The Hindu Business Line : A remedy not apt for the disease

The Indian stock market has become the envy of even some of the developed economies. It works with clockwork precision, thanks to the excellent system put in place. It triggers self-correction mechanism wherever required even though its circuit-breakers have come to be questioned for their appropriateness and efficacy.

But, by and large, the secondary market functions like a well-oiled machine even at the height of frenetic buying or selling. The same however cannot be said of our primary market with price discovery being a festering problem.

If the erstwhile office of Controller of Capital Issues smacked of dirigisme, the extant book-building mechanism is riddled with a lot of holes. The participants in the book-building exercise are effectively presented with a fait accompli inasmuch as they have to bid for shares within the narrow range called price band already fixed by the issuing company.

Thus, if a company calls upon the participants in the book-building exercise to bid within Rs 400 to Rs 450 per share with a face value of Rs 10, there is very little room for price discovery with the price having been already discovered substantially by the company in league with its merchant banker.

SEBI formula

The Securities and Exchange Board of India (SEBI) has now come up with a formula, albeit in the context of Follow-up Public Offers (FPO), in terms of which whenever a listed company goes for the second or subsequent round of public issue, it will have to just set the floor price and not the ceiling.

In other words, there would be a floor but not a ceiling. Alas this mechanism was mandated for the Initial Public Offers (IPOs). SEBI seems to have got its order wrong.

This is the mechanism one has been pleading for all along in the context of IPOs where one tends to whistle in the dark in the absence of definitive set of factors determining the size and appropriateness of premium a company can charge. The problem with the extant mechanism is that a company effectively foists the price it desires on the unsuspecting public. To be sure, that price is vetted and approved by the more financial savvy Qualified Institutional Buyers (QIBs) which participate in the book-building exercise, but the bottom line is the price is not discovered by them but by the company effectively. What SEBI proposes to do is to prescribe a remedy that is not apt for the disease the primary market is suffering from. In fact, for an FPO, there is a benchmark and hence there is no need for a rigorous price discovery process on a par with IPO.

When a share is listed, there is a market for it and quotations therefor for a reasonable period of time can be taken as indicative of its true worth. That being the case, where is the need for a fresh round of bidding? After all, the company itself is in a position to fix the issue price in the light of the market quotations and the surrounding economic and political environment.

To be sure, it may have to fine-tune the market quotation benchmark keeping in mind the inevitable dilution likely to be engendered by greater number of floating shares sloshing around post-issue. The point is, SEBI ought to have first addressed the more pressing concerns rather than reaching out to and addressing problems that are less significant.

A better mechanism

SEBI's proposal malapropos as it is - it is a remedy more for the IPO rather than for FPO - goes on to say that the floor price would be the price at which the retail subscribers would be given the shares and the QIBs participating in the book-building exercise would have to take their bidding more seriously than hitherto because they would now be sticking their necks out - they have to cough up the money they have promised to.

In others words, if a QIB quotes Rs 500 per share for a 5 per cent stake and another quotes Rs 600 per share for a 10 per cent stake, both would have to cough up different prices. This is much better than the extant mechanism where the company fixes a cut-off price that applies across the board to all the allotees, be they QIBs or the retail investors.

The QIBs, under the extant mechanism, have to pay upfront only 10 per cent of their quotation with the company left twiddling its thumbs should it renege on its promise. For good measure, the SEBI proposal allows fixation of ceiling of a different kind - the maximum a QIB can bid for in terms of quantum of shares lest he comes to hog all the shares on the table or a substantial part of it.

Public interest has been taken admirably because the public would be paying much less than what the QIBs have even though companies even under the extant mechanism have the freedom to charge a lesser premium from retail investors. But in the past that has proved to be tokenism, whereas under the proposed dispensation it could be substantial.

The proposed regime is infinitely better. Alas, SEBI had not mandated it for FPOs and mandated it for IPOs. Hitherto, listing gains have been savoured by the more fleet-footed institutional investors. If the proposed regime is made applicable to IPOs, the public would savour them for a sustained period of time. If the initial quotations are way ahead of the highest bid, there would be substantial gains for the retail investors vis-…-vis the QIBs.

(The author is a Delhi-based chartered accountant.)

Related Stories:
Institutions get a free hand in follow-on issue pricing
Marketmen welcome removal of cap for FPOs

More Stories on : Regulatory Bodies & Rulings | Public Offer

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