In May the Securities and Exchange Board of India (Sebi) introduced what it dubbed a safety net mechanism for retail investors looking to invest into IPOs. The regulation allows retail investors to get a refund on shares from any IPO after 180 days if the average share price in the last 60 days of the six month period falls below the issue price. Pulling the plug on this idea was a step in the right direction.
Introducing the mechanism sparked an industry-wide backlash in which bankers slammed the regulators’ decision for tilting the balance unfairly in favour of retail investors and scaring issuers away.
Sebi has finally come to its senses. It may have taken them four months, but the regulator now realises that insulating retail investors from any exposure to market risk brings little or no benefit to its equity market and it is now hoping to lure issuers back.
It needs to. There has only been $271m of IPO volume in India so far this year — a far cry from the $1.3bn seen in the same period during the heydays of 2011.
Unfortunately, the Indian market is still highly skewed — damagingly so — in favour of retail investors meaning that issuers may not be back any time soon.
Sebi’s meddling is a large part of the problem. Recently it asked bankers to deliberately price IPOs at anything between 10%-30% lower than their actual value. Its rationale was that it would help reduce volatility when the stock starts trading in the secondary market given it estimates more than two thirds of Indian companies are trading at least 25% below their listing price.
As retail investors are already given an extra 5%-10% discount on any IPO price anyway, this could mean they could pay up to 40% less for a company’s shares — hardly an incentive for issuers to rush to the equity market.
The over-protection just increases the likelihood of investors buying into companies whose risks they don’t understand.
While Sebi isn’t necessarily wrong in wanting to protect retail investors from wild swings in equity markets, it needs to understand that the price volatility India is experiencing is mainly due to the lack of a proper price discovery process. And that is where it should focus its efforts.
In mature equity markets such as Hong Kong and Singapore, allocations are usually split in a 9:1 ratio, with the smaller portion allocated to retail.
Books for the institutional tranche open first and bankers usually rely on this demand to fix the final price. And if demand from retail investors is good, a percentage of shares are transferred to the retail tranche from the institutional portion so as to ensure that the general public gets a more substantial piece of the pie.
By contrast, Indian regulations mean the retail tranche is much bigger, at 35%. Institutional investors get 50% and there is typically another 15% set aside for other non-institutional investors.
This is hurting the price discovery process because bids from institutional investors usually come in late. There is no advantage to being an early mover — institutional investors are unlikely to get a bigger allocation because the institutional tranche is so small to begin with.
As a result, bankers have difficulty accurately pricing their deals, which contributes to the price volatility which has seen the India Volatility Index almost double to 27.02 since the start of the year.
By removing the safety net mechanism, Sebi has taken one positive step. However it’s time for Sebi to wean retail investors off the idea of risk-free investments and allow market forces to determine pricing. Perhaps then it can get India’s equity market moving again.