An alternate way

One of the major functions of the stock market is to enable corporations to raise capital for funding projects or expanding capacities. Sometimes, funds are raised to meet working capital requirements, deleverage, or allow promoters and private equity firms to exit. Risk capital is often provided by investors through IPOs, rights issues, or follow-on offerings. Raising capital through IPOs is one of the most popular methods, and this mode has evolved over the years from fixed prices determined by the capital controller to the open price and price band system prevalent now.

However, the current IPO system has its flaws. Firstly, it gives a misleading picture of subscription levels, as applications made with borrowed funds create a false impression of the issue being oversubscribed multiple times. Retail investors, following the trend of these so-called sophisticated investors, tend to be misled. In several cases, despite multiple oversubscriptions, the issue opens at or near the allotment price. One reason for this is that higher application money increases the chance of proportionate allotment. Leveraged investors and many HNIs flip the issue and sell it upon listing. To ensure the issue does not fall below the issue price, promoters, in league with merchant bankers, support the issue and buy shares through friendly brokers to maintain price stability. SEBI is taking steps to curb manipulators, but the problem is too large to be resolved by fining or suspending licences for specific periods. It has also reduced the period from the application date to the allotment date to improve the process.

The Offer for Sale (OFS) platform offers a much better way of raising funds. While currently used for follow-on issues, several PSU companies have effectively raised money for the government through the OFS platform. OFS mandates that at least 10 per cent should be held by the promoters. A lot of divestment by the government has been done through OFS, which is a much quicker method. The entire exercise is completed within a period of 3-4 days, with a two-day prior notice to the exchange required ahead of the issue. Sometimes, one extra day is given exclusively for retail investors. It is also more cost-effective for the company, saving costs in marketing, legal expenses, and time. Besides, it cuts the uncertainty involved from the date of filing the prospectus to the actual approval date.

SEBI can begin by giving companies the option of conducting IPOs through OFS (which can be renamed as the IPO Platform). There are two ways this can be done. One is with the existing system, allowing investors to place bids through their respective brokers who already have their required KYC details. It can mandate that all respective segments of investors must place bids only on one particular day. A separate window can be kept for investors placing bids through borrowed funds. Promoters can have the discretion of allotting a fixed percentage for this segment of investors, say 10 per cent. A small discount of 5 per cent, currently given to retail investors, can be retained, and they could bid at cut-off rates. This mode will be more transparent and will not allow manipulation of prices. The shares will be listed on the very next day or the second day as allotment will be done on the spot, depending on the number of bids received. Transferring shares to the respective accounts of the investors can be done through the clearing house, as is currently done for transactions in the secondary market. Post-allotment and transfer, the shares will be listed and can open at or near the allotment price, leaving less room for investors to flip their shares.

At a later date, once the system of raising IPO funds becomes popular, SEBI can even do away with the pre-set price band. Let it be entirely free, depending on the overall demand and supply for the new issue. The average indicative price can be arrived at, and all shares will be allotted at this price. Manipulation in this case can be checked by not allowing bids to be withdrawn on the same day. This will curb artificial rigging of prices by inflating demand. SEBI can implement the necessary checks and balances to curb these practices, allowing companies to realise a fair price. In the case of Tata Technologies, instead of the share prices moving up by more than 2x and 3x within a short time of listing, if shares were sold through OFS, the promoters (in this case, Tatas) would have gained more and realised a fair price. OFS is, in a way, democratising the IPO market and enabling proper price discovery by gauging the genuine demand of investors in the market. Promoters will also prefer shares going into the hands of genuine investors rather than short-term speculators. OFS will help revolutionise the IPO market. In either case, other investors who feel left out can always buy shares in the secondary markets post-listing.