The Hindu Business Line : Keeping turmoil out of markets

SEBI needs to bring reforms in pricing of equity shares as well as the process of book-building, including allotment of shares, margin money requirement and eligibility criteria for raising capital from the primary market.
The set-back for IPOs is a short term phenomenon. The fundamentals of the economy have demonstrated the resilience of the Indian capital market.

M. Y. Khan

The primary market is the pace-setter for mobilising resources by corporates. Over the last four years, particularly from 2003-04 to 2007-08, it has notched up a stunning performance, as the capital raised, which was just Rs 4,000 crore in 2002-03, leaped to Rs 23,000 crore and, thereafter, continued to rise consistently. The year 2006-07 saw mobilisations rise to Rs 33,500 crore, from 124 issues.

Even during 2007-08, the market was booming and by January-end the corporates were able to report more than Rs 60,000 crore. It is worth noting that throughout these four years under reference, IPOs contributed 50-80 per cent of the total capital mobilised.

This performance was assisted by good GDP growth and the market regulator’s investor-friendly policies.

There is no doubt that the bull-run in the secondary market enabled and emboldened companies to enter the market with big issues and attract investors and traders to invest in public issues to reap high profits following their listing.

The companies’ profitability performance was also good. The market, however, underwent a turmoil as soon as an FII-driven crisis developed in the secondary market and the mega crash occurred in January second week, the effects of which persist even today, albeit in toned down fashion, with the Sensex at a low of 15,967.

This shook the investors and resulted in pessimistic sentiments and narrow-range expectations, which were only aggravated following the Reliance issue of Rs 11,700 crore.

Bearish mood

The bearish mood of investors was in evidence at the time of Wockhardt Hospital issue and thereafter, of Emaar MGF.

There are two main factors for this grim outlook — continuing uncertainties and further crash of the stock prices and hesitation on the part of investors due to fall in shares of Reliance Power as soon as they were listed. Investors lost nearly Rs 70 per share on listing of Reliance Power.

However, the set-back for IPOs is a short term phenomenon. The fundamentals of the economy, such as GDP growth, export performance, level of foreign exchange reserves and confidence level of foreign financial markets, have demonstrated the resilience of the Indian capital market.

The withdrawal of foreign institutional investors is a short-term move. Their unloading has been for profit booking and they will come back to the market with full vigour.

The primary market may continue in this state for about six months, after which it will recover. Though a number of IPO issues have been stayed due to fear of dearth of investors, they will be taken care of by the market in the future, since the saving potential of the domestic economy is on the rise.

Today our savings ratio is estimated to have reached the 35 per cent level, which is reflected in deposit growth and sharp rise in demand for gold and commodities.

It is also reported that insurance companies, mutual funds and other funds have accumulated large funds from retail investors which will be available for investment in equity issues. The IPOs of good standing will surely have a market in about three months.

Of course, raising tax burden on capital gains and security transaction tax on commodities may have some marginal impact on activities in the secondary market, but it is not going to affect long-term investment perceptions.

Also, the issuer companies will have to be more realistic in attempting their valuation for fixing price range which is presently loaded by heavy premium and is backed by hype of publicity but with limited information.

Financial literacy is key

What we need today is financial literacy, particularly in case of retail investors.

On the one hand, investors in the equity market need education and awareness of investment strategies with full knowledge of issuer company; on the other hand, the Securities and Exchange Board of India (SEBI) has to bring some reforms in valuation technique and fixing of price range and allotment methodology.

If retail investors have full knowledge of the market, and companies, they will not run away from the market when stocks prices are falling.

One should buy when prices fall and sell when prices rise, is the general rule. However we did not see this in investors partly due to their belief that equity investment is a short-term activity. It is also possible that a large number of investors were traders who wanted to book quick profit from Reliance Power and other companies.

If investors, who sold during the crash, had continued to hold their investment till the end of 2008, they would not have possibly lost their hard-earned savings.

The pricing process is not investor-friendly. The issuers and issue advisors tacitly collaborate to determine the price range which is always on the high side. They do not specifically spell out the method of valuation of their company.

Price discovery does not take place on the basis of all competitive bids, including retail investors’ bids. As a matter of fact, the issue price should be at the point where the company is able to sell the entire equity.

As such, the bids can be arranged in descending order of price quotations and the price cut-off-point will be at which a company is getting the entire capital issued. This price, of course, will be the lowest.

Allotment procedure

No doubt companies some times allot shares to retail investors at 10-12 per cent discount but this is not a rationalistic approach.

The entire equity allotment should be proportionately done taking all the bidding investors, including qualified institutional buyers and non-institutional investors, above the cut-off point.

However, the share of each group, as specified by SEBI, should be maintained. This will be a rational and fair equity allotment.

At present, the allotment procedure is in favour of qualified institutional buyers.

It should be binding on the issuer company that it appoint a market maker in order to maintain the price of equity at least for one month following the date of listing of the shares on the stock exchange.

Besides, margin money should be the same for all bidders and non-allottee bidders should receive back their funds within three days of announcement of allotment. The allottees, however, should receive their shares in demat accounts within one day following the allotment.

The entry norms for IPOs should be based on strong fundamentals. For instance, companies that specified net tangible asset (Rs 3 crore), net worth at least (Rs 1 crore) and distributable profit for three years out of preceding five years should have market making condition attached to the IPOs.

Other issues through book-building should also follow net worth criteria, at least the capital pooled by the promoters, and such issues should be guaranteed for market making and utilisation of fund monitoring. It is also proposed that grey market trading should be totally banned by SEBI.

(The author is a Mumbai-based writer.)

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