Open up IPOs

After dithering on the issue for years, the Securities and Exchange Board of India is finally summoning the courage to tackle some of the abuses of IPO allotments.

The abuses of the book-building process in IPOs""including the creation of artificial demand, the hype built up of over-subscription, and the allotment to friends and well-wishers""have been well known ever since the process started in this country.

The MS Verma committee recommended, in late 2002, that the book-building process should be a closed one, i.e. the book should not be made public, so that retail investors are not misled by the so-called over-subscription.

The Malegam committee recommended that qualified institutional investors, who don't have to put in any money when making their bids, should be forced to put in a certain percentage of their bid as a margin.

Subsequently, Sebi's Primary Market Advisory Committee pointed out that "a lot of the "over-subscription" in the book-building issues may be caused by the fact that QIBs can make a bid for any number of shares, without having to substantiate their bids by a commensurate margin.

Thus, it appears that the "over-subscription" in the QIB portion may be more on account of the absence of any margin money requirement than any genuine demand for the issue.

The members were also of the opinion that "over-subsciption" without margin money may amount to fraudulent over-subscription.

The committee could hardly have been more blunt. And yet, at the time of tightening IPO norms, Sebi did not impose a margin for QIBs.

Instead, it stipulated that institutional investors not be allowed to withdraw their bids, in the hope that this would put an end to the creation of artificial demand.

However, the allocation is entirely in the hands of the lead book running managers and, in the case of over-subscription, they can easily reject the artificial bids of friends, thus letting them off the hook.

It is also possible for bidders to "revise" their bids, which is farcical, since a bid for 10,000 shares may well be revised to a few hundred. Imposing a margin on QIBs would discourage such frivolous bids.

At the same time, the market regulator has been conscious that it has an important role to play in attracting the small investor to the primary market.

Over the years, it has ensured that retail investors get a larger proportion of public issues""the proportion currently stands at 35 per cent.

Since it is generally recognised that the best way for small investors to enter the market is through mutual funds, keeping mutual funds as a separate category in the book-building process makes sense, too.

Such a move will also help increase the popularity of mutual funds among investors, since the chances of allocation will go up sharply if investors go through the mutual fund route, instead of directly.

Whether other local institutions such as banks and insurance companies should be clubbed in this category, however, is debatable.

In fact, the latest attempt to tighten IPO norms comes in the wake of allegations by domestic financial institutions that most of the allotments are being cornered by FIIs, and reserving part of the issue for local institutions appears to be an attempt to correct that situation.

Perhaps a better way out would be to ensure more transparency in the allotment process so that allegations of favouring a few institutions do not arise.