Indian IPO Market - Prospects & Challenges
(by R.Kannan)
(This article of mine was originally published in "ICFAI READER" issue of October 2004
published by The ICFAI University Press)

Primary Market & its Place as the Driver of Economic Growth in the Country

It is primary market that is in the center-stage of the capital market bringing together the investors and the seekers of capital in the country. Regular growth in the economy of the country presupposes a robust and vibrant primary market. The secondary market no doubt affords liquidity to the investment in securities. But it provides inter-se dealings between investors among themselves and others who trade/speculate in stock investments. The secondary market does not result in percolation of funds to the capital seekers. Operations in the secondary market, however, indirectly promote savings and investment, by providing the unique quality of liquidity to investment in securities.

Similarly the Primary market infuses new listed securities in the market generated through new public issues floated regularly and thus widen the security base to be traded in the secondary market. There is thus inter-dependency between the two markets.

Mobilisation of savings by commercial banks promotes the source for working capital needs of the business and industry and a portion of medium term loans. It is capital issues floated through stock exchanges that provided long term equity/ capital. Economic growth can be indicated when there is capital accretion in the system and further channeled to productive enterprises.

The investor faces limited risk in the secondary market. He is adequately protected from counterparty risks by he stock exchange. But he needs much more protection and safeguards in the primary market. This is because in an initial public issue, except for the offer documents/prospectus he has no source of information about the bonafides of the issue-raisers. Instances of vanishing companies and fly-by-night promoters act as a deterrent to investor confidence. Further secondary market deals are isolated transactions involving sale/purchase of individual lots of shares/bonds, while in the primary market news issues are for very large amounts sometimes even hundreds of crores of rupees. Fraudulent promoters may try to dupe the entire community of investors, who are covertly persuaded to invest in a particular issue through subtle pretensions.

The regulation of primary issues poses an acid test for SEBI. On the one hand in view of the leading role of these issues in the development and economic growth of the country through much needed capital mobilisation and infusion, SEBI on account of its responsibility for development of the market has to do every thing to promote new issues and make it easier for bonafide promoters to raise funds for productive ventures, and on the other hand SEBI has to ensure that the interests of the easily vulnerable investors are protected to the best possible extent and for this purpose put each promoter for public issue under and disclosure obligations to ensure bonafides and performance capacity. SEBI has to draw a filter that allows easy entry to genuine and solvent issue-raisers at the same time clearly blocking entry or exposing unscrupulous promoters seeking funds for speculative or unlivable projects.

The responsibilities to promote and to protect are counterbalanced by SEBI through process of equitable regulation on the one hand of the attendant process relating to public Issues and on the other regulating those who carry out these processes to strict disciplined and code of conduct. SEBI in the year 1992 issued exhaustive guidelines to standardise disclosure obligations and make it incumbent for corporates floating public issues to publish all relevant information affecting investors' interest. Based on experience gained these regulations were reviewed and revised in the year 2000 And fresh guidelines were issued. The guidelines of the year 2000 were amended on 14th Aug. 2003 and further on 9th April 2004 Presently The Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 as subsequently amended as above is operative and in force.

With the onset of the liberalised economy of the Nineties, a robust IPO market depicting a boom was growing in volumes. This growth was steeply affected in the subsequent years(1994-95) by the stock market Scam (popularly identified as the Harshad Mehta Scam). It became the Era of Fly-by-night operators. A number of promoters queued up to raise funds through IPOs after controls on pricing of issues were lifted in 1992. Encouraged by the buoyant stock market, a slew of finance companies flocked to the market with issues priced at substantial premiums. Most of the issues were of poor quality and the funds raised were routed into treasury operations. Investing in the shares of a finance company was taken as lucrative. Little did people realise the risk involved in it. Most companies vanished later. And the returns from the few that survived did not justify the premium. The quality on offer was poor, and the size of most of the offers small - far below Rs 2 crore. Stringent disclosure requirements were not in place to check fly-by-night operators. The offer document of those days gave the investing public little information of relevance.

The bad experience in the mid-1990s put off investors from the primary market for several years to come. 1998 was the worst year as public issues practically dried up. Only 150 companies tapped the market in 1997-98, against 1,500 companies in 1995. The amount mobilised through public and rights offers too shrunk to about Rs 15,000 crore against Rs 25,000 crore in 1997-98. This period saw a shift towards the debt market and the preferential issue route to make up for the in the IPO segment. Corporates could switch to easier available options for raising capital requirements.

The IT boom of the late 1990s and the introduction of the book-building system for pricing of public issues came to revive investor interest in the primary market to an extent. The primary market was laden with issues from the media and technology segment as against earlier years, when the primary issue market was dominated by the finance sector or core industries such as cement, steel and petroleum. There was an awakening of sorts in the public issue market in 2003 after it had hibernated for nearly six years.

Year 2004 appears to be a big year for IPOs. Big-ticket issues, including those of PSUs such as ONGC and GAIL, the long-awaited TCS and those in the power and oil and gas sectors such as Power Trading Corporation, NTPC and Petronet LNG, are in line to raise funds. The total funds to be mobilised are estimated at a whopping Rs 50,000 crore - higher than the amount raised in any of the previous years. Most of these are quality offers - a departure from the past. These issues can have a significant impact on the secondary market too as current holdings could be liquidated to mop up new issues.

However the recent fiasco (during earlier months of 2004) in issuing allotment letters to ONGC mega issue has come as a rude hock to the resurrecting IPO market. The better part of the first week of April 2004 "has been dominated by utter chaos following the over-allotment goof-up in the Oil and Natural Gas Corporation's (ONGC) mega Rs 10,000 crore public offer which concluded recently. Fortunately, the damage which had been done on account of the over-allotment in certain categories of investors has been minimised after the Securities and Exchange Board of India (SEBI) and stock exchanges stepped in with a clear-cut damage control plan. For some days, the markets were in a tizzy because some investors had already sold the shares in the market on the basis of the incorrect allotments. But after the auction on Monday, much of the problem has now been addressed." [Sourav Majumdar in Financial Express Online issue dated 07.04.2004].

Mr.Majumdar further states " At a time when the Indian stockmarkets are looking up and the primary market is witnessing healthy investor interest for big-sized public offers, is the supporting infrastructure in the Indian markets adequate? Don't forget, even the Power Trading Corporation listing has been delayed because of "technical problems" after the issue. Obviously, these two fiascos - in particular the ONGC one - have come as a major wake-up call for the primary market as a whole, at a time when the entire market and investment banking community was basking in the glory of the six successful public offers from the government stable. But suddenly, even as disinvestment minister Arun Shourie talks of raising Rs 1 lakh crore every year from the markets, a section of the primary market looks ill equipped to handle the load. It is alleged that the registrar in question, while finalising the allotment of the ONGC's mega issue of Rs 10,500 crore, did not follow the allotment formula and credited more shares to high net worth individuals than was warranted. There was excess allotment of 4 lakh shares to 52 high net-worth individuals due to operational snags at the office of the registrar. While some shareholders have been erroneously allotted shares more than what they were entitled to while others have neither received shares nor their refund orders till date. The result was that the entire process of allotment was delayed and investors who had borrowed funds to invest in the shares could not immediately sell them. The result was high interest burden and losses. Many such allottees, in turn, sold the shares, some of which at least they were not entitled to. The resultant post-issue mess, involving the issuer, the stock exchanges, the investors and the Securities and Exchange Board of India, besides the registrar, has taken off the erstwhile credit and good performance exerted by number of contributors thus far including the Disinvestment Minister in what has been a highly successful season for the government-issue.

It is in this background that the issue of opportunities & challenges of IPO market is analyzed. It is obvious the infrastructure deficiency in back office processing of a mega assignment had led to the fiasco. It is deskwork or handling clerical routine at the office that has let us down. It is not a business problem or setting up of a roadblock, but merely avoidable human error that has come to jolt the entire market. A nail in a horseshoe was lost and it led eventually in the battle being lost. But will this an isolated event or a trend of things to come? Let us look to this issue at greater depth in the next article.