Dear Debasish,
Great article on investor behaviour and the IPO market in Business Standard today! https://www.business-standard.com/article/opinion/rational-man-regulation-a-farce-122071700944_1.html
It is time to reform the IPO market in India which is clearly not working efficiently and has large distortions in pricing. I am also writing this in the hope that the current SEBI Chairperson has hands on experience of Capital Markets in India and will therefore better appreciate my suggestions! #SEBICHAIRPERSON.
As you have rightly pointed out, increasing risk factors will not do the job. The practical issue is that a long list of risk factors, written in legalese is only CYA for the issuer! The investor, especially the retail investor does not have the ability to understand the complicated legalese of 500+ pages of today’s red herring prospectus, even if he or she is diligent enough to download it from SEBI’s site! The only people who salivate at the sight of Red Herrings are the lawyers, who make fat fees out of it!
The first question, to therefore ask, is on what basis or information do investors invest in IPOs? This is all the more relevant as no futuristic projections or estimates are allowed in the Prospectus or allowed to be disseminated otherwise. Do institutional investors invest in these IPOs without seeing any financial models or future projections?
Retail investors are to some extent investing based on the reputation of these institutional investors but largely on the basis of prevailing grey market premiums! Again, this information is very tenuous as most retail investors do not have a direct access to this informal market but rely on the information provided by 2-3 websites on the same. I do not have to spell out the manipulations and distortions that can result from these!
My first contention is that Research Reports by Lead Managers should be made compulsory in IPOs. Investors rely on research reports for investing in listed equities, for which a large body of data is even otherwise available – so why not for IPOs? To protect against gold plated projections by Lead Managers, two risk mitigations can be employed. One, their track record of projections on the lines of their track record on IPO pricings may be included in the Prospectus. Second, and in my view a more effective mitigation will be to open the data room on which such Research Reports are written to other brokers, distributors, investment advisors and investment magazines, who may want to write their own research reports on the IPO. In addition, organize a management access where all brokers writing research can ask questions from the management and make the recordings of these interactions public! A similar recording of Q&A sessions with institutional investors should also be made public.
This will ensure that very relevant, focused information in easy to understand language will reach prospective investors. There will be a plethora of viewpoints, both positive and negative which will make price discovery more efficient! This will also democratize availability of information between institutional and retail investors!
The second need is to take the IPO access back from institutional investors and give it back to retail investors! Lopsided allotment of 50% to 70% to institutional investors only inhibits widespread distribution and allows institutional investors to scalp IPOs at the expense of retail investors! Institutional investors also tend to dump stocks which underperform or outperform in the aftermarket, again increasing volatility!
Priority allotment and majority allotment to smaller retail investors will have the following benefits:
· Result in widespread distribution and better aftermarket stability.
· Force institutional investors to accumulate in the aftermarket, again leading to better, longer term price stability and rational price discovery.
· Greater participation in wealth generation from IPOs by domestic retail, who have proved themselves to be the backbone of India’s stock market even in the face of large and continuous selling by FIIs in recent times.
· Last, but not the least, compulsory majority allotment to retail will nudge issuers to get their issues underwritten prior to approaching the market, which in turn will make Lead Managers propose much more rational prices because of this underwriting risk! Today, Lead Managers tend to propose outlandish prices to get mandates, as they have no financial risk if the IPO book doesn’t build!
18th July 2022