicants to the eight issues of March-April 2004 applied at the cut-off price. This means that retail contribution to price discovery is marginal. In the circumstances, the committee recommends allotment incentives to encourage early applications and avoid the last minute bunching of issues. However, investor associations have been suggesting that a better option would be a fixed price issue for retail investors at the cut-off price fixed in the book building process.
This still doesn’t answer the allegation that Qualified Institutional Buyers (QIBs) influence pricing by showing “an inflated book in the early stages of the issue, thereby luring unsuspecting retail investors who are impressed by the response”. Unlike retail investors, QIBs don’t back their applications with funds; they cough up the money only after confirmed allotment. So SMILE wants a 10% margin on every QIB bid, to be remitted into the issuer’s escrow account.
This recommendation makes it the third committee to ask for a margin for institutional investors. Earlier, the Primary Market Advisory Committee and the Malegam Committee had both recommended similar margins; the SEBI board rejected their suggestions on the grounds that it was out of sync with international practice.
Google’s successful IPO in the US will hopefully cause our regulators to rethink the issue. If an iconoclastic triad of entrepreneurs can rewrite IPO rules in America, despite pressure and criticism from analysts and market intermediaries, then India too must learn to ignore foreign opinion and structure appropriate rules to suit our market.
Another issue flagged off by the SMILE committee is the increasing IPO expenses. It estimates issue expenses at 5.9% for a Rs 100 crore book-built issue. It also says that 25% of the cost of a primary issue is spent on application forms and prospectuses. Of these, only around 5% are actually utilised. The committee further says that prospectuses are rarely read; hence there is a strong case for moving to an electronic prospectuses.
They point about eliminating superfluous paper is correct, but SEBI must ensure that the full prospectus is available at multiple websites (SEBI, the stock exchanges and the issuer company) and that investors, in all parts of the country can demand a print out at designated centres merely on the payment of printing costs.
If the regulator does not ensure easy access to prospectuses, the new system would militate against the very notion of full disclosure, which is the basis of our capital market regulation.