IPO grading system fails to produce desired results

Sebi should change the way issues are graded, say experts.

Perceived as the quality gauge for public issues, grading of initial public offers (IPOs) has failed to make a major impact either on the investment rationale of retail investors, or the wealth created by the underlying companies post-listing.

In fact, the higher the grade of an IPO, the poorer has been its performance in the market. Companies such as Reliance Power, Edelweiss Capital and Gammon Infrastructure, which were rated four out of five (meaning above average fundamentals), have posted losses in the range of 46 to 56 per cent. And, nine out of 10 which were similarly graded lost more than 40 per cent, according to a report from SMC Capitals.

During 2007 and 2008, the boom years for IPOs, investors hardly took cognisance of ratings assigned to a particular company. And that was the reason why some of the companies with even absolutely low ratings managed to gather stellar subscription figures.

Despite opposition from several quarters, the Securities and Exchange Board of India (Sebi) had made it mandatory for all IPOs to be graded by rating agencies from April 2007 onwards. After a company gets Sebi approval for an IPO, it has to rope in rating agencies such as ICRA, Crisil, Fitch and CARE to get the issue graded.

According to Sebi guidelines, an IPO grade cannot be rejected. Irrespective of whether the issuer finds the grade acceptable or not, the grade has to be disclosed as required under the DIP guidelines. However, the issuer has the option of getting its issue graded by another rating agency.

“Investors have completely ignored IPO grading... In my view, equity as an instrument cannot be graded. It is a risky asset class and one needs to capture a lot of other factors apart from the ones listed in the draft red herring prospectus (DRHP). Though India is the first country to introduce IPO grading, it has not served its basic purpose,” said Prithvi Haldea, managing director, Prime Database.

Recently, Sebi chairman CB Bhave had said that the regulator would review the IPO grading concept as it had gained some experience after receiving both positive and negative responses on the move.

Though there was a view that Sebi should scrap it, experts said that the regulator would bring in some changes to the way grading was being done rather than doing away with it.

“Grading has not really caught on with retail investors as it was intended to be. Retail investors still get carried away by the herd syndrome. Rating agencies are mainly concerned with vetting the DRHP. They do not evaluate it as an investment proposition. Pricing of the issue is an important part, which is not covered by rating agencies while grading an IPO,” said Kavita Shah, senior vice- president, Collins Stewarts Inga.