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Widening capital market access

Two recent decisions of the the Securities and Exchange Board of India will have far-reaching consequences for investors and issuers of capital. To make the process of capital-raising easier and cost-efficient for the small and medium enterprises (SMEs), those listing on a specially created platform or exchange will be exempted from the eligibility norms applicable for initial public offers. Only companies with less than Rs.25 crore of paid up capital will qualify for this concession. That the special requirements of SMEs need to be addressed has long been recognised. In fact, in 1990, the OTC Exchange of India (OTCEI) was set up with the twin objectives of helping the smaller companies raise capital in a cost-effective manner and providing the investors with an efficient and transparent method of trade. But it failed to take off, despite its innovative features such as screen-based trading; it was probably ahead of its time. It remains to be seen whether the institution now proposed, almost two decades after the OTCEI, will fare better. SEBI is banking on financially sound and better-informed investors giving stability to this niche segment. The minimum application-size of Rs.1 lakh will however shut out many smaller investors.

The other important decision of SEBI is to permit auction as an additional method of book-building in “follow on” issues —the issues by companies that are already listed on the exchanges. The market price will be the benchmark. Bidders would be free to bid at any price above the floor price, and the allotment will be on the basis of the bid price and at differential prices. Retail investors will be allotted shares at the floor price. The auctioning a portion of shares, it is hoped, will help the issuers in better price discovery. Shares can be bid up to levels that may not be possible in the existing book-building process. However, for all the transparency it promises, auction has not been popular in almost all the countries where it was tried out. In the U.S., the spectacular success of Google Inc. in 2004 in auctioning its shares did not lead to a general revival of interest in the method. Various academic studies have shown that auction might trigger “winners’ curse,” a situation where the winners overbid. Secondly, it is possible that uninformed investors will be among the winners, shutting out the more knowledgeable ones. SEBI’s gradual approach is to be commended. It should be able to fine-tune the new scheme in the light of its experience.

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