Don’t take low for an answer
Several equity capital market transactions mooted by the Indian government have ruffled feathers recently, with the mandates for Cochin Shipyard and NMDC delayed due to disagreements on low fees. But the government isn’t the one to blame. If banks want an end to price undercutting, they need to take action.
In India, there is competition on price, and then there is the Rp1 ($0.15) fee. Also called the token fee, banks have often accepted Rp1 for running offer for sales (OFS) of the government’s shares in listed firms.
While the practice is no longer as rampant as it used to be, it rears its head now and again as the banks bidding for lead roles on the IPO of government owned Cochin Shipyard and the sell-down in iron ore miner NMDC found to their chagrin.
Cochin Shipyard was widely expected to pick banks for its Rp10bn listing in March. But the request for proposals had to be issued again after firms were said to have revolted when asked to match the fees of the lowest bidder. The mandate was finally handed out last week, half a year after the company received the government’s nod for its IPO.
The bidders for NMDC have also been caught in a similar predicament. When bidding closed last week Citi is understood to have proposed a Rp1 fee, prompting the government to ask the other bidders to match that or drop out of the race.
To the casual observer it might seem like the government is throwing its weight around and forcing banks to push down pricing. But as these cases show, banks must also take responsibility.
As one frustrated banker in India put it: “There is always someone desperate enough to do the trade at Rp1”. And that’s the unvarnished truth: banks only have themselves to blame for competing on price. Citi declined to comment on the transaction and the bidding process.
The government, to an extent, is simply being consistent with its policy of choosing the lowest bidder.
Although the exact fees that each bidder put in for NMDC are not known, some bankers say the gulf between Rp1 and the second lowest bid was wide enough for them to be able to match the latter. Not so the Rp1, which would be a loss leader despite the chunky Rp37bn in league table credit up for grabs and chance to generate a decent amount of trading commission.
The fallout could cause problems for future transactions. Take Housing and Urban Development Corp, in which India said it plans to hive off a 10% stake via an IPO. Already some foreign banks have indicated to GlobalCapital Asia that they will stay away from the bidding process, believing it would be “too painful” to participate in another low priced deal.
That banks resort to undercutting each other to win trades is nothing new, as large and liquid ECM transactions can be hard to come by in Asia. And in India, once firms pass the government’s technical qualification, everybody is considered to be on equal footing so the main differentiator banks can offer is price.
So banks are willing to stomach low or Rp1 fees for OFSs because these are undocumented trades, which unlike IPOs do not involve nearly as much due diligence and regulatory approval.
Needless to say, banks are well aware that this practice has negative consequences for the long term and is dragging down their ECM businesses. This is why recently there have been fewer offering just Rp1, as lossmaking deals become increasingly hard to justify.
But as long as there are banks willing to undercut on price, the practice will self-perpetuate, no matter how damaging.
Banks have long railed against the scant fee pool in India, but these have remained mere complaints. If there is to be genuine change, then they need to turn that talk into action.