Retail investors don't need safety net

Improving their risk-taking ability will only hurt them and encourage speculation

The Securities and Exchange Board of India (Sebi) wants more retail participation in the stock market. But its reported suggestion of providing a safety net for them isn’t the right way.

Since 2012, the market regulator has been keen on some kind of safety net for retail investors. It floated a discussion paper on safety net for initial public offers (IPOs) which proposed that if the stock price fell sharply, the company would buy back the shares up to a limit of 1,000 shares per allottee, at the original price. This proposal received stiff opposition from all quarters, Sebi chairman U K Sinha admitted in an interview in 2013.

But, it seems that the idea of safety net hasn’t been shelved. As reported by Business Standard recently, Sebi is mulling a ‘modified safety net’ after its initial plan faced strong opposition. Under this mechanism, a company will have to appoint a stabilising agent – a broker or an investment banker. The agent will have to support the secondary market price by transacting in shares through the open market  for up to six months. T

The question is why does the regulator want a safety net for retail investor from fraud IPOs or tough market conditions? The basic idea of participating in equities is that an investor becomes the part-owner and enjoys the rewards, and of course, the risk that comes with it. Consequently, the results with a good company can be spectacular and with a bad one, disastrous.

There is another issue here. A safety net will improve the retail investor’s risk-taking ability substantially. If he starts investing in shady companies which price their issues aggressively to take advantage of the current market conditions, he is quite likely to burn his fingers after the stabilising agent exits after the mandated six months – something that the regulator does not want. The entire idea that retail investors should invest in good companies for the long-term (read 5-10 years) will be defeated, if a safety net is provided.

He will, then, start behaving like a trader who enters the market, holds it for a short time and exits after making a quick buck.   

Of course, both companies and investment bankers will be uncomfortable with such an arrangement because it will imply less aggressively pricing (a good thing). The latter will also have to be bound to the issue for a longer period.

In times like these, when the benchmark indices are rallying, more companies may want to launch IPOs and FPOs and the market requires long-term investors who will participate by buying good companies. A safety net will only encourage more speculation.