Initial Public Offers (IPO), as public issues of shares/securities are commonly known, have been in the news for several reasons. One is the handsome profits made by allottees in many cases due to the shares listing at a price far higher than the issue price (though some showed losses too). Then expectedly linked to this is that many IPOs have been oversubscribed many times. The other factor is the rapid rise of IPO financing, which also incidentally came to attention recently due to an alleged abusive call made by a prospective borrower to a bank officer who allegedly failed to provide the promised IPO finance. What became widely known was the enormous leverage being available through IPO financing to subscribers. SEBI has also decided to amend some IPO related provisions in the SEBI ICDR Regulations. Finally, the Reserve Bank of India has recently decided to place some very stringent restrictions on IPO financing by NBFCs, so much so that it is very likely that IPO financing could drop down to a miniscule level of what exists today. Further, the question repeatedly raised is whether there is an IPO bubble, that IPOs are priced too high and that the market boom is being taken advantage of by making IPOs. This subject generally also has a colourful history, and it is worth seeing some aspects of the past and the most recent developments.
EARLIER BOOMS IN IPOs
Many may remember the massive rise in IPOs during the Harshad Mehta times. The boom in the stock market also made new issues by companies attractive. Numerous IPOs were oversubscribed. There was actually a grey market for IPOs functioning, albeit with no legal backing, and the grey market quotes were often published in pamphlets and quoted elsewhere. To increase the odds of getting allotment in shares, it was commonly known that people resorted to multiple applications by using names of their family members and even staff and making applications in different combinations of names of such persons. The technology at that time was not advanced enough to weed out such multiple applications. Of course, those were also the times when many companies with dubious backgrounds made IPOs and then ‘vanished’.
DEMATERIALISATION OF SHARES
Dematerialisation of shares and other changes eliminated the earlier practice of multiple applications by the same person. However, a new abuse came to light, particularly surrounding the SEBI rules mandating allocation for retail investors. It was found that lakhs of Demat accounts were opened in Benami or even fake names. Amusingly, for this purpose, some names with photographs were reported to have been picked up from matrimonial sites! Applications were made in such names, financed by others. When shares were allotted, they were sold, and the sale proceeds with the profits paid to the financier. These cases became famous by one of the allegedly involved – Roopalben Panchal. Such persons whose name is ‘borrowed’ for carrying out transactions in shares by others now even have a term – ‘mules’. SEBI’s action in such cases, which saw prolonged litigation though, supplemented with other efforts such as know-your-client verification, stronger penal provisions for using fake names, etc., dealt with this abuse.
CURRENT BOOM IN IPOS AND RESPONSE OF SEBI
Very large amount of money is being raised through IPOs of several companies in recent times. New age web-based companies have finally come to roost, and some of them have offered shares to the public at a significant premium. Apart from this, several other companies have joined the party. What has been particularly notable has been the generally massive response to such issues from the public. Several public issues have seen applications that are many times the issue size.
SEBI has long moved from having a say in determining the pricing of issues. The emphasis is on due disclosure of information sufficient for the investor to make an informed decision, supported by due diligence by merchant bankers and others. Other safeguards include eligibility requirements, minimum holding and lock-in requirements, etc. But other than that, the issue price is generally not controlled.
However, this time, considering factors such as there being offers for sale by existing holders too and for other reasons, SEBI has decided to make certain amendments to the SEBI ICDR Regulations at its Board Meeting held on 28th December, 2021, followed up by formal amendments to the Regulations. The following are some of the important amendments:
a. If an object of the issue is for future inorganic growth, but specific acquisition or investment targets are not identified, in that case, the amount raised for such objects, including for ‘general corporate purposes’ shall not exceed 35% of the total amount being raised. Of this, the amount earmarked for such use for inorganic growth shall not exceed 25% of the issue size.
b. In the case of an offer for sale by companies without a track record, certain limits have been laid down for specific categories of existing shareholders. A shareholder (along with persons acting in concert) who holds more than 20% of the pre-issue shareholding (on a fully diluted basis) shall not offer more than 50% of his pre-issue shareholding. Other shareholders cannot offer more than 10% of their pre-issue shareholding.
c. Credit Rating Agencies will now act as Monitoring Agencies in place of presently recognized monitoring agencies. They will monitor the use of issue proceeds until 100% is utilized, compared to the present 95%.
d. For Anchor Investors, the lock-in now will be 30 days for 50% of shares allocated to them and 90 days for balance shares. This will apply for issues opening on or after 1st April 2022.
e. Modifications have been made to the allocations made regarding Non-Institutional Investors with effect from 1st April 2022.
The amendments thus appear to be intended to ensure only partial exit for existing shareholders in some instances or to anchor investors and generally make other fine-tuning.
HIGHLY LEVERAGED IPO FINANCING AND RESERVE BANK OF INDIA’S RECENT RESTRICTION
Earlier, we referred to financing persons who acted merely as front or were even fake to subscribe for IPOs, which is an abuse of the law. However, what is widely prevalent is also financing by lenders to subscribers to IPOs. The objective of obtaining such finance can be many. One is to acquire a higher quantity of shares of a company whose issue price is perceived by the subscriber/borrower as low, leaving scope for quick profits. However, considering that many issues are heavily oversubscribed, applying for a larger quantity of shares boosts the chances of getting a higher quantity of shares than otherwise. IPO financing thus has become quite common. Thanks to the ever-shortening gap between the date of application for shares and payment and allotment/refund, IPO financing is thus for a very short period – about a week or so. This increases the attractiveness of the finance since the attendant costs are also lower. Further, lenders have shown willingness to lend an amount that is many times the amount contributed by the borrower. Thus, there is enormous leverage. The consequence is that the profits would also be magnified, and so would the losses. The risk of losses is as much to the borrower as is to the lender since if there are huge losses (owing to, say, the price of the allotted shares being quoted far below the issue price), there could be concerns of recovery if there is not adequate other collateral.
The matter of borrowing and lending is under the purview of the Reserve Bank of India, which has taken a strong – and possibly drastic – action. It has issued guidelines dated 22nd October, 2021, stating that, from 1st April 2022, “There shall be a ceiling of Rs. 1 crore per borrower for financing subscription to Initial Public Offer (IPO). NBFCs can fix more conservative limits.”. Thus, non-banking financial companies (‘NBFCs’) shall lend a maximum of Rs. 1 crore per borrower for IPO. While Rs. 1 crore by itself does sound to be a significant sum, considering that IPO financing has been of massive amounts, this would significantly affect IPO financing. To take just one example, in the recent case referred to earlier, which came widely in the news because of an abusive call allegedly made, the amount of IPO financing said to be involved in just this one case was Rs. 500 crores that too for one single IPO. The absolute limit of Rs. 1 crore stated by the Reserve Bank of India thus sounds relatively puny in comparison. Of course, questions are raised about the interpretation of the guidelines. Whether the limit is per IPO and hence a borrower can raise Rs. 1 crore separately for each IPO? Whether the IPO is per NBFC and hence the borrower can borrow Rs. 1 crore each from different NBFCs? And so on. While clarity on this may hopefully come from RBI before the date when it will come into effect, the fact remains that the amount of IPO financing may go down substantially. The concerns of RBI are, of course, valid – that giving of huge financing may be risky for the sector itself, apart from allowing borrowers to take huge unhealthy risks. But whether the answer to this was to place such an absolute limit or whether other solutions were possible? For example, the limit could have been placed in the form of margin – say, 50% whereby the borrower would have to put in as much amount himself as he borrows. Alternatively, the borrower could provide adequate collateral of such nature that may not present difficulties in realizing if recovery has to be made. One will have to see whether RBI makes any changes before the rule comes into effect.
CONCLUSION
There are views that, retail investors are more involved in the stock market, particularly due to the pandemic with numerous people working from home. Apart from acquiring shares in the secondary market, acquisition through IPOs has also seen a rapid rise. Time only will tell us whether this is a bubble or not. But if the restriction on IPO finance comes into effect, that would also contribute to a reduction in amounts subscribed through IPOs.
