SEBI announces mandatory Safety Net Mechanism for IPO’s

SEBI today released a discussion paper for its proposed Safety Net mechanism. The trigger point is 20% price erosion from listing price. The listing price would be calculated as the volume weighted average market price for a period of 3 months from date of listing. Secondly all IPO’s would have to be benchmarked to either the BSE500 or CNX500. Thirdly the safety net would only be available to those retail investors who apply for shares worth Rs 50,000.

At first glance it appears that SEBI is introducing this safety net as an obligation but the entire scheme is designed to benefit just the issuer of capital. The scheme in intent is aimed at minimising the loss that an issuer may have.

Let us analyse the same in detail. The first eligibility criteria is application amount should be Rs 50,000 or less. The retail category in India till a few years ago was Rs 1 lakh and it was just about two years ago considering inflation and the value of money that the limit of retail investor was raised to Rs 2 lakhs. Within this category subdividing the portion eligible for safety net to Rs 50,000 is unfair in spirit. The average ticket size of retail applications is Rs 95,000. This means that those applicants applying for shares worth Rs 50,000 would be roughly 20-25% of the retail portion. The retail portion is 35% of the issue size and taking a maximum of 25% applying for Rs 50,000 the same would come to roughly 9% of the issue size.

The maximum liability of the promoter is limited to 5% of the issue size. To use this amount to the fullest the retail applications not exceeding Rs 50,000, the share would have to fall a minimum of 55% for the money to be used up. What I fail to understand is that this scheme is to protect the issuer of capital or the investor.

The investor to get compensation needs to ensure the following : –
• He must apply for Rs 50,000 or less
• The stock price must fall by 20% or more
• He must ensure that the benchmark index selected by the issuer does not underperform the stock price   otherwise he would not be eligible
• The buyback would be restricted to a maximum of 5% of the issue size
• The period of buyback would be at the end of 3 months from the listing of the share.

The scheme is full of flaws and is heavily skewed in favour of the issuer. The scheme is supposed to protect the investor not the issuer of capital, however here it is the opposite.

I believe the scheme should be completely modified and overhauled. I suggest the following changes in the proposed white paper for discussion.

Changes proposed.

1. The eligibility criteria should be available for all retail investors and should work in the reverse order where the smallest applicant gets full benefit and the largest investor gets the least benefit. For example if there is money available after meeting the claims for investors upto Rs 50,000, then the same to apply to investors upto Rs 1 lakh and then Rs 1.5 lakhs and so on upto Rs 2 lakhs.
2. The scheme has fixed a band of 5% on the issuer of capital. Within this band the money should be distributed so that maximum benefit is available to investors and not to the issuer.
3. SEBI has given benefit of index performance to the issuer in calculating price fall and the same is visible in illustration-2. However in illustration-4 the same logic is not used and SEBI is speaking in favour of the issuer. I believe the 20% trigger should be on the basis of change in price considering index as mentioned by SEBI.

In conclusion it appears this is yet another half-hearted effort from SEBI where the intent is excellent but the formulation of the scheme is meant for only one section of people i.e. the issuer of capital and not for safeguard of minority or small shareholders.

Dear readers I would welcome your comments on the above issue and would forward the same as a suggestion to the regulator. Please forward your views and suggestions to the website by the 25th of October.

The full text of the white paper may be downloaded from here.

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