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Analysis of Sansad TV Discussion : New Rules for IPOs

Context

  • Recently, Capital and commodities market regulator SEBI amended the rules for initial public offerings(IPOs), both for investors as well as the issuing companies.
  • The regulator also made changes to the rules relating to preferential allotment of shares.

Background

  • Stock markets across the world have witnessed a boom in IPO offerings with a record amount of capital being raised by companies in 2021.
  • The Indian securities market also witnessed robust growth during this period, both in terms of a number of issues and the amount raised from the equity market.
  • Investment by retail individual investors in IPOs has also grown from about 5,000 crore rupees during 2019-20 to 8,300 crore during 2020-21 and to about 15,100 crore rupees till November 2021.
  • There are multiple IPOs lined up for 2022 as well with a strong pipeline of companies, including both new-age technology companies as well as big names.

What is Initial Public Offering(IPO)?

  • An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.
  • An IPO allows a company to raise capital from public investors.
  • Companies must meet requirements by exchanges and SEBI to hold an IPO.
  • IPOs provide companies with an opportunity to obtain capital by offering shares through the primary market.
  • Companies hire investment banks to market, gauge demand, set the IPO price and date, and more.
  • An IPO can be seen as an exit strategy for the company’s founders and early investors, realizing the full profit from their private investment.

What are the New Rules?

  • These new rules deal with various aspects such as funds raised through IPOs and their utilisation, preferential allotment pricing formula, offer for sale by existing shareholders, the lock-in period for Anchor investors, creation of subcategory for individual investors and price band for a book built IPOs.
  • According to the new SEBI rules, the price band of an IPO should be set in such a way that the ceiling price is at least 105% of the floor price.
  • Secondly, companies will not be allowed to use more than 35% of the money that they collect through IPOs to fund the purchase of other businesses unless they offer sufficient details.
  • Thirdly, promoters with a stake of over 20% in a company cannot sell more than half of their stake in an IPO.
  • And lastly, anchor investors will not be able to sell more than half their shares before 90 days from the date of the IPO, against the current time stipulation of 30 days.

How has the regulatory environment encouraged startups to go for IPOs?

  • The Securities and Exchange Board of India (SEBI) has relaxed a number of norms to make it easier for startups to get listed on Indian exchanges.
  • Earlier this year, SEBI reduced the time that early-stage investors need to hold 25 per cent of the pre-issue capital to one year from two years earlier.
  • SEBI also amended regulations that previously barred startups that are going public from making discretionary allotments to allow startups to allocate up to 60% of the issue size of the IPO to an eligible investor subject to a lock-in period of 30 days on such shares.
  • The new rules will oversee how companies price their shares, how they use the money that they receive from investors, how much of their stake promoters of a company can sell during an IPO, and how soon anchor investors can sell the stakes they picked up before the IPO.

Why has SEBI come up with these new regulations?

  • Stock markets across the world have witnessed a boom in IPO offerings with a record amount of capital being raised by companies.
  • In India alone, capital worth over ₹1 trillion has been mopped up through IPOs this year.
  • It is natural for both the number and the size of IPOs to rise during a bull market. Companies see bull markets, in which usually a lot of investor money is chasing stocks and causing them to be overvalued, as an opportunity to collect the necessary funds for their growth.
  • The owners of many companies may also see the IPO boom as an opportunity to sell their stake in the business at an attractive price.
  • Notably, a lot of companies that raised funds through IPOs this year, such as Zomato, Paytm etc., are loss-making. This puts investors who have invested in these IPOs at the risk of huge losses if the prices of these shares witness a sharp correction. Paytm, for instance, has lost more than one-third of its value since it was listed for trading.
  • SEBI believes that the new regulations will ensure that promoters of companies will have more skin in the game. Its price band rule, on the other hand, seems to be aimed to tackle the trend among companies of setting a narrow price band for their issues. SEBI believes that a narrow price band impedes the price discovery process.

What Critics Say?

  • SEBI’s new rules are an attempt to protect retail investors from risks in the booming IPO market. However, some fear that the new rules may hinder the raising of fresh capital by companies to fuel growth.
  • For instance, mandating companies to be specific about how they will use the money that they collect through IPOs can affect flexibility as business conditions can change fast in the real world.
  • Further, the restriction on anchor investors can affect liquidity in the market as many large investors may not be willing to hold their investments over 90 days and thus decide to completely abstain from participating in IPOs.
  • Some critics also raise the question of whether SEBI should be trying to handhold investors at all when it comes to making investment decisions.
  • The same goes for how companies decide to price their IPOs. Companies would generally avoid under-pricing or over-pricing their issues since it would affect how much capital they can raise. In fact, setting narrow price bands could be a way to avoid valuation uncertainties that can affect fundraising.

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