Sebi moots safety net for small investors in IPOs

The Securities and Exchange Board of India (Sebi) has proposed that investors in initial public offers (IPOs) be provided a safety net, allowing them to sell shares back to the issuers should the share price fall below a certain level.

The safety net would be triggered if the stocks fall more than 20% below the issue price within three months of listing, the regulator said in a discussion paper inviting comments from the public, put up on its website on Friday.

The fall would be considered relative to a benchmark index such as the BSE 500 or the S&P CNX 500. The market index to be used would be disclosed in the offer document.

If the stock and the index are both down, say 25% and 10% respectively, then the fall in the stock is considered relative to the index. In the above case, the relative drop is 15% (25%-10%) and the safety net would not be triggered.

If the index is up while the stock is down, then only would the drop in the stock be considered. If the stock is down 15% but the index is up 10%, then only the 15% fall in the stock is considered, though the relative underperformance is 25%.

This will be applicable to retail investors who invest up to Rs50,000.

Prithvi Haldea, CMD of Prime Database said the move will help bring some sanity to the pricing of issues. “Though, theoretically, a safety net should not form a part of equity offering, in the Indian context, it is necessary to have some sort of a safety net in order to bring back faith among small retail investors. In recent times, right pricing of the issue has become a contentious issue with promoters and merchant bankers trying to extract the maximum.

The safety net will end the debate on mispricing of IPOs, bring in sanity in pricing and would provide comfort level to investors. At the same time, the recommendations are fair to promoters as their performance is being benchmarked to some index and not in isolation,” he said.

Jagannadham Thunuguntla, strategist and head of research at SMC Global Securities, said it would still expose retail investors to some risk. “The basic idea seems to encourage equity investing among small investors who till now were scared of investing in IPOs becasue of the poor performance record of the IPOs listed over the last few years. However, the equity risk would still be there as, if the markets themselves go down, the investor would not be entitled to the safety net,” he said.

The regulator observed in its discussion paper that 72 out of 117 scrips that hit the markets in the 2008-2011 period were trading below the issue price after six months of listing.

“In this scenario, if the trend continues, the sentiments of the investors would get affected and they may lose confidence in the capital market. Thus, there is a need to provide a safety net arrangement for RIIs (retail individual investors) to build their confidence in capital market,” said the circular.  Turn to Page 18

In addition to saving retail investors from a fall in share price, the move is also expected to help ‘discipline’ issuers and market intermediaries.

“The Primary Market Advisory Committee (PMAC) was of the view that considering the recent post-listing price performance of IPOs, it is necessary to make the safety net mechanism mandatory for IPOs so as to reinforce investor confidence in capital markets and discipline issuers and market intermediaries,” said the circular.
The price for this provision shall be calculated as the volume-weighted average market price of such shares for a period of three months from the date of listing.

The safety net would be restricted to 5% of the issue size.
The issuer will have to buy back at the issue price. If more than 5% tender their shares, then they will be accepted on a proportionate basis.

The current regulations allow for an issuer to provide for a safety-net arrangement to provide an offer to purchase up to 1,000 shares per retail investor at the issue price within six months of the investor getting his shares.

Under the suggested revision, the issuer or merchant banker will have to announce, within three working days from the date of completion of three months from the listing date, triggering of the safety net provision and invite eligible shareholders to tender their shares.

Safety net arrangement shall be open for 10 working days from the date of announcement.

Eligible investors may tender their shares through a separate exchange window (similar to buyback of shares).

The primary safety net obligation would rest with the promoters of the issuer. However, they may choose to fulfill the same, directly or through merchant bankers or through a ‘safety net provider’.

Sebi has invited comments on the discussion paper  by October 31.