Sebi bells the primary cat

If you say the secondary segment of the domestic equity markets is booming, what term would you use to describe the surge in the primary market? Initial public offerings (IPOs) have been flowing in thick and fast and oversubscription by over 50 times followed by 100 per cent gains on listing no longer surprises anyone. However, all sections of investors don't seem happy.

A typical book-built public issue is earmarked thus: 50 per cent for qualified institutional buyers (QIB), including mutual funds, domestic and foreign institutions; 15 per cent for high net-worth individuals (HNIs) and the balance 35 per cent for retail investors. Mutual funds have been miffed at the step-motherly treatment they have received in the primary market.

Their annoyance stems from the right granted to merchant bankers to exclude them from the allotment process by using their own discretion in the QIB category.  They conveyed their resentment to Sebi (Securities and Exchange Board of India).

In one of its most significant announcements in recent times, Sebi cracked the whip on the practice of discretionary allotments given to QIBs during IPOs. In contrast to internationally followed practices, the market regulator asked companies making IPOs to allot shares to QIBs in proportion to the bids made by them.

Investment bankers - who were allegedly throwing caution to the wind while allotting shares to QIBs using their 'discretion' - are the ones complaining the loudest. Hitherto, shares were ostensibly being allotted - or not allotted - using a variety of parameters including timeliness, quality and aggressive price of the QIB bids.

All along, there were not so subtle whispers of rampant favouritism, formation of cartels and malpractices galore.  Sebi's bold move should set to rest such speculation henceforth.

In an equally significant move, the market regulator has also asked QIBs to cough up 10 per cent margin money while bidding for shares in an IPO.

Hitherto, QIBs were not needed to pay any margin money, whereas retail investors had  to (and still have to) cough up the entire amount on application. There were complaints from many quarters that some QIBs were using this loophole to boost certain IPOs to lure small investors.

To illustrate the point, many issues were oversubscribed several times over within minutes, if not seconds, of the issue opening for subscription. The speed with which issues were oversubscribed would make even the winners of  the 'fastest finger first' contest segment of the popular 'KBC' show hosted by film star Amitabh Bachhan, go green with envy!

It is believed that this was the handiwork of certain 'favoured' QIBs who could, of course, bail out by revising their bids downward at a later date. The 'massive response' when flashed in the electronic media which is 'live' and inter-personal, often induced a sense of demand in the minds of retail investors, who were undecided on whether to invest in the issue or not. Here too Sebi has got the equation right. It was time to stop this nonsense!

Like the BSE brokers who had lamented interminably when 'Badla trading' - their favourite albeit much abused toy - was taken away from them, the merchant banking community too has been reduced to doing the same at this moment.

Merchant bankers have been citing forex flow regulation problems for FIIs and the danger of hedge funds becoming beneficiaries, but none of that is cutting much ice.

The not-so-subtle threat in the argument that QIBs might not participate, resulting in poor price-discovery leads for the retail investor, borders on the hilarious.

Given that merchant bankers and most FIIs have been waxing eloquent about the 'India growth story', 10 per cent margining and mere procedural hassles cannot be a deterrent when it comes to the opportunity of participating in such a 'promising' market. 

Sebi has also carved out an exclusive 5 per cent share for mutual funds from the 50 per cent share reserved for QIBs in IPOs. Further, mutual funds are also free to compete for the balance 45 per cent available to QIBs. The compulsory allotment of 5 per cent to mutual funds could attract more retail investors thereto.

While this can benefit retail investors, albeit indirectly, they will have to take a call on whether to back mutual funds, and if so, which mutual fund to back. Mind you, making this choice might prove more difficult than choosing which IPO to back.

Simply put, while everyone is an outperformer in a bull market, the moot question is - how many have done so in adverse  conditions? A look at mutual fund performances against appropriate benchmarks between 2002 and 2003 might provide some clues.   

Sebi has also indicated the need to work towards a standard 25 per cent free float for listed companies in the stock market in a 'non-disruptive' manner. However, the rule will not be applicable to government firms, infrastructure companies and those referred to by the Board of Industrial and Financial Reconstruction.

Currently, there are two categories of listed companies. The first, which comprises the majority, includes a large number of companies which have a minimum public share holding requirement of 25 per cent.

The other is those with a lower public holding requirement of 10 per cent. Companies not meeting the proposed criteria of a minimum public share holding of 25 per cent have been given two years to comply with the new requirement. 

If one were to take a closer look at this announcement, it seems that the rule would apply only to companies under Rule 19 (2) (b) of the Securities Contract Rules & Regulations, wherein promoters have listed shares after diluting 25 per cent of the company's equity, and reduced their free float later.

This might provide leeway for companies like TCS and Jet Airways against the need to immediately hike their free float to 25 per cent from the current 10 per cent which they diluted during their public issue. Furthermore, the non-promoter holding could also include GDR, ADR, and stakes held by private equity investors which might open the floodgates for overseas issues.

Notwithstanding the sensibility of the proposal of a minimum 25 per cent  free float for all listed stocks, there is skepticism about the likely end-result, given the propensity of corporate India to lobby and drag its feet.

A review of the fate of proposals pertaining to independent directors and segmental revenue reporting strengthens that viewpoint. Yet, given that the earlier-mentioned announcements will be immediately implemented, there is bound to be a shake-out in the primary market segment.

That shake-out will be for the better in the long-run. The immediate fallout could be more sensible issue pricing, subscription and listing. If that were to happen, as I believe it will, Damodaran and his team at Sebi can take a bow as serious retail investors may well return to the primary market.