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Meaningful primary market reforms

Small investors should benefit with the change in rules

AT A time when the secondary market is hogging all attention _ with the Sensex crossing 8000 on Thursday _ it is worth looking at some of the regulatory moves to beef up the new issues market. Most of these new measures were recommended by one SEBI appointed committee or the other and, when implemented, are capable of transforming the primary market. Yet, as with many issues of the capital market, it is unwise to exaggerate the beneficial consequences of even well intentioned measures.

The primary market has received considerable attention from the Securities and Exchange Board of India recently. Major changes have been made in the regulatory rules governing issues that go through the "book-built" route. Till now, in a typical book-built public issue, 50 per cent was reserved for qualified institutional buyers (QIBs) including mutual funds and domestic and foreign institutions; 15 per cent for high net worth individuals (HNIs) and the balance 35 per cent for retail investors.

QIBs' privileged status

Even without the 50 per cent reservation (under the book-building route), QIBs have had a privileged position. The merchant bankers had the discretion to allot shares to these in any manner they liked. Obviously cordial business relations between the two have counted in such acts, which are prevalent in the developed markets too. Second, all QIBs could bid without having to deposit any money.

The changes now brought about are far reaching: (a) The merchant banks' discretionary quota to the QIBs is being done away with. (b) Within the overall 50 per cent reservation for QIBs, mutual funds have been given a share of 5 per cent. Significantly, mutual funds can apply for the remaining 45 per cent portion too. (c) QIBs will now have to bid with margin money of 10 per cent of the application value. In a separate but equally significant announcement, the SEBI has stipulated that a listed company should have a minimum public holding of 25 per cent of its shares on a continuous basis.

The implications of these moves are enormous. Even as the community of merchant banks is reportedly resentful of having some of its well-entrenched privileges taken away, many others feel that the SEBI has done the right thing. In fact, it is pointed out that the regulator might have been late in changing these rules, some of which at least were opaque and worked to the detriment of small investors.

Prop to liquidity

Small investors should benefit with the change in rules. By insisting on a minimum float of 25 per cent the SEBI is trying to improve liquidity in specific stocks. Illiquid stocks were hurting investors. Welcome as the proposal to increase the floating stock is, it does not go far enough in many specific cases.

In any case, capital market tradition in India had been to encourage a high level of public holdings in relation to that held by promoters. For a long time, in a new issue promoters could hold no more than 40 per cent of the capital on offer and often they held less.

If at all promoters wanted to invest more than 40 per cent, as in a joint sector project with a state-level investment /development institution, they had to seek relaxations from the Government. A similar course was adopted when a portion of the shares was earmarked for foreign collaborators.

From being confined to a minority role (by the existing rules), promoters could subsequently invest much more. Also to be remembered, there were no reservations for institutions, high net worth individuals and so on in those days.

Free float (of 25 per cent) simply refers to the non-promoter holdings. Given that retail investors have, by and large, kept away from new issues it is likely that the non -promoter holdings will comprise shares held by institutions including mutual funds.

Hence the stipulation of a 25 per cent minimum float may not immediately translate into a tangible benefit for retail investors. However, promoters of companies that fall short of this free float level will have to divest a portion of their holdings. Whether this will give an opportunity to retail investors remains to be seen. In any case, a reasonable compulsory free float is good for liquidity and one of the means to check price manipulation.

A similar roundabout benefit accrues to retail investors from the stipulation earmarking a larger share for mutual funds. Here again, the point has been made that mutual funds do not handle investors' money alone. There have been sizable institutional holdings in specific schemes.

Again, the provisions to check the nexus between merchant banks and large investors is a step forward even though the gain to retail investors is not clear or immediate.

The facility given to QIBs to tender for shares in specific issues without having to pay any margin, it was alleged, had led to several undesirable practices. They could form a cartel and submit massive applications within minutes of opening of the subscription list, only to withdraw later. The news of oversubscription within a short time then became a magnet for retail investors to put in their money. Manipulating oversubscription is however an age-old trick and there will always be gullible investors and unscrupulous investors participating in the game.

C. R. L. NARASIMHAN

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