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Growth Hormone: Retail reservation in IPOs must stay
IN THE IPO arena, every time some new investigation is conducted by Sebi or a new development is reported, some set quarters start demanding scrapping of retail reservation. For example, this happened when the IPO demat scam, which involved fictitious applications, was uncovered by Sebi in 2005 or recently when a report came that some retail investors are renting their PAN cards to brokers for a fixed profit, by putting in applications on their behalf with all gains/losses to the account of the brokers.
The reasons forwarded for eliminating the retail are many. Some are as simplistic as all reservations lead to malpractices. Let me put this reservation issue in its proper perspective. Until the late 1990s, IPOs were available to all categories of investors, with no reservations. The big guys found this unacceptable because under the basis of allotment system, they would get only a handful of shares. The arguments used by them for demanding a reservation for themselves was that the retail lacked depth and with the IPO size becoming larger, issuers would have a comfort level of having 60% of their issues subscribed to by the big guys, who incidentally were willing to come in only with a high reservation and with allotments on a discretionary basis. This argument was buttressed by another — which though made sense—that compulsory institutional participation would validate the issues for the small investors though, in all fairness, this could have been achieved with, say, a25% reservation. So, in fact, there is no reservation for the small investors. What they are getting are the leftovers. Importantly, unlike in other reservations where there is an opportunity to favour specific groups/persons, the IPO retail quota is allotted only on an anonymous basis.
Some are against the reservation because of the huge gains that are made by the retail in what they call as the IPO lottery. This lobby argues that the retail obstruct the issuers from realising the right price. This is invalid as it is QIBs who dictate the issue prices, the retail only uses the cut-off option, agreeing to whatever price QIBs discover. The last year’s Economic Survey proposed doing away with reservation arguing that multiple applications stem from the incentives offered by under priced IPOs. This established at least one thing, that IPOs are under priced. Is it not a paradox that concerns about aggressive IPO pricing also exist simultaneously? What this argument overlooks is that QIBs and HNIs also get the benefits arising out of under pricing. For another, it is a myth that IPOs mean assured profits; IPOs can mean losses too as recent past has shown and so this reservation is not of a goodie. What was lost out is that the IPO demat scam actually happened because of the absence of a unique investor identification number. Significantly, the misuse has now been hugely curtailed because of the mandatory PAN requirement, as also the fear of an alert regulator.
The Economic Survey, like many others, recommended that we should shift IPOs to an auction system. Supporters argue that though QIBs, given their clout, will outbid retail investors in IPOs, if we do not object to QIBs outbidding retail investors in the secondary market, why should we object in the primary market. This is a faulty argument. The supply is infinite in the secondary market and so there is never an outbidding. In the primary market, the supply is limited, and at a low fixed price. Most importantly, would even QIBs want the auction system? Would they want to invest in an IPO that has only a handful of only QIB investors? What will then happen to the after-market and to liquidity? A public market will get converted into a private market.
What is the way forward? The auction system does have merit. Presently, book-built and fixed price issues are alike as the issue price in both cases is decided by the issuer (and not discovered by the market), the only difference is that instead of a single price, there is a price band. What I am not for is the entire IPO being sold through auction. Such a move would sound me death knell for the small investor.
Who is not equipped to work out issue pricing. Only 25% of the IPO should be reserved for auction to QIBs, the rest 7 5 % be reserved for the retail.
The allotments to QIBs should be done on a top-down bid price basis. This would help issuers get the best price for their shares from the institutional buyers, who too would be happy getting the desired quantity of shares at prices they are willing to buy at. After completing the QIB portion, the balance IPO should be sold at fixed price to the retail, for example, at the lowest of the QIB allotment price. An argument may be offered that a smaller reservation may push the QIBs away. Not true — if an issue is good, QIBs will subscribe. They have subscribed to 50% of a Rs 100 crore issue and to 50% of a Rs 5,000 crore issue.
If the big goal is to move more household savings into the capital market, it is imperative that the domestic investor base grows, IPOs have always expanded the investor base, as these are typically the best entry points. For the frauds of a handful millions of investors should not be denied the opportunity of participating in IPOs.
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