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New IPO norms — Making allotment fairer

Raghuvir Srinivasan

SEBI's new norms for allotment to institutional investors are a welcome step towards a more equitable system that puts retail investors on a better footing.

THE latest changes to IPO (initial public offer) regulations announced by the Securities and Exchange Board of India (SEBI) on Friday take the IPO process another step towards being transparent, equitable and investor-friendly. Allotments to the category of QIBs (qualified institutional bidders) comprising foreign institutional investors, domestic institutions and mutual funds, will henceforth be made on a proportionate basis. Hitherto, the merchant bankers to the offer made allotments to these investors on a discretionary basis.

This had led to complaints of favouritism against the merchant bankers and allegations of discrimination against particular institutions. Such complaints and allegations are inevitable in any discretion-driven process. The change is welcome because it ensures that there can be no quid pro quo deals between the merchant banker and the institutional investor as was possible in the system of discretionary allotment.

It will be a fairer and more transparent system, just as it is for retail investors.

Of course, investment bankers are not too happy with the change and say that the post-listing price may drop as QIBs with a short-term outlook — namely hedge funds — may book profits on listing. If indeed this happens, it may not be a bad thing after all, as it will make IPO investment a serious business rather than a lottery game. Long-term investors never look for listing gains anyway and are not going to be disturbed by a low listing price.

SEBI has also addressed the other important issue of QIBs not being required to make advance payment a la retail investors while applying for an IPO. Once the new regulations are in place, the QIBs will have to pay 10 per cent of the value of the shares they are applying for, along with the application.

The existing system discriminated between institutional and retail investors; while the former did not have to pay any money upfront, the latter had to pay the full value of the shares they were applying for.

The result was that in their desire to secure maximum allotment, institutional bidders collectively bid for disproportionately high numbers of shares in relation to those on offer, exploiting the fact that there was no need to commit money upfront. Such speculative bidding had had the twin effect of skewing the response pattern to the offer and influencing the pricing decision. When the number of shares bid for at the upper end of the price band exceeded those on offer, the temptation was to price the IPO at that level.

SEBI's endeavour to correct this situation must be appreciated but it is doubtful if a 10 per cent margin will be enough to curb speculative bidding by the QIBs. A margin of at least 50 per cent may be necessary to ensure that institutional bidders do not resort to speculative bidding. However, a start has been made and, hopefully, SEBI will review this threshold based on responses to future IPOs.

While the issues addressed now are important, SEBI may have to soon focus on yet another aspect of the IPO process — funding by banks and other institutions.

With funds easily available, a number of investors, particularly in the high net worth (HNI) category, and also some retail investors, borrow short term to invest in IPOs. Their strategy is to secure allotment and dump the shares on the listing day to book profits.

This category of non-serious bidders end up skewing the picture as they put in disproportionately high bids to maximise their speculative gains. They have to make enough profit when they dump their shares to cover the interest charge they pay the financier.

The vested interest that they, therefore, have in the stock listing at a price substantially higher than the allotment price, has led to allegations of rigging of the listing price.

While nothing has been proved yet on this, the fact is that easy bank finance is also a cause for a large number of speculative bids in the IPO process.

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