The Hindu Business Line : New SME guidelines: Compromising on liquidity

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New SME guidelines: Compromising on liquidity

Stipulating a market lot of Rs 1 lakh for trading in SMEs can pose a serious threat to liquidity that can, in turn, throttle the trading platform’s growth prospects.

SEBI’s move is an effort to make finance easily available to small and medium enterprises.

Lokeshwarri S.K.

The Securities and Exchanges Board of India (SEBI) recently laid down guidelines for the listing and trading of small and medium enterprises (SMEs). These guidelines have made it easier and less expensive for such companies to raise equity. But in its zeal to keep smaller investors away from these riskier investments, the regulator may have compromised on liquidity; this could threaten the future of this endeavour.

Small and medium enterprises (SME), which contribute over 17 per cent to GDP and provide employment to about four crore people, have an important role to play in the country’s growth.

Unfortunately, this sector has borne the brunt of the credit crunch in 2008, with most of its credit requirement met by non-banking financial companies and through other informal channels where the cost of borrowing is very high. SEBI’s move is an effort to make finance easily available to these enterprises.

Easier guidelines

The guidelines released by SEBI this month do relax the listing and disclosure requirements for SMEs significantly by doing away with the need to comply with the eligibility norms for initial public offerings and follow-on public offerings as prescribed by SEBI’s (Issue of Capital and Disclosure Requirements) Regulations, 2009.

The need to have a track record has also been done away, with making it possible for start-ups to also approach the equity market. The offer documents prepared by merchant bankers need not be ratified by SEBI and the submission of financial results is to be on a half-yearly instead of quarterly basis.

These measures would considerably reduce the expenses associated with public issues and the subsequent listing on exchanges. But fewer disclosures make these investments riskier as they limit informed decision-making.

One way to circumvent this difficulty would be to run though the list of institutional investors who hold a stake in these SMEs. Large and credible institutions as shareholders will ensure that the companies adopt proper corporate governance practices and make adequate disclosures to shareholders even if they are not legally bound to do so. Moreover, SEBI has laid down that all the provisions of Clause 49 (corporate governance) have to be complied with.

Solace can be derived from the Alternative Investment Market (AIM) platform of the London Stock Exchange that has been a runaway success in attracting smaller companies, both domestic and foreign, due to the flexibility it provides by less regulation.

Though some view the AIM as a ‘casino’ where companies disappear within a year, the London Stock Exchange has pointed out that the closures on AIM in a year are less that 2 per cent.

Liquidity

SEBI has acknowledged the risk associated with investing in these less regulated smaller companies by setting a minimum subscription of Rs 1 lakh for investing in their IPOs. This is a step to keep away less-informed investors. The minimum number of shareholders may be as few as 50.

While these measures can be justified in view of the need for investor protection, maintaining a market lot of Rs 1 lakh for trading in these companies can pose a serious threat to liquidity that can, in turn, throttle the trading platform’s growth prospects.

Retail investors and day traders, who are essential for providing liquidity to any counter, would be deterred by this measure and it would be up to the merchant banker to play market-maker for three years from inception to provide an exit route to investors. It is not clear how liquidity can be maintained three years after the listing of the issue.

Role of merchant bankers

Merchant bankers have an onerous role to play in the development of the SME platform or exchange. To begin with, they have to ensure that initial offerings are 100 per cent underwritten. Then they have to play the market-maker for at least three years.

SEBI has allowed merchant bankers to get into a contractual agreement with private equity or venture capital funds, high net worth individuals or qualified institutional buyers to act as a market maker. It is to be seen how this experiment turns out.

Since companies with paid-up capital of up to Rs 25 crore can list on the SME platform, companies listed on regular exchanges with paid-up capital of less than Rs 25 crore can shift to the SME platform to take advantage of the easier listing and disclosure requirement.

However the lower liquidity and visibility on this exchange could be a deterrent.

OTCEI experiment

The previous attempt to set up a market for start-up ventures was the Over The Counter Exchange of India (OTCEI) that began operations in September 1992. An online trading platform on the lines of the Nasdaq when Indian market participants were still trading with badla system in the ring proved to be an idea that was way ahead of its time.

The lack of an established infrastructure for dematerialising stocks was another lacunae. The final straw was the market crash that immediately followed the launch of this exchange that resulted in OTCEI stocks losing ground faster than those listed on other exchanges due to low liquidity.

Many are of the opinion that lack of liquidity was the main reason why this exchange failed to take off and has only 100 companies listed on it currently. Clearly the provision of two market makers for every counter has not proved too useful.

Another issue with the OTCEI is the strict guidelines these companies need to follow. Though the paid-up capital of companies listed on OTCEI could be from Rs 30 lakh to Rs 25 crore, companies with capital exceeding Rs 3 crore had to meet the listing requirements and guidelines as currently applicable on other exchanges.

The IndoNext saga

The IndoNext trading platform of the Bombay Stock Exchange was yet another SME financing experiment that failed to take off.

The stocks listed primarily on the regional stock exchanges (RSEs) suffered from lack of liquidity and it was envisaged that providing a national platform for these securities could generate more investor and trading interest.

But lack of sufficient information and insufficient marketing of companies listed on this exchange proved to be the drawback.

Tough guidelines regarding track-record, net worth and number of shareholders for companies seeking listing on these exchanges also proved to be a difficulty.

The new guidelines for SME listing have addressed some of the issues that led to the derailment of the OTCEI and IndoNext but replicating the OTCEI model to ensure liquidity is a move that can back-fire