More than 12 years after it was introduced in the Indian capital market, the Securities and Exchange Board of India (SEBI) has brought the curtains down on what could perhaps be termed one of its most criticised moves in the primary market —grading of initial public offers (IPOs).
The board of the capital market watchdog, which met in Mumbai on Thursday, approved the deletion of all the provisions related to IPO grading from the SEBI (Issue of Capital and Disclosure Requirements) Regulations.
IPO grading was first introduced as an optional feature in April 2006, but later made mandatory in May 2007. Again, it was made voluntary in 2013.
The IPO grading process, however, never took into account the price of the public issue and factored in only the company fundamentals, management quality and financial and business risks among other parameters.
‘No correlation’
More importantly, an internal analysis by SEBI in 2010 had showed that there was no correlation between the IPO grades and the post-listing performance of the stock, putting a question mark on the efficiency and utility of the whole exercise, the cost of which had to be borne by the IPO-bound company.
“I’ve always been against IPO grading for the simple reason that equity is a volatile and high-risk instrument and so cannot be graded,” said Prithvi Haldea, managing director, Prime Database.
“Moreover, the IPO grading did not factor in the price and so, was a kind of an oxymoron where a fundamentally good company by overpricing can actually become a bad investment. There is no jurisdiction in the world where equity is graded and somebody had to take a decision to do away with this despite several studies that it served absolutely no purpose,” he added.
Interestingly, the SEBI analysis had come close on the heels of a similar study done by Crisil, though it concluded that companies with a higher IPO grade traded at a higher price to earnings multiple.
According to the Crisil report, companies with an IPO grade of 4/5, which indicated above-average fundamentals, traded at an average P/E multiple of 28 times, compared with 11.2 times for entities that were graded 1/5 denoting poor fundamentals.
Meanwhile, the SEBI Board also approved the deletion of the provisions related to the safety net feature, which was introduced in 2013. The feature was basically brought in as a deterrent against alleged aggressive pricing of IPOs by merchant bankers, but its mechanism came under sharp criticism.
“The current SEBI chairman should be complimented on the courage that he has shown in dropping both these as these are typically perceived as pro small investors,” said Mr. Haldea.
