In recent times one hears of a compulsory safety net being introduced by SEBI and merchant bankers or many intermediaries opposing the idea of the same saying that a capital market product comes with an inherent risk and therefore there can be no capital protection. Why has this situation come with strong views on either side? One must also remember that mutual funds offer schemes which give capital protection, so why not IPO’s?

In the last four to five years of the total IPO’s that have come broadly 75% are trading below their issue price. The loss varies from a mere 10% to over 90%. The fall of more than 50% is higher in number than that of below 50%. This includes offeringsfrom private as well as PSU’s. In India capital market offerings have moved from the days of CCI (controller of capital issues) when there were pricing formulas for the IPO price to the days of SEBI where it is completely free pricing and issues have come at market prices of their choice. SEBI has understood that the greed of promoters and their merchant bankers who gets fees on the basis of the funds raised, have a vested interest in higher pricing. This of course is a natural activity and there can be no issues on the same as long as the price remains at that level post listing when the financial performance of the company improves. The company would deploy the IPO proceeds and therefore be able to grow and expand the business.

The merchant banker promoter nexus has been found wanting in price performance of the IPO post listing. This is the ground of contention between the regulator and the issuer of capital. The regulator believes that in any case it is the merchant banker who is responsible for the issue and why not be made accountable for offering a proper price. It is with this in mind that even after cautioning merchant bankers to be realistic in pricing over the last many years and failing, SEBI has decided that a mandatory safety net of some kind be introduced.

On the flip side the provision for a voluntary safety net already exists and there has been one issue which had offered this to their investors. Usher Agro, a rice processor had introduced this scheme when he offered a voluntary safety net in October 2006. The salient features of the voluntary safety net are as follows: –

• It is restricted to retail investors and a maximum of 1,000 shares can be bought per investor
• The period of safety net is to original investors for six months from the date of credit of shares in the demat account
• The shares offered for buyback have to be originally allotted to the investor and if traded or bought from the market become ineligible.
• The size of the safety net is upon the individual issuer, however the total value of shares per investor offered in the safety net cannot exceed the limit of retail investors of Rs 2 lacs
• The mode of delivery is to the designated demat account of the promoters of the company and direct payment to the shareholder/investor’s bank account

The scheme achieves a twofold objective of firstly reassuring the retail investor for six months of the issue price. Secondly it gives him effectively a call option for six months at zero cost to surrender his shares to the promoter if they go below issue price or sell in the market if he is making money. It is this comfort that the retail investor gets that will force some sort of discipline in pricing by issuers of capital on the one hand and the returning of confidence in the minds of retail investors on the other hand. It could become a win-win situation for all concerned.

When merchant bankers want to oppose this methodology of safety net they must just go back into the good old days of CCI regime and remember the fixed price formula of that era. SEBI chief Mr U.K.Sinha has been informing merchant bankers time and again that if proper pricing is not introduced and a check kept in place by introduction of safety net, he would bring price control. It is becoming apparent that the regulator wants the primary markets to become active and one needs the retail to participate for that. However until proper pricing happens retail would not participate. The simple solution and as they say in English, “killing two birds with one stone” would be achieved if the company offers a safety net. This would give a six month option to investors to exit at cost through the safety net or the market if he makes money there. The second and bigger objective achieved would be an indirect restraint on the pricing with the merchant banker and issuer of capital realising that if there is no proper pricing, the share would be under pressure and the promoter would have to buy shares.

I believe there is no option for issuers of capital and if they want public money they have to leave something on the table for investors. They would sooner than later willingly or unwillingly have to offer a safety net and if they don’t the days where pricing formula for IPO’s would be introduced is not far away.

In the next few weeks the active introduction of safety net on a voluntary basis would happen and it would be an eye opener for those opposed to this mechanism.