Primary issue

Institutional and private equity investors should be made to act as filters before IPOs are offloaded to retail investors

By Mohan Sule

Though the market has recovered after dipping below 16,000, the need to revive investors’ confidence in equities has never been more urgent than now. After Lehman Brothers was allowed to collapse, there was unanimity among central banks and governments around the world about the dangers of letting the markets drift to the bottom and then wait till they bounce back on their own. There was no appetite for a repeat of the decade-long Great Depression of the 1930s, or Japan’s lost decade of the 1990s. The composition of the current crisis differs from that in 2008, when a credit-crunch threatened to stall the economy. Central banks had to pump in cash to keep the wheels of industry moving. Second, inflation was low, which allowed leeway for printing more money. This time, emerging economies are concerned about too much of liquidity stoking inflation and are prepared to sacrifice growth to tame price indices. In the US, the Federal Reserve is swapping short-term government bonds with longer dated ones to replace short-term pessimism with optimism about future. The increase in bad assets of banks in China and India, as the downgrading of SBI implies, also discounts loose-money policy. The bottom line is risk aversion rather than access to loans is the issue now.  Fiscal stimulus, initiated soon after the global meltdown three years ago, may compound inflation. Governments, therefore, are looking at other means. For instance, the Indian government has indicated reduction in stock-market transaction levies. The market has welcomed the move.

The finance ministry needs to go one step further and bring down the short-term capital gain (STCG) tax to 10% in the limited window of opportunity available in the run-up to the Direct Taxes Code, with peak STCG tax at 30%, to be implemented from the next fiscal. Besides short-term measures, it should also overhaul the capital-raising framework. Sebi initiated many reforms during the dull phase a decade ago, while preparing the market for better days that followed from 2003. In 1999-2000, procedures for the participation of foreign institutional investors (FIIs) in the primary and secondary markets were eased. By 2003, the number of FIIs exceeded 500, with over 1,500 sub-accounts. Due to FII interest, the Rs 100-billion ONGC IPO in March 2004 was oversubscribed in 10 minutes. T+5 rolling settlement was introduced in 2000 for dematerialised scrips and was expanded to cover more stocks with the facility of automated lending and borrowing mechanism or modified carry-forward system in any stock exchange. Trading in futures contracts based on the BSE’s Sensex and S&PCNX’s Nifty index began in June 2000. Norms for private placement were tightened in 2003 to provide for more disclosures. At the same time, there were missteps. At the height of the dot-com boom in 1999-2000, Sebi allowed tech companies  to offload only 10% post-IPO share capital instead of 25% mandatory for issuers in other sectors in an attempt to revive the primary market. This blatant pandering to the fancy for tech stocks eventually boomeranged with investors getting stuck in illiquid counters as software companies are not capital guzzlers.

Similarly, the response to offer individual investors, who have 5o% quota, shares at a price determined through book building has ranged from lukewarm to overwhelming. The procedure allows issuers and FIIs to create appetite for high-priced offerings. The spinoff is post-listing stampede for exit. At the same time, there is no interest in issues without substantial institutional participation. With the deepening of the investor pool, issuers prefer private placement with institutional investors rather than go through book building to mop up the mandatory retail subscription. The result is the entry of small-sized issues shunned by big investors. The present volatile times, therefore, are appropriate to review the primary market. The initial focus of reforms should be on small and mid caps, which have the maximum scope for appreciation and mischief. These issuers should be made to place their IPO/FPO with domestic and foreign funds, who should offload the capital to retail investors after three years. Only venture capitalists should be allowed to offer for sale shares of startups. By inserting the filter of institutional investors, Sebi would ensure that only equity checked for quality would be available in the market. After obtaining a stock at reasonable pricing, institutional investors would be compelled to monitor the company to create long-term value instead of thinking of making short-term gains. Issuers would be spared of catering to retail investors out of compulsion rather than choice. Thus, issuers as well as institutional and retail investors stand to benefit.

Mohan Sule