Primary market stability

Sebi's decisions will improve investor confidence

The Securities and Exchange Board of India (Sebi) has made a number of changes to the primary market processes and to the regulations for preferential allotment. These changes broadly serve the purpose of transparency, and could reduce price volatility in newly listed issues. In addition, the regulator has introduced a new provision wherein the reappointment of directors (including managing directors), who fail to get elected, can now only be made with the prior approval of shareholders. One of the key changes in the primary market rules for capital issues is that firms launching an initial public offer (IPO) must either cap the percentage of funds allocated to the acquisition of unspecified businesses, or state specific targets in the prospectus. The lock-in period for promoters in preferential allotments has been reduced, but more disclosures must be made.

The Sebi board has recommended several changes in the context of IPOs. There should be a cap of 35 per cent of the total issue size on the combination of allocation to future inorganic growth and “general corporate purposes”. This cap does not apply if the prospectus identifies specific acquisition targets. The cap on allocation of funds for unidentified acquisitions only is set at 25 per cent of the issue size. This may hamper new age businesses, which use merger and acquisition strategies to foster quick inorganic growth. But it offers shareholders more clarity about strategy. Sebi has also mandated that a credit rating agency must monitor the use of IPO funds until 100 per cent of such funds are deployed. In an offer for sale (OFS), majority shareholders (defined as holding at least 20 per cent of the pre-issue stake) can only sell up to 50 per cent of the stake. Anchor investors can sell 50 per cent of their stake under the current lock-in period of 30 days and the remaining 50 per cent only 90 days after the IPO has closed. There will be a price floor set at a minimum of 105 per cent of the lower end of the IPO price band. This is applicable from April 1, 2022.
 

Investors with less than a 20 per cent pre-IPO stake can sell a maximum of half of their holdings in an OFS. This should reduce the trend where anchor investors have rapidly divested holdings in an OFS. It should also reduce price volatility immediately after listing. The regulator's view seems to be that this will give other investors more confidence by ensuring anchor investors retain skin in the game. It’s hard to judge if it will inhibit venture capital and private equity players until this new regulation comes into practice. In preferential allotments, valuation reports will be mandatory if 5 per cent of fully diluted share capital is allotted to any one entity, and if there is change in control, independent directors must provide reasoned recommendations. The lock-in for preferential allotment up to 20 per cent of capital is reduced to 18 months from the current three years. For allotment of above 20 per cent, the lock-in period is reduced from one year to six months. Promoters may pledge shares for loans only if a pledge is a specified clause for loan sanction. Such a loan should also be approved by the issuer for achieving the objects mentioned in the preferential issue. Share swaps will be allowed if there is a valuation report. All these changes should lead to faster turnaround in capital, while fostering more disclosure at the same time.