Holes in proposed IPO safety net

That the extant voluntary safety net has not been unfurled by a single company making an IPO in India reiterates the reality that no one takes any regulation seriously until and unless it is made mandatory.

The extant rule says, should the market price of a listed share register a fall below its offer price during the first six months of listing, the one standing guard, usually the promoter, will have to buy the share from the resident retail investors at the offer price up to a maximum of 1,000 shares per such investor.

The availability of this safety net needs to be mentioned in the offer documents. Predictably, nobody has stuck his neck out for fear of having to fork out huge sums to retail investors. The SEBI discussion paper on the case for making the safety-net regime mandatory concedes the futility of grandiose voluntary schemes.

Between 2008 and 2011, it points out that as many as 72 out of 117 issues fell below the offer price within six months, with 55 of them registering a precipitous fall in excess of 20 per cent vis-à-vis the issue price.

Mandatory but feeble

If the extant regime is looked askance by companies because of its voluntary nature, the proposed one cocoons a company promoter too much to be effective. For one, it deigns to offer the safety net only if the fall is in excess of 20 per cent vis-à-vis the offer price.

And secondly, the fall should be over and above the general market fall. The general market fall would be gauged with reference to either BSE 500 or S&P CNX 500, whichever is mentioned in the offer document.

The examples given in the discussion paper leave no one in doubt as to the efficacy of the proposed potion. Suppose the offer price was Rs 100 but the scrip, at the end of three months, drops to Rs 79 reckoned on the basis of volume-weighted average market price during this period, the mandatory mechanism would have to be unfurled assuming the chosen market index stood at 1,000 at both the points of time — at the beginning as well as at the end of three months — because the net fall is more than 20 per cent, 21 per cent, to be precise.

But this would rarely be the case in reality, with market index coming to the rescue of the safety net provider. To wit, should the fall be to Rs 79 all right, the safety net will not have to be unfurled if in the meanwhile the index has also fallen from 1,000 to 900 because the net fall would be only 11 per cent (21 minus 10).

In other words, for the investor to stake his claim before the safety net provider, the fall in the subject scrip should be so sharp and precipitous vis-à-vis the fall in the market that the net fall is more than 20 per cent. For example, if the scrip falls to Rs 69 from Rs 100 and the market index has fallen from 1,000 to 900, the fall in the individual scrip of 31 per cent is large enough to shake off the latitude made available by the market of 10 per cent with the net fall being 21 per cent.

What the discussion paper effectively says is the subject scrip must have registered a precipitous fall vis-à-vis the market fall so as to expose the safety net provider to any liability.

Forked tongue

The fourth example provided in the discussion paper is virtually heads-I-win-tails-you-lose. The scrip falls to Rs 89 (drop of 11 per cent) but the market has been upbeat, with the index registering an increase of 10 per cent, from 1,000 to 1,100 at the end of the three-month period. The safety net would not have to be unfurled even though the net fall has been more than 20 per cent, 21 per cent to be precise --11 minus (minus) 10 -- because the absolute fall is less than 20 per cent. This is clearly speaking with a forked tongue. Having premised the entire scheme on the fall in the scrip vis-à-vis the market index, one cannot frustrate the retail investors by bringing the concept of absolute fall selectively.

In fact, this is a clear case where the company’s poor performance in the market comes into prominent relief — the general performance of the companies has been good but the individual company has been a laggard — and yet there is no salvation for the retail investor. Isn’t the company guiltier when its shares plummet even as the market has risen?

The safety net provider, the discussion paper says, will not have to shell out more than 5 per cent of the issue size. Thus, if the issue size was Rs 1,000 crore, then he will face a maximum exposure of Rs 50 crore.

The mechanism, however, is open only to those who invest not more than Rs 50,000, even though a retail investor is one who invests not more than Rs 2 lakh in the particular IPO.

This could have the effect of investors holding themselves back and restricting themselves to just Rs 50,000 so that they make the grade for the mirage of safety net. If there is a flood of safety net applications resulting in the liability of the provider going up beyond the 5 per cent exposure limit, the buyout at the offer price would be done on a proportionate basis.

Curiously, the buyout will have to be at the offer price and not at the offer price less 20 per cent, the trigger for the safety net mechanism. There would be very few instances, if at all, of the net being unfurled, given the tall order — a net fall in excess of more than 20 per cent when both the given scrip and the market are moving in tandem and when they are not moving in tandem but in opposite directions, the fall in the scrip absolutely must be more than 20 per cent.

The ephemeral nature of the protection should also be noted — just for three months, which can be further reduced effectively to two months, given the Greenshoe option that can be exercised for a period of 30 days by a company making an IPO.

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

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