Reforms in the Primary Market

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Reforms in the Primary Market

1.0 Objective

This memorandum seeks to review the public issue processes in the primary market

and make proposals for amendments to the regulatory framework.

2.0 Background

2.1 In the Union Budget 2012-13, the Hon'ble Finance Minister, proposed as under:-

"I now propose to take the next steps in deepening the reforms in Capital market by:

......

simplifying the process of issuing Initial Public Offers (IPOs), lowering their costs and helping companies reach more retail investors in small towns. To achieve this, in addition to the existing IPO process, I propose to make it mandatory for companies to issue IPOs of Rs. 10 crore and above in electronic form through nationwide broker network of stock exchanges."

2.2 In addition, in the recent past, concerns have been raised on the efficacy of the

capital raising process and certain structural infirmities have also been pointed out.

There was also a feedback from the investing fraternity that their interests were not

adequately protected. To address these concerns, certain initiatives, viz., trade

controls on day of listing, enforcement actions, etc. were undertaken, the details of

which are discussed as under.

2.3 Call Auction/Trade controls on day of listing

In the light of high volatility and price movement observed on the first day of trading,

a framework has been put in place with certain trade controls in the normal trading

session. It has been prescribed that the normal trading session shall commence

only after the conclusion of “Call Auction” session for such scrips on BSE and NSE.

In the normal trading session, the scrip will be subjected to normal price filters with

reference to the equilibrium price discovered in the “Call Auction” session. It has

also been prescribed that in case of IPOs of issue size upto Rs. 250 crore, the

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shares of the issuer shall be traded in the "Trade for Trade" segment for the first 10

days from commencement of trading.

2.4 Enforcement Actions Taken by SEBI

SEBI had initiated investigations into certain IPOs during 2011 wherein it was prima

facie found that, many of the prospectuses did not contain all material, true and

adequate disclosures. However, the directors and other signatories had wrongly

certified in the Red Herring Prospectus (“RHP”) that all the disclosures made in the

offer document were true and correct. Book Running Lead Managers (“BRLMs”),

companies and respective directors had apparently colluded with the issuers or had

failed to exercise the required level of due diligence. It was also observed that in

some cases, the issuers did not make prompt, true and fair disclosure of all the

material developments that took place between the date of the RHP and the date of

allotment of securities through public notices, as required. Further, in some cases,

funds raised by the issuers had reached some traders through various layers and

these traders had traded significantly on the day of listing or around that time, in

manipulative patterns or in a way that allowed exit to certain investors who had

subscribed to the IPO.

Based on the preliminary findings/observations, SEBI, passed ad interim, ex-parte

orders which contained, inter-alia, the following salient directions:-

A. The issuers were prohibited from raising any further capital from the securities

market, in any manner whatsoever, till further directions. The issuers, directors

and other signatories who signed the RHP were prohibited from buying, selling or

dealing in the securities market in any manner whatsoever, till further directions.

B. The issuers were directed to call back money invested in Inter-Corporate

Deposits and invest the same in interest bearing deposits/accounts.

C. BRLMs, their CEOs and Heads of Merchant Banking were prohibited from taking

up any new assignment or involvement in any new issue of capital including IPO,

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follow-on issue etc. from the securities market in any manner whatsoever, till

further directions.

D. In some cases, brokers were prohibited from buying, selling or dealing in any

securities in their proprietary accounts and were prohibited from entering into any

fresh agreements with new clients in their operations as stock broker till further

orders.

3.0 Need for Review

3.1 Notwithstanding the above, securities market, including the market for public

offerings, is dynamic and need to keep pace with the evolving environment. It is,

therefore, appropriate and necessary to periodically review the extant regulatory

framework and various issue related processes with an aim to improve the quality of

public offerings and expanding their reach amongst investors. Such a review would

facilitate capital raising for trade and industry through the public offerings route

while also protecting the interest of investors.

3.2 Some of the reforms that have been identified include the following:-

a) Increasing the reach of IPOs through nation-wide broker network of stock

exchanges in electronic form

b) Enhancing the reach of Applications Supported by Blocked Amount (“ASBA”)

c) Review of the public issue processes and regulatory framework

d) (This portion has been excised)

e) Putting in place a framework for rejection of offer documents

f) Evolving an appropriate mechanism for effective monitoring of issue proceeds

g) Reduction of the time taken from issue closure to the date of listing from T+12

days to T+5 days, in a phased manner

h) Rationalisation of disclosures in the offer document

Out of the above, proposals with regard to points (a) to (g) are placed as part of this

Memorandum. Work in respect of point (h) is presently underway.

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4.0 Reference to Primary Market Advisory Committee (PMAC)

4.1 With the above backdrop, SEBI presented a discussion paper to the PMAC of SEBI.

The discussion paper examined extant processes and raised questions or issues

that may point areas where structural modifications might be necessary to

streamline the issue processes. Relevant practices in the Indian context were

studied vis-à-vis corresponding international practices and issues which are felt

necessary for safeguarding the interest of various stakeholders involved in the

processes were flagged for discussion. The Report of the PMAC detailing the

deliberations, the recommendations and the rationale therefor is placed at

Annexure-I. The current provisions, recommendations of PMAC and SEBI’s views &

proposals are detailed in the following paragraphs for the consideration of the

Board.

4.2 IPOs in electronic form and distribution channels for public offerings

4.2.1 Current Provisions

Currently, public offerings are largely distributed through a syndicate network

comprising various brokers and sub-brokers with payments done through either

cheques or ASBA mechanism (use of banking channels).

4.2.2 Recommendations

1. In the near term, a shift from the present 'syndicate ASBA' to a 'bank ASBA',

together with making ASBA mandatory for all primary issue payments, would bring

significant efficiencies in the time taken to close issues, and extend the

geographical and retail reach of the market.

2. In the medium term, portal-based investing could provide a competitive

alternative. The problems of risk management and of distributor incentives would

need handling, and are more complex than in secondary markets.

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3. In addition, distribution of IPOs through the broker network of stock exchanges

should be permitted subject to legal feasibility.

4. It would be desirable to view the three channels for investing, indicated above, as

part of a composite menu of choices available to investors, phased in sequentially if

necessary.

4.2.3 SEBI's Views and Proposal

4.2.3.1 The need for compressing time-lines for the closure of an issue once it opens for

subscription is important since it reduces market risks for investors. In this respect,

India's primary market compares unfavourably with its secondary market, as also

with the primary markets in several other jurisdictions. One of the factors

contributing to delayed closure is the large number of retail applications with

associated payment complexities. It is proposed to accept the recommendations of

the Committee.

4.2.3.2 In order to achieve the objective of reducing the time taken from issue closure to

the date of listing from the existing T+12 days, the following are proposed:-

a) Pursuant to the announcement by the Hon'ble Finance Minister in his speech while

presenting the Union Budget 2012-13, in order to ensure that the public issuances

route reaches out to larger number of retail investors spread across the country, it is

proposed to use the nationwide broker network of stock exchanges for distributing

IPOs in electronic form. The salient features of the proposed framework are as

under while the detailed modalities for this purpose are placed at Annexure-II.

Salient Features:-

This facility is likely to be extended to 1038 locations where atleast one of the

clearing banks has a branch. Investors can approach any of the brokers in these

locations to submit their application forms.

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Stock Exchanges shall provide for download of application forms on their

website.

Stock Exchanges shall facilitate investors to view the status of its issue

application on their website, similar to secondary market transactions.

Brokers shall be made responsible for uploading the bid on the exchange

platform & for banking the cheque/handling ASBA applications.

Brokers to be adequately compensated by the issuer, so that they will be

interested in directly/indirectly marketing the issue as well.

If Issue size is less than Rs. 250 cr., issuer shall appoint atleast 5 clearing banks

as Bankers to the Issue (BTIs)

If issue size is more than Rs.250 cr., issuer shall appoint atleast 10 clearing

banks as BTI.

b) Enhance the reach of ASBA by mandating all ASBA banks to provide the facility in

all their branches. However, this would be implemented in a phased manner to

provide sufficient time for banks to upgrade their infrastructure.

c) Make ASBA mandatory for RIIs in a phased manner.

d) Enable payment by investors through various portals including ATM/Debit/Credit

Cards/Mobile, etc. after examining the operational/legal feasibilities.

4.3 Eligibility criteria for IPOs


In the present disclosure-based regime, while issuers have been allowed to access

the market subject to adequate disclosures, certain objective eligibility criteria have

been put in place to decide the mode of issuance, viz. compulsory or voluntary

book-built mechanism. Issuers satisfying the conditions laid down under ‘profitability

track record route’ can access the market under the voluntary book-built route in

which a minimum participation requirement by QIBs is waived. This is based on the

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premise that the existence of a good operating history for a certain period, leading

to an adequate minimum net worth and profitability, would create credibility about

an issuer.

4.3.2 In parallel with this, in order to provide sufficient flexibility so that issuers setting up

green field projects or newer and smaller issuers are not disadvantaged on account

of rigid eligibility criteria that may hamper their fund raising plans, an alternative

'compulsory book-built' route has also been provided to issuers not eligible under

their profitability track record. The most critical difference in this second alternative

criterion is the requirement of minimum 50% subscription of issue size by QIBs

which is expected to lend credibility to the issue and provide signals to non-

institutional investors (NIIs) on the issue quality.

4.3.3 Recommendations of PMAC

1. The Committee recommends that in order to access the primary market through

an IPO, a company should have been profitable for at least 3 out of the preceding 5

years, with a minimal average pre-tax operating profit during the 3 most profitable

years of Rs. 15 crore.

2. Profitability would be computed on a restated, consolidated basis. Divisional

profits would be permitted to be carried forward in cases of situations like de-

mergers.

3. A full disclosure would need to be made of related party transactions with the

BRLMs certifying the extent to which profits from these transactions constitute

legitimate business profits.

4. It is recommended that the compulsory book-building mechanism be

discontinued.

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5. SEBI should penalise the audit firms that have certified the books of accounts of

companies which were later found to have been manipulated, including debarring

them for a specified period from certifying the accounts of listed companies.


4.3.4.1 Considerable time has elapsed since the extant regulatory framework governing

compulsory and voluntary book building routes were put in place. Therefore, it is

desirable to have a re-look on the eligibility norms.

4.3.4.2 As regards profit-making companies, it is proposed to accept the recommendations

of the Committee indicated at Pts. 1, 2, 3 and 5 above.

4.3.4.3 As regards Pt. 4, while it is desirable that public issue route is the last bastion of

fund raising for issuers, it is also necessary that an alternative route is available to

the non-profit making companies which have good business models. In this regard,

in order to promote the growth of the Small and Medium Enterprises (SMEs), SEBI

has put in place a relatively diluted regulatory framework which, inter-alia, includes

the following:-

An issuer whose post-issue face value capital is less than Rs. 25 Crore can get

its shares listed in the SME segment of the stock exchanges

Relaxation from filing DRHP with SEBI for observations

Minimum application value shall not be less than Rs. one lakh per application

Minimum number of prospective allottees is less than fifty (instead of 1,000 in the

case of non-SMEs)

Requirement to file half yearly financial results instead of on a quarterly basis

Exemption from publishing financial results in newspapers

It is proposed to retain the above framework for SMEs. However, there is a need to

provide an alternative route for issuers who neither meet the proposed profitability

criteria as brought out in Para 4.3.3 above nor qualify for the norms prescribed for

the SME segment. Such issuers should have access to the market subject to

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complying with more stringent requirements than what is presently applicable to

them as stated in Para 4.3.2 above. It is, therefore, proposed that any issuer not

meeting the aforesaid profitability criteria may be permitted to tap the public

issuance route subject to the following:-

i. Atleast 75% of the issue size shall be mandatorily allotted to QIBs, as against the

existing 50%.

ii. Out of the remaining 25%, 15% shall be allocated to NIIs and 10% to RIIs.

4.4 Eligibility criteria for follow-on public offers (FPOs) and rights issues through

the fast-track route


Fast track route of fund raising is an alternative available for well-established and

compliant companies to access public funds by way of further capital offerings. One

of the conditions for companies to be able to access funds through the fast track

route is to have a minimum average free float market capitalisation of Rs. 5000

Crore.


The threshold average free float market capitalisation level for issuers to access the

market through fast-track FPOs and rights issues should be reduced to Rs. 3000

crore.


Considering the objective of making the process of such fund raising faster and

easier for issuers, it is proposed to accept the recommendations of the Committee.

About 80 issuers are expected to benefit from this proposal.

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4.5 Minimum promoters’ contribution, lock-in and pledge of shares


Minimum promoters’ contribution is required to be atleast 20% of the post-issue

capital, in the case of an IPO, FPO or a composite issue. The said minimum

promoters’ contribution is required to be locked in for 3 years from the date of

commencement of commercial production or date of allotment in the public issue,

whichever is later. Holdings in excess of minimum promoters’ contribution and

entire pre-issue capital (in case of IPOs) are to be locked in for 1 year.

Shares held by promoters and locked in (for the purpose of minimum promoters’

contribution) may however be pledged as collateral security with any scheduled

commercial bank or public financial institution for any loans granted for financing

one or more of the objects of the issue, provided the pledge of shares is one of the

terms of sanction of the loan.


1. The term 'promoter of a company', in terms of securities market regulation,

would apply for a period of 3 years from the date of commencement of commercial

production or date of allotment in an IPO, whichever is later.

2. After this period, those shareholders who voluntarily ask to be categorised as

controlling shareholders would be termed accordingly, with greater fluidity being

permitted to sell shares under securities laws, though banks and financial

institutions who are creditors to the company may impose additional constraints on

share transfers.

3. The existing requirement of minimum promoters’ contribution of 20% shall be

retained, which will be locked in for 3 years from the date of allotment in the IPO.

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4. In companies without promoters, or (in exceptional cases) in companies founded

by professionals or first generation entrepreneurs where the post-IPO equity held by

promoters is less than 20%, Alternative Investment Funds (“AIFs”) could be

permitted to provide the balance equity, subject to a minimum of 10% being

contributed by the promoters. However, the capital contributed by AIFs for this

purpose shall be locked in for 2 years.

5. The tenure for lock-in should be reviewed at periodic intervals by SEBI keeping in

mind international practice.

6. While retaining the existing restrictions on the pledge of locked-in shares, a

minimal relaxation would be permitted whereby locked-in shares could be pledged

for loans taken by the company for other objects of its business as laid down in its

memorandum and articles of association.


4.5.3.1 On the recommendations of PMAC regarding relevance of the term 'Promoter'

post-listing (Pts. 1 and 2 above), it is pertinent to note that there is a reference in

SCRR regarding classification of 'Promoter', 'Promoter Group' and 'Public'. Further,

the term 'Promoter' holds significance in various continuous disclosure obligations

cast under the Listing Agreement and SEBI (Prevention of Insider Trading

Regulations), 1992. There is also a reference to the term 'Promoter' in the proposed

Companies Bill, 2011. It is, therefore, proposed to retain the term 'Promoter', post

listing as well for the time being and revisit the issue at a later date.

4.5.3.2 It is proposed to accept the recommendation of the Committee at Pt. 3 above.

4.5.3.3 It is proposed to accept the recommendations of the Committee on minimum

promoters' contribution and lock-in thereof as stated at Pt. 4 above, as this would be

a progressive step and would encourage start-ups by first generation entrepreneurs

who may not have the requisite minimum promoters’ contribution. However, it is

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proposed that the present requirement of lock-in of three years shall uniformly be

applied to both Promoters and AIFs. Further, although the Committee has

recommended that the lock-in shall be applicable even for issuers with

unidentifiable promoters, it is proposed to retain status-quo in this regard.

4.5.3.4 It is proposed to accept the recommendation of the Committee at Pt. 5 above.

4.5.3.5 On the recommendation of the Committee regarding pledge of locked-in shares

(Pt.6 above), the existing requirement of restricting the pledge of locked-in shares

only for the purpose of financing one or more of the objects of the issue is with a

view to ensure the commitment of the promoters towards the objects of the issue.

Accordingly, any dilution on this count may not be desirable. It is, therefore,

proposed to retain the existing requirements in this regard.

4.6 Disclosure of objects of the issue and means of finance in the draft red

herring prospectus (“DRHP”)


Post the issuance of observation letter by SEBI, the extant regulations stipulate

conditions that would trigger fresh filing of the draft offer document. It also specifies

conditions which only require filing of the updated offer document with updation fees

and certain conditions requiring filing of updated document without any fees.


1. For a DRHP already filed, an addition to the objects to the issue resulting in

increase in estimated issue size above 25% of the earlier issue size, will require a

re-filing of the offer document with the payment of a fresh filing fee.

2. Any deletion to the objects of the issue or reduction of an object which leads to a

decrease in the issue size by above 25% will typically not necessitate re-filing,

unless SEBI has grounds to believe that there is an exacerbation of risk.

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3. Where the increase or decrease in estimated issue size is between 10-25%, the

offer document will require updation based on the payment of the requisite updation

fee.

4. Where the increase or decrease in the estimated issue size is less than 10%, the

offer document will be permitted to be updated without the payment of any fee.

5. In IPOs, General Corporate Purposes ("GCP") will not exceed 25% of the

estimated issue size. However, no such restriction will apply to FPOs and rights

Issues.

6. The minimum time period between the RHP filing with the Registrar of

Companies (“RoC”) and the opening of the issue should be altered to 3 working

days (from the present 3 days).

7. The validity of SEBI's observation letter shall be retained at one year.


4.6.3.1 The recommendations at Pts. 1 to 4 above seek to ease the conditions that trigger

refiling of the draft offer document by BRLMs with SEBI. It is, therefore, proposed to

accept the recommendations of the Committee subject to modifying the trigger limit

to 20%, instead of 25%.

4.6.3.2 On the recommendation of the Committee pertaining to GCP at Pt.5, it is felt that

the reasons behind capping the limit of GCP in IPOs are equally relevant for FPOs

and Rights Issues as well. It is, therefore, proposed to extend the restriction on GCP

to FPOs and Rights Issues as well.

4.6.3.3 It is proposed to accept the recommendations of the Committee at Pts. 6 and 7

above.

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4.7 Annual updation of the prospectus


Presently, upon closure of the issue, the issuers update the RHP with the price

discovered through the book built process and submit a copy of the final prospectus

to RoC and SEBI. Thereafter, upon listing, issuers are bound by the continuous

disclosure obligations cast on them in terms of various provisions of the Listing

Agreement. The provisions of the Listing Agreement contain, inter-alia, periodical

disclosures regarding the company’s financial information, shareholding related

changes, material developments in the business, etc. Such disclosures are also

disseminated in public domain by the stock exchanges.

Post listing, any further developments related to the company are disclosed to the

stock exchanges on an as and when basis and depending on whether the company

considers it material or not. Apart from these, certain periodical disclosures are also

mandated. Thus, all such information is available in fragments and there is no single

document which contains all subsequent updates of the company at one place. As a

result, one who desires to invest in the shares of the company in the secondary

market has to sift through various individual disclosures made or rely on the reports

of the analysts for the purpose.

Also, listed entities, when they opt for FPOs or rights issues need to prepare the

offer document [Letter of Offer (“LoF”) for Rights Issues and Prospectus for FPOs]

that is almost as comprehensive and exhaustive as in the case of the IPO

document. This process is time consuming and since most information about these

companies is in public domain, some of the disclosures in the document prepared

for further capital offerings could appear redundant. More particularly, in the case of

a rights issue, since shareholders have been in receipt of annual reports and other

papers relating to passing of key resolutions, preparation of a comprehensive LoF

does not appear too relevant. In this context, although companies are permitted to

come with reduced disclosures for rights issues/FPOs, such flexibilities are

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available to only those listed entities who comply with certain eligibility norms

prescribed for the same.


1. Updation of information about a company in the form of post-issuance

disclosures should be done annually. For this purpose, SEBI could be guided by the

report of the SEBI Committee on Disclosures and Accounting Standards (SCODA)

on integrated disclosures.

2. Till such time as the SEBI project for online filing of continuous disclosures is

completed, these should be accessible through stock exchange website links.

3. SEBI may examine the feasibility of replicating the annual 20F filing, with suitable

modifications, if needed, as is done in the US markets. Such filings can then be

incorporated into the information memorandum by listed entities during a

subsequent capital raise. For companies which are planning IPOs, this requirement

should commence with the IPO. For existing listed entities, SEBI should consider

introducing this provision in a phased manner. While similar annual reporting

requirements exist in India as well, all relevant disclosures under 20F-type filings

could be suitably built in as a part of the annual filings.


4.7.3.1 The above recommendations seek to update the disclosures made by issuers at

the IPO stage on an annual basis so as to ensure that at any point of time, updated

information in respect of such issuers is available in public domain. Listed entities,

while making follow-on offerings (FPOs and Rights Issues), may be permitted to

incorporate disclosures that are available in public domain, by way of suitable

references without a requirement to repeat the same in the follow-on document. It is

proposed to accept the recommendations of the Committee.

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4.8 Procedure for the filing and regulatory scrutiny of offer documents


SEBI’s role as far as the issuance process is concerned is to peruse the draft offer

document filed by BRLMs and comment on the disclosures in the offer document.

Amongst the three iteration of documents that are available in public domain

(DRHP, RHP and Prospectus), the DRHP is available in public domain for the

longest period, about 3 months. However, in several cases, significant

changes/observations/details of litigations have been added after the DRHP stage

and the same are reflected only in the RHP which is hardly available in the public

domain before opening of the issue. Since the DRHP is made public from the date

of filing the same with SEBI, it provides sufficient scope for competitors/other rival

players in the industry to raise baseless issues and deliberately delay the fund

raising process of the issuer.


1. The practice of making the DRHP available in the public domain provides

transparency and boosts confidence. It needs to continue. Confidential filing of the

DRHP is not desirable.

2. Objective criteria would need to be specified for the quality of disclosures in the

DRHP. Where disclosures are significantly deficient, SEBI should adopt the practice

of rejecting the DRHP.

3. Upon rejection of a DRHP, the company should not be permitted to make a fresh

filing for a certain period of time. To begin with, stipulating a one year waiting period

would appear fair.

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4.8.3.1 On the feasibility of a confidential filing process for the Indian markets, the

Committee has recommended (Pt.1 above) against introduction of the same on the

grounds of greater transparency. It is proposed to accept the recommendations of

the Committee.

4.8.3.2 As regards putting in place a framework for rejection of offer documents (Pts. 2 and

3 above), it is felt that the availability of such a mechanism is critical from the point

of view of ensuring that only reasonably credible issuers with adequate disclosures

in their offer documents are allowed to access the public issuances route. There is a

need to protect the interest of investors since they may not always be in a position

to assess the risks associated with a business model due to complexities involved

therein. It is, therefore, proposed to accept the recommendations of the Committee.

Accordingly, the proposed framework for rejection of offer documents containing the

illustrative list of criteria for the purpose is detailed in Annexure-III to this

Memorandum.

4.9 Allocation to various classes of investors


Current Regulations require that in all book built issues, the allocation of net offer to

public shall be not less than 35% to RIIs, not less than 15% to NIIs and not more

than 50% to QIBs (5% of which shall be allocated to Mutual Funds). In mandatory

book built issues, atleast 50% of the net offer to public is required to be allotted to

QIBs.


1. It is recommended that the three current investor allocation categories be

reduced to two – retail and non-retail. The non-retail category would club together

NIIs and QIBs. However, for the purpose of disclosure during the offer period, a

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break-up of QIB and NII subscription shall be provided, so as to enable retail

investors to note the extent of QIB subscription before investing.

2. With all IPOs being structured as voluntary book-built issues, the retail allocation

would need to be at least 35% of the net public offer, as at present. An issuer could

opt for a higher retail allocation if it chooses, subject to disclosure in the offer

document. An under-subscription in either category could be compensated by the

other.

3. Retail subscriptions will continue to be capped at Rs. 2 lakh per investor.

4. Minimum application size for all investors shall be increased to Rs. 10,000-Rs.

15,000.

5. All retail applicants shall be given allotments no less than the minimum bid lot

computed in this manner, subject to availability of shares. The remaining shares

shall be allotted on a proportionate basis. For non-retail applicants, the existing

system shall continue.

6. No withdrawal or lowering the size of bids shall be permitted for non-retail

investors at any stage. Such restrictions shall be clearly spelt out as a condition

precedent in the offer document. However, retail investors will be permitted to

withdraw or downsize their bids until the finalisation of allotment.


4.9.3.1 On the Committee's recommendations (Pt. 1 above), i.e., to combine the three

investor allocation categories from the QIB, NII, RII buckets to 'Retail and 'Non-

retail' (QIB and NII) categories, the downside could be that out of the 65% meant for

the 'non-retail' category, QIBs may crowd out the domestic institutional

investors/NIIs/corporates who may have otherwise got a greater share of the issue

if the present bucket of 15% were to be retained. It is, therefore, proposed to retain

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the existing classification of QIBs, NIIs, RIIs in the ratio of 50:15:35. This would also

be in line with the objective of having widely dispersed public shareholding in listed

entities.

4.9.3.2 Further, the Committee has recommended that an under-subscription in either

category could be compensated by the other (Pt.2). However, this could result in a

situation wherein an issue that has been under-subscribed in the QIB and NII

bucket is foisted upon unwary RIIs. It is, therefore, proposed not to accept the said

recommendation to this extent.

4.9.3.3 As regards the recommendations of the Committee at Pts. 3, 4, 5 and 6 above, it is

proposed to agree with the same.

4.10 Two-stage issuance process


Presently, in India, public issues are simultaneously open for both institutional

investors and RIIs unlike certain international jurisdictions wherein certain

institutional investors pick up the entire offering from issuers and thereafter down-

sell the same to RIIs. Such a possibility of allotting the entire issue to institutional

investors at the first stage after which it could be sold to RIIs was discussed by the

Committee.


The two-stage issue process for IPOs does not merit adoption.


It is proposed to accept the recommendation of the Committee.

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4.11 Open book vs. closed book


Presently, an open book system is in place in the Indian markets wherein the

category-wise subscription details are made public during the offer period. The

possibility of a closed book system in the Indian context was discussed by the

Committee.


1. The closed book does not merit adoption. The advantages of transparency in an

open book outweigh the disadvantages in terms of unfair practices that could be

spawned.

2. Other ways of alerting retail investors about unfair practices by QIBs in an issue

need to be devised.


The prevalent open book system may be continued in the Indian context on the

grounds of greater transparency for the market and public at large. It is proposed to

accept the recommendation of the Committee.

4.12 Modification of the bidding period consequent to a revision in the price band


Presently, Regulations require that the bidding period shall be a minimum of three

working days and a maximum of ten working days, including the number of days for

which the book is kept open in case of a revision in price band. In case the price

band is revised, the bidding period is required to be extended for a minimum of

three working days, subject to the cap of ten working days. The extant requirement

restricts an issuer from extending the bidding period in case there is no revision of a

price band.

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1. The offer period for an issue is recommended to be shortened to either 2 or 3

working days, the precise period being indicated in the RHP and the issue-opening

advertisement.

2. One extension of not more than 2 working days could be allowed irrespective of

whether there is change in the price band. Equally, if there is an extension, all

investors will have the option to withdraw their earlier bids made until the revised

issue closure date.


On the Committee's recommendations to reduce the issue period, it is felt that such

a move would induce greater process efficiencies and enhance the confidence in

the issue. It is proposed to accept the recommendations of the Committee.

4.13 Price discovery process in book-built issues

4.13.1 Current Provision

In an IPO, an issuer may announce the floor price or price band at least two working

days before the opening of the offer period. In the case of an FPO it needs to be

announced at least a day before the offer period opens. However, in actual practice,

price band information alongwith the relevant financial ratios are disclosed about 5

days before issue opening.

As a consequence of this, during the brief period before an issue opens, there is no

information contained in the RHP on the price band, minimum bid lot and category-

wise number of shares on offer, for the benefit of prospective investors.


1. Disclosure of the price band in the RHP is infeasible and ought not therefore to

be mandated.

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2. The basis upon which the issue price, the price band and other related ratios

have been computed, should be disclosed in the price band advertisement and the

issue opening advertisements of the IPO. These should also be available on the

stock exchange websites concerned and on the websites of stock exchanges for the

ASBA interface.

3. The current process of a common offer period for all categories of investors

should continue.


4.13.3.1 As regards recommendations at Pts.1 and 2 above, it is stated that currently, there

are three advertisements in relation to opening of the issue, viz., 'pre-issue'

advertisement, 'price band announcement' advertisement and the ‘issue-opening’

advertisement, in that order. The 'pre-issue' advertisement contains only broad

details of the issue and the issuer without any price band information. The 'price

band announcement' advertisement contains critical information relating to price

band alongwith relevant financial ratios at both ends of the price band. There is a

requirement to announce the price band atleast 2 working days before opening of

the issue; whereas, in practice, the ‘price band advertisement is issued on an

average of 5 days prior to issue opening.

4.13.3.2 Since the 'issue opening' advertisement follows the price band announcement

advertisement, it may not serve any meaningful purpose to repeat critical price band

information in the 'issue opening' advertisement, as has been recommended by the

Committee. Instead, it may be more relevant to require that the price band

alongwith the relevant financial information is announced through an advertisement

atleast 5 working days prior to the date of issue opening. Since issuers are, in any

case, disclosing this about 5 days before issue opening, it may not be too onerous

to explicitly require the same by way of a regulatory requirement as well. It is,

therefore, proposed that the price band alongwith relevant financial information shall

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be published by way of an advertisement atleast 5 working days prior to opening of

the issue.

4.13.3.3 As regards recommendation of the Committee at Pt.2 above on availability of price

band information on the stock exchange websites concerned and on the websites of

stock exchanges for the ASBA interface, it is proposed to accept the same.

4.13.3.4 As regards recommendation at Pt.3 above, it is proposed to accept the same.

4.13.3.5 Further, it is also proposed that the information relating to price band may be pre-

filled in the application forms that are available for download from the websites of

the stock exchanges.

4.14 Allotment process


Presently, allotment is on a proportionate basis to all classes of investors with a

discretionary allotment only to the Anchor Investors category.


1. Proportionate allotment to non-retail investors, other than to anchor investors,

should continue.

2. Status quo may be maintained as regards discretionary allotment to anchor

investors.


15,000.

4. All retail applicants shall be allotted at least the minimum application size, subject

to availability of shares in the aggregate. (If there are an inadequate number of

shares to ensure this, then allotment shall be through lottery). The remaining shares

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for retail investors shall be allotted on a proportionate basis. For non-retail

applicants, the existing system shall continue.


The above recommendations of the Committee seek to ensure that every RII is

allotted a certain minimum number of shares. This would encourage wider retail

participation in public issues. It is proposed to accept the recommendations of the

Committee.

4.15 Investment by BRLMs and their associates in public issues


A BRLM is not permitted to invest in a public issue managed by it. However, there is

no prohibition on the participation of an associate company of the BRLM.

A BRLM, which is also an associate company of the issuer, is permitted to

participate in the marketing of the issue but not in the due diligence process. A

market practice has however evolved wherein such a BRLM signs the due diligence

certificate so as to declare itself as one of the BRLMs on the cover page of the offer

document.


1. Associates of BRLMs managing a public issue may continue to be permitted to

invest in the issue, though such an investment would not be mandatory. While there

could be conflicts of interest, group investment of this nature could signal

confidence in the issue. With the allotment process being proportionate with no

discretion in allotment, the conflict of interest appears contained.

2. A BRLM which is also an associate of the issuer shall have the restricted role of

marketing the issue, and shall accordingly declare itself as a 'marketing lead

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manger' on the cover page of the offer document. However, all the BRLMs to the

issue, including the marketing BRLMs, will need to sign the due diligence certificate.


The above recommendations of the Committee seeks to bring in ample clarity on

the role of a BRLM who may be an associate of the issuer by way of adequate

disclosures for the purpose. It is proposed to accept the recommendations of the

Committee.

4.16 Broad-basing the definition of QIBs


A QIB is presently defined to include, inter-alia, mutual funds, venture capital funds,

foreign venture capital institutions, foreign institutional investors and their sub-

accounts, scheduled commercial banks and provident funds. QIBs are therefore

deemed to be financially sophisticated investors who are legally recognised by

securities market regulators world-wide as needing less protection than other public

investors.


1. In view of the proposed reclassification of investor categories into retail and non-

retail categories, recommended elsewhere in this report, the QIB share becomes

part of the non-retail category.

2. SEBI shall specify the eligibility criteria for Indian entities to register as QIBs

similar to the practice followed in registering/regulating the overseas entities, such

as, HNIs/Funds/Trusts, who desire to invest in India.

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4.16.3.1 On the recommendation of the Committee at Pt.1 above, the same may not be

applicable, as it is proposed to retain the existing classification for investor

categories, viz., QIBs, NIIs and RIIs.

4.16.3.2 On the recommendation of the Committee at Pt.2 above to broaden the definition

of QIBs so as to include new category of investors, it is felt that the existing

definition of QIBs is adequately inclusive and it may not be necessary to modify the

extant framework.

4.17 Revision in pricing for QIPs


Regulation requires that QIPs be priced at not less than the average of the weekly

high and low of the closing prices of the equity shares of the same class quoted on

the stock exchange during the two weeks preceding the relevant date.


1. The minimum price at which a QIP is offered needs greater sensitivity to

difficulties which arise in a falling market. It is recommended that the issuer may

offer a maximum discount of 5% to the price calculated as per the SEBI

Regulations.

2. Shareholder approval should be obtained for offering the QIP with this revised

minimum price.


The recommendations of the Committee would provide flexibility to issuers on

pricing QIPs which are primarily private placements made to QIBs. It is felt that such

flexibility could be helpful for issuers to carry out QIPs during volatile markets. It is

proposed to accept the recommendations of the Committee.

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5.0 (This portion has been excised)

6.0 Evolving an appropriate mechanism for effective monitoring of issue proceeds

6.1 Current Provision

Currently, the extant framework requires that in public issues exceeding Rs. 500 Cr.,

the issuer shall make arrangements for monitoring the proceeds through a

monitoring agency which can be a Scheduled Commercial Bank or a Public

Financial Institution. Such monitoring agency is also required to submit a six monthly

Report to the issuer till the issue proceeds are fully utilised. In case there are any

deviations, the issuers are required to report such deviations to the stock

exchanges. In addition, the Listing Agreement requires all issuers to submit a

statement of material deviations in the utilization of issue proceeds vis-à-vis the

stated objects in the prospectus.

Also, listed entities are required to disclose to their Audit Committee, on a quarterly

basis, the use of issue proceeds and, on an annual basis, prepare a statement of

funds utilised for purposes other than stated in the objects of the issue and submit

the same to the stock exchanges.

6.2 SEBI’s Views and Proposal

There is a need to strengthen the efficacy of the existing mechanism so as to

reinforce investor confidence in the markets as well as instill discipline amongst

issuers. Accordingly, it is proposed to put in place additional mechanisms for

monitoring of issue proceeds within the extant legal framework.

7.0 Proposal

The Board is requested to:-

A. Consider and approve the proposals under the following headings:-

1. IPOs in electronic form and distribution channels for public offerings and

distribution channels for public offerings at Para 4.2.3.2

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2. Eligibility criteria for IPOs at Paras 4.3.4.2 and 4.3.4.3

3. Eligibility criteria for follow-on public offers and rights issues through the fast-

track route at Para 4.4.3

4. Minimum promoters’ contribution, lock-in and pledge of shares at Paras

4.5.3.1, 4.5.3.2, 4.5.3.3, 4.5.3.4 and 4.5.3.5

5. Disclosure of objects of the issue and means of finance in the DRHP at Paras

4.6.3.1, 4.6.3.2 and 4.6.3.3

6. Annual updation of the prospectus at Para 4.7.3.1

7. Procedure for the filing and regulatory scrutiny of offer documents, including

rejection framework at Paras 4.8.3.1 and 4.8.3.2

8. Allocation to various classes of investors at Paras 4.9.3.1, 4.9.3.2 and 4.9.3.3

9. Two-stage issuance process at Para 4.10.3

10. Open book Vs. Closed book at Para 4.11.3

11. Modification of the bidding period consequent to a revision in the price band at

Para 4.12.3

12. Price discovery process in book-built issues at Paras 4.13.3.2, 4.13.3.3,

4.13.3.4, 4.13.3.5

13. Allotment process at Para 4.14.3

14. Investment by BRLMs and their associates in public issues at Para 4.15.3

15. Broad-basing the definition of QIBs at Para 4.16.3.2

16. Revision in pricing for QIPs at Para 4.17.3

17. (This portion has been excised)

18. Evolving an appropriate mechanism for effective monitoring of issue proceeds

at Para 6.2

B. Authorize the Chairman to make consequential amendments to applicable

regulations/Listing Agreement.

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Annexure - I

REGULATORY AND PROCESS REVIEWS FOR INDIA'S PRIMARY MARKET

REPORT OF THE PMAC OF SEBI

Introduction

The primary equity capital market disintermediates the process of corporate capital

access by providing a direct link between investors with financial savings and

companies raising capital by issuing securities. With the establishment of SEBI as the

regulatory body for the securities markets in India over two decades back, the primary

capital market has transformed in several ways, not least in its adoption of a regulatory

philosophy very different to the earlier period of the Controller of Capital Issues. The

primary capital market dynamic has consequently altered, and despite its volatility over

the years in terms of issuance volumes, it has over long years acted as a powerful

disintermediator of finance for India's companies. It has thereby become a critical

instrument of economic development.

SEBI's objective has been to make the process of investing in primary markets

transparent and efficient, with the completion of each issuance being organised so as to

be fair to investors and safe in terms of minimising risks which can be anticipated and

cutting out fraudulent practices. A number of reforms have therefore been initiated over

the years to the IPO process. The principles adopted by SEBI over this period include

the shift from a merit to a disclosure based regulatory regime, the introduction of book

building guidelines, norms on communication through advertisements, rationalized

disclosures for listed companies, and the introduction of alternative issuance processes

such as qualified institutions placements (QIPs) and fast track issuances.

SEBI's Primary Market Advisory Committee ("PMAC"), in its meeting held on November

17, 2011 constituted a Sub-Committee under the Chairmanship of Dr. P J Nayak. The

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Sub-Committee’s Report was discussed by the PMAC in its meeting held on July 31,

2012. The deliberations and the recommendations of the PMAC are provided below.

Principles

In the course of its deliberations, the Committee noted that the very large number of

amendments made over the years to the regulatory framework for the primary market

gave regulatory law a 'patchwork' appearance, encouraging the Committee to articulate

broad principles upon which a reformulation could be envisaged. These principles

included:

1. Investor protection to be adopted as the cornerstone of primary market regulation.

This implies that while regulation would rely on issue-disclosures to guide investors,

SEBI's gate-keeping role to prevent poor quality issues from accessing the market

would also need to be more prominent than before.

2. Adequate due diligence to be recommended as the basis of investments for all

categories of investors, rather than retail investors 'looking over their shoulders'

to assess the participation of institutional investors as the predominant criterion for

investing. Where retail investors are ill-equipped to conduct such due-diligence, they

would need financial advice. Investment in the IPO market is intensely risky for

uninformed investors.

3. A simplification and rationalisation of guidelines which would reduce both the number

of categories of investors for which specific allocations are to be made, as also

eliminate the distinction between voluntary and compulsory book building.

4. Greater sensitivity to the changing ownership structure of India's companies, which

has implications for the design of primary market regulation and the constraints imposed

upon promoters of companies which access the primary market.

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A. REGULATORY FRAMEWORK FOR PUBLIC ISSUES

I. Eligibility criteria for initial public offers

Current Provisions

1. In the present disclosure-based regime, while companies have been allowed to

access the market subject to adequate disclosures, certain objective eligibility criteria

have been put in place to decide the mode of issuance, viz. compulsory or voluntary

book-built mechanism. Companies that satisfy the conditions laid down under

‘profitability track record route’ can access the market under the voluntary book-built

route in which a minimum participation requirement by Qualified Institutional Buyers

(QIBs) is waived. This is based on the premise that the existence of a good operating

history for a certain period, leading to an adequate minimum net worth and profitability,

would create credibility about an issuer.

2. In parallel with this, in order to provide sufficient flexibility so that companies setting

up green field projects or younger and smaller companies are not disadvantaged on

account of rigid eligibility criteria that may hamper their fund raising plans, an alternative

'compulsory book-built' route has also been provided to companies not eligible under

their profitability track record. The most critical difference in this second alternative

criterion is the requirement of minimum subscription by QIBs which is expected to lend

credibility to the issue and provide signals to NIIs on the issue quality.

Deliberations

1. A fundamental argument against the adoption of dual criteria for issuance is that the

second (compulsory book-built) criterion could admit companies at the cost of sound

investor protection. Companies ineligible in terms of a minimal track record as laid down

in the first criterion get to access the public markets. A scrutiny of regulation in other

major markets reveals that the need for such a track record of profitability is invariably

built into regulatory law, although the precise profit norm may differ.

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2. Ruling out the second criterion (compulsory book-building) would encourage

companies without an adequate track record to access capital in the form of private

equity (or venture capital in the case of very early stage companies), which would

encourage more thorough due diligence. It is observed that Indian companies access

public markets very early in their life cycle compared to other, possibly more mature

markets. With private equity being more liberally on offer in India today, compared to a

decade back, keeping early stage companies from the public markets could improve the

quality of such markets, without necessarily impeding good quality young companies

from accessing capital through other means.

3. This second criterion has also encouraged companies with a very inadequate track

record in the infrastructure and manufacturing sectors from accessing public markets.

Investor protection is weakened, for instance, if an infrastructure company which has

hitherto not created any productive capacity, but which promises a future string of

capacities yet to be created, is permitted to access the IPO market. Such polar

situations are best avoided in the market for IPOs.

4. The rebuttal that, to insist on a minimal track record (in the form of profits), could lead

to a manipulation of accounts, has been made, and some companies have been

suspected to game the situation in their favour. This rebuttal is however best countered

through SEBI de-barring auditors who have signed off on such erroneous accounts from

auditing listed companies in future for a specified number of years. Companies utilising

such auditors ought not to be permitted to raise fresh capital.

5. It would also be helpful to specify the necessary track record precisely. While criteria

such as minimum revenue and asset size were considered for adoption, in accordance

with the practice in most other market jurisdictions it is felt that minimum profit has the

advantage of simplicity and would boost investor confidence. Further, there are several

asset-light sectors such as services, ruling out asset size as a suitable criterion. Further,

the move to more stringent profit criteria such as minimum return on equity is a

trajectory which SEBI could possibly pursue in the years ahead.

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6. Another rebuttal in specifying a minimum profitability track record arises from certain

sectors taking much longer to attain profitability. Insurance and infrastructure companies

are quoted as examples. It must however be recognised that a longer period for a

company to break even implies greater risk for investors if they are to provide capital to

the company ahead of such break-even. The existing mandatory book-building process,

wherein retail investors come into providing capital to the company on the back of

institutional investors, provides a poor proxy for safe investing, and precludes the

importance of each investor investing on the basis of adequate due diligence rather

than relying on surrogate signals such as the extent of institutional participation.

7. There was also a recognition that related-party transactions could help boost the

profits of a company. Several ways of curbing such a practice were discussed:

Disregarding such profits or putting a cap of 20% on such related party transaction

profits are two options. However, for several firms, such related party transactions are

legitimate business transactions, especially with group companies or ancillary

companies which transact business. An unintended consequence of ruling out a

proportion of such profits is that, in order to access the primary market, companies may

then be induced to change the way group companies are organised for business, which

would impose a wholly avoidable transactions cost on the group. It was therefore felt

that disclosures were the most preferred option. BRLMs should be asked to scrutinise

such related-party transactions and ensure adequate disclosures.

8. If the revised criterion for IPO eligibility, as recommended below, had been adopted

during the 4 calendar years 2008-11, out of 76 companies with a minimum issue size of

Rs 100 crore during that period, 37 companies would have qualified whilst 39

companies would not have. The post-listing performance of these 76 companies

(relative to the market index) is tabulated below:-

Eligible Scrips Ineligible Scrips

No. of Issues 37 39

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Price movement after 1 Week 7% 1%

Price movement after 1 Month 7% -5%

Price movement after 2 Months 6% -7%

Price movement after 6 Months 8% -3%

Further, these 39 ineligible companies accounted for 33% of the total funds raised.

Thus, a consequence of the norms now proposed is that the focus on investor

protection will lead to a significant fall in IPO issuances. The Committee believes that

this trade-off between investor protection and volumes of issuance is worthwhile.

Recommendations

1. The Committee recommends that in order to access the primary market through an

IPO, a company should have been profitable for at least 3 out of the preceding 5 years,

with a minimal average pre-tax profit during the 3 most profitable years of Rs. 15 crore.

2. Profitability would be computed on a restated, consolidated basis. Divisional profits

would be permitted to be carried forward in cases of situations like de-mergers.

3. A full disclosure would need to be made of related party transactions with the BRLMs

certifying the extent to which profits from these transactions constitute legitimate

business profits.

4. It is recommended that the compulsory book-building mechanism be discontinued.

5. SEBI should penalise the audit firms that have certified the books of accounts of

companies which were later found to have been manipulated, including debarring them

for a specified period from certifying the accounts of listed companies.

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II. Eligibility criteria for follow-on public offers and rights issues through the fast-

track route

Current Provisions

1. The present guidelines provide that companies need a minimum average market

capitalisation of Rs 5000 crore to access the fast-track route.

Deliberations

1. The existing threshold of Rs 5000 crore provides an advantage to larger and better

capitalised companies in comparison to mid-cap companies.

2. Making the fast-track route available to all companies might be undesirable, as there

is a restricted due-diligence on the fast-track route. It would therefore be preferable to

reduce the threshold. It is observed that as on March 31 2012, at BSE, 252 and 174

companies had market capitalisation of over Rs. 3000 Cr and Rs. 5000 Cr. respectively.

At NSE, the corresponding numbers were 250 and 172.

3. In volatile or falling markets, several companies see a significant erosion in their

share prices, and therefore slip below the threshold average market capitalisation norm.

If the number of companies permitted to access the fast track route is not to be severely

restricted, it would be preferable to reduce the average market capitalisation threshold.

Recommendation

1. The threshold average market capitalisation level for companies to access the market

though fast-track FPOs and rights issues should be reduced to Rs. 3000 crore.

III. Minimum promoters’ contribution, lock-in and pledge of shares

Current provisions

1. Minimum promoters’ contribution: 20% of the post-issue capital, in the case of an

IPO, FPO or a composite issue.

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2. Lock-in: Minimum promoters’ contribution to be locked in for 3 years from the date of

commencement of commercial production or date of allotment in the public issue,

whichever is later. Holdings in excess of minimum promoters’ contribution and entire

pre-issue capital to be locked in for 1 year.

3. Pledge: Shares pledged with creditors are ineligible to be reckoned as minimum

promoters’ contribution. Shares held by promoters and locked in (for the purpose of

minimum promoters’ contribution) may however be pledged as collateral security with

any scheduled commercial bank or public financial institution for any loans granted for

financing one or more of the objects of the issue, provided the pledge of shares is one

of the terms of the loan sanction.

4. Transfer: Shares held by a promoter and locked in may be transferred to another

promoter or person of the promoter group or a new promoter or a person in control of

the issuer. Further, shares which are locked in and held by persons other than

promoters may be transferred to any other person holding shares which are similarly

locked in.

Deliberations

1. The Committee noted that the intent of specifying minimum promoters’ contribution,

lock-in and pledge thereof is to secure promoters’ commitment to the company for a

certain period of time and to lend credibility to the issue.

2. Permitting transfer or pledging of such shares could dilute this objective, since the

shares could then get transferred resulting in a change of control of the company

consequent to loan default.

3. In most market jurisdictions, the concept of a company promoter finds no mention in

capital market regulation. Instead, from a corporate governance perspective, it is

customary to distinguish between inside and outside shareholders, the former also

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known as controlling shareholders. The inside shareholder is a wider and more flexible

concept than a promoter, allowing for control to evolve and change over time, without

regulation constraining this. Thus, a founding promoter of a company might sell its

shareholding to a new inside shareholder. Alternative investment funds (particularly

private equity funds) are often inside shareholders but not promoters. It appears

desirable that regulation in India moves in that direction, as otherwise the fluid transfer

of shares which could be good for shareholder value creation could be impeded.

4. The concept of a promoter is also problematic in certain companies which are

employee-managed with no discernible promoter. As Indian industry matures a

significant number of companies will not be family-owned but started by like-minded

professionals. This is already visible in the services sector making the identification of a

promoter group more difficult.

5. As against this there is a less sanguine perspective which points to the spectre of

certain companies in which capital has been raised after which promoters sell out and

the companies subsequently flounder. The lock-in of shares has merit as it counters

such moral hazard.

6. As a way of reconciling these two contrasting perspectives, the promoter concept

could be used for a company during a specified initial period of time after the company

lists. Thereafter the concept would cease to have relevance.

7.The present regulatory insistence on promoters holding at least 20% of the post-

issuance capital could also deter professionals and technically skilled entrepreneurs

desirous of starting businesses. However, the moral hazard issue, discussed earlier,

could also surface in such cases if the stipulation were to be relaxed. Again, a

harmonisation of these two opposing perspectives could be achieved by allowing

certain financial investors to agree to lock in shares, without being termed as promoters,

in order to get to the 20% lock-in threshold. Such a harmonisation would particularly

benefit professionals who are first-generation entrepreneurs without the financial

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capability of contributing the threshold equity, but with the credibility to induce financial

investors to provide balancing equity which would be locked in. Capital market

regulation should be encouraging of such a process. Many such financial investors are

however reluctant to be termed as company promoters, with the added obligations this

would bring under the Companies Act.

8. The lock-in of shares by controlling shareholders in FPOs, under certain conditions,

should similarly be retained.

9. Restrictions on the pledging of locked-in shares could also restrict the ability of

company promoters to raise finance for other objects of the company, such as a

diversification of business. A limited relaxation for this purpose, but not more widely,

would be helpful.

Recommendations

1. The term 'promoter of a company', in terms of securities market regulation, would

apply for a period of 3 years from the date of commencement of commercial production

or date of allotment in an IPO, whichever is later.

2. After this period, those shareholders who voluntarily ask to be categorised as

controlling shareholders would be termed accordingly, with greater fluidity being

permitted to sell shares under securities laws, though banks and financial institutions

who are creditors to the company may impose additional constraints on share transfers.

3. The existing requirement of a minimum promoters’ contribution of 20% shall be

retained, which will be locked in for 3 years from the date of allotment in the IPO.

4. In companies without promoters, or (in exceptional cases) in companies founded by

professionals or first generation entrepreneurs where the post-IPO equity held by

promoters is less than 20%, alternative investment funds could be permitted to provide

the balance equity to be locked in for a duration similar to those of promoters, subject to

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a minimum of 10% being contributed by the promoters. However, the capital contributed

by AIFs for this purpose shall be locked in for 2 years.

5. The tenure for lock-in should be reviewed at periodic intervals by SEBI keeping in

mind international practice.

6. While retaining the existing restrictions on the pledge of locked-in shares, a minimal

relaxation would be permitted whereby locked-in shares could be pledged for loans

taken by the company for other objects of its business as laid down in its memorandum

and articles of association.

IV. Disclosure of objects of the issue and means of finance in the draft red herring

prospectus

Current Provisions

1. Changes to a Draft Red Herring Prospectus (DRHP) are categorised as requiring

either updating or fresh filing. An updated offer document is filed with SEBI along with a

flat nominal fee. A fresh filing of a draft offer document is processed as a new offer

document.

2. Present regulations require a fresh filing of a document if the estimated issue size

increases or decreases by more than 10%, as also if there is any addition or deletion to

the objects of the issue resulting in a change in estimated issue size or estimated

means of finance by more than 10%.

3. Updated documents need to be filed within a year of SEBI's observations.

4. Issuers file draft offer documents with SEBI, based either on the number of shares

proposed to be issued or on the value of the indicative issue size. With the offer

documents BRLMs pay filing fees with SEBI, calculated on the basis of the upper end,

the lower end, or the median of the price band.

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Deliberations

1. The merits of shortening the validity period of a year of SEBI's observations to a

DRHP were considered. In weak market environments the present adequately long

period is helpful, and should be retained. In strong markets, BRLMs are likely to turn

around the observations much faster.

2. The current options for estimating the issue size for the purpose of computing the

SEBI filing fee also lead eventually to a re-filing in a large proportion of cases, in view

particularly of the +/- 10% variation clause, which is readily breached in volatile markets.

The principle needs to be established that an altered risk perception should be the

predominant reason for re-filing. Most other reasons should be covered under updation.

3. A decrease in the issue size, even if it be by more than 10% (unless it leads to a

capital shortfall in the completion of a project), or a deletion of some of the objects of an

issue, will normally reduce risk and should therefore necessitate an updating of the offer

document, rather than a fresh filing.

4. One way of avoiding a change in the objects of the issue is to specify these at the

Red Herring Prospectus (RHP) stage rather than at the DHRP stage. It would however

be unwise for SEBI to clear a DHRP without a specification of the objects of the issue.

5. One of the permitted objects of an issue is General Corporate Purposes (GCP), an

omnibus residual item. The merits of capping this amount as a proportion of the total

issue size were discussed. Leaving it uncapped could induce capital to be raised for

what might appear to be non-specific purposes, in order to escape from the post-

issuance monitoring discipline stipulated by SEBI. On the other hand, certain categories

of companies, such as in the services sector, may have no specific 'projects' for which

capital is being raised. Even in other sectors, there might be legitimate business

grounds for a company to build a 'treasury chest' of surplus cash for future business

opportunities, including acquisitions, though it was unlikely that surplus cash on a

company's balance sheet for a long duration would create shareholder value. On

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balance, and other than in exceptional circumstances, a cap on GCP would appear

prudent.

6. The minimum time period between filing a RHP with the Registrar of Companies and

the issue opening for subscription, has also become problematic. RoC regulations

presently permit a minimum of 3 days, but this is proving difficult to adhere to because

of the time taken in the updation of the RHP, and the printing and distribution of forms.

Recommendations

1. For a DRHP already filed, an addition to the objects to the issue resulting in increase

in estimated issue size above 25% of the earlier issue size, will require a re-filing of the

offer document with the payment of a fresh filing fee.

2. Any deletion to the objects of the issue or reduction of an object which leads to a

decrease in the issue size by above 25% will typically not necessitate re-filing, unless

SEBI has grounds to believe that there is an exacerbation of risk.

3. Where the increase or decrease in estimated issue size is between 10-25%, the offer

document will require updation based on the payment of the requisite updation fee.

4. Where the increase or decrease in the estimated issue size is less than 10%, the

offer document will be permitted to be updated without the payment of any fee.

5. In IPOs, GCP will not exceed 25% of the estimated issue size. However, no such

restriction will apply to FPOs and rights Issues.

6. The minimum time period between the RHP filing with the RoC and the opening of

the issue should be altered to 3 working days (from the present 3 days).

7. The validity of SEBI's observation letter shall be retained at one year.

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V. Annual updation of the prospectus

Current Provisions

1. Upon closure of an issue, the issuer updates the RHP with the price discovered

through the book-built process and submits a copy of the final prospectus to RoC and

SEBI. Thereafter, upon listing, company is bound by the continuous disclosure

obligations cast on it in terms of various provisions of the listing agreement.

2. After listing, any further developments related to the company are disclosed to the

stock exchanges on a quarterly, bi-annual, annual or as-and-when basis, the last only if

the company considers it material to do so. Thus, all such information is available in

fragments and there is no single consolidated document which contains all subsequent

updates of the company at one place. As a result, a prospective investor has to sift

through various individual disclosures made or rely on the reports of analysts who cover

the stock.

3. Other than financial reporting, which is certified by the auditors of a company, other

periodical filings such as the shareholding pattern or the status of utilisation of issue

proceeds, are typically not required to be certified or vetted by any external entity, and

any disclosures made on these are purely voluntary, at the behest of the issuer

company.

Deliberations

1. Continual investor-centric disclosures need to be improved since, after listing,

information about the company is not centrally available. Consequently, the company’s

Annual Report is the predominant source of information, but these disclosures may not

necessarily relate well to earlier listing disclosures.

2. SEBI informed the Committee that it was executing a project to enable the issuers to

provide online filing of material information, which would then be available on a central

database with SEBI and would be accessible by members of the public. It was also felt

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that continuous post-issue disclosures, particularly for large companies, should assist

them in faster subsequent access to the primary market. It was observed that the US

has a similar practice (the 20F filing).

Recommendations

1. Updation of information about a company in the form of post-issuance disclosures,

should be done annually. For this purpose, SEBI could be guided by the committee

report on integrated disclosures.

2. Till such time as the SEBI project for online filing of continuous disclosures is

completed, these should be accessible through stock exchange website links.

3. SEBI may examine the feasibility of replicating the annual 20F filing, with suitable

modifications, if needed, as is done in the US markets. Such filings can then be

incorporated into the information memorandum by listed companies during a

subsequent capital raise. For companies which are planning IPOs, this requirement

should commence with the IPO. For existing listed companies SEBI should consider

introducing this provision in a phased manner. While similar annual reporting

requirements exist in India as well, all relevant disclosures under 20F-type filings could

be suitably built in as a part of the annual filings.

B. PUBLIC ISSUE PROCESS

VI. Procedure for the filing and regulatory scrutiny of offer documents Current

Provisions

1. SEBI’s role is to peruse the draft offer documents filed by BRLMs and comment on

the adequacy of disclosures in the offer documents.

2. Among the three iterations of documents available in the public domain (DRHP, RHP

and prospectus), DRHP is available for the longest period, about 3 months. However, in

several cases, significant changes, observations or details of litigation are added after

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the DRHP stage and these get reflected in the RHP which is available in the public

domain just a few days before the opening of the issue.

3. While several constructive criticisms are received after the DRHP is put into the

public domain, SEBI has noticed that it also provides scope for competitors and interest

groups antagonistic to the company to raise baseless issues and deliberately delay the

company's fund raising. Frivolous complaints have been rising.

Deliberations

1. Attending to frivolous complaints takes up a considerable amount of time in SEBI.

The merits of a confidential filing were assessed, which would reduce delays in the

vetting of the DRHP, but this would imply that the first document open for public scrutiny

would be the RHP. This would have the merit of public scrutiny occurring after the

document has undergone an initial regulatory review. However, the period of public

scrutiny would then be confined to just a few days. Moreover, the current system of

making the DRHP public provides for fuller public scrutiny, thereby bolstering investor

protection, a principle which must outweigh the nuisance value of frivolous complaints.

SEBI may need to find other ways of dealing with such complainants, drawing a cue

perhaps from the way Indian courts have recently begun dealing in odd cases with

frivolous litigants.

2. There are DRHPs filed with SEBI which sometimes contain inadequate and poor

disclosures, and sometimes also provide incomplete financial data. In other cases,

disclosures can appear vague, inconsistent or inadequate, sometimes with the intent of

being technically compliant with the requirements of regulatory law, although not with

the spirit of the law. In order to dissuade such DRHPs being filed, the outright rejection

of such DRHPs by SEBI, instead of referring them back to BRLMs with comments, may

have merit.

3. BRLMs argue that the reason disclosures are sometimes weak or incomplete is

because companies are unwilling to provide such information. If SEBI rejects a DRHP,

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there may also be merit in stipulating a waiting period before the same company does a

fresh DRHP filing. The signaling impact of this, that the primary market cannot be

accessed with poor disclosures, would be beneficial.

4. SEBI has also observed significant delays in replies to queries from BRLMs,

especially when the primary market is weak. There could be merit in providing time-lines

for responding to queries raised by SEBI, failing which the DRHP could be deemed by

SEBI as inactive or closed.

Recommendations

1. The practice of making the DRHP available in the public domain provides

transparency and boosts confidence. It needs to continue. Confidential filing of the

DRHP is not desirable.

2. Objective criteria would need to be specified for the quality of disclosures in the

DRHP. Where disclosures are significantly deficient, SEBI should adopt the practice of

rejecting the DRHP.

3. Upon rejection of a DRHP, the company should not be permitted to make a fresh

filing for a certain period of time. To begin with, stipulating a one year waiting period

would appear fair.

VII. Distribution channels for public offerings

Current provisions

1. The geographical spread of the primary market continues to be restricted. The main

limiting factor is the inadequate reach of distribution channels under the present

syndicate-based distribution.

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2. The Companies Act stipulates that payments for shares in primary offers need to be

made by cheque. Some years back, SEBI introduced an alternative payment

mechanism called Applications Supported by Blocked Amounts (ASBA). ASBA has

hitherto been made mandatory for QIBs and NIIs, but not for retail investors.

Deliberations

1. A significant impediment to widening the geographical reach of the primary market

arises from the payment system adopted. A mandatory insistence on ASBA,

complemented by other on-line payment channels, could relieve the existing payment

inefficiencies. SEBI needs to steer this trajectory. 2. The spread of core banking

software across all commercial banks in the country makes ASBA a feasible payment

mechanism for banks to handle. If all bank branches are trained in the operations of

ASBA payments - which is not complex - this would significantly widen the primary

market reach.

3. The present ASBA process is characterised as a 'syndicate ASBA' process, as

applications are collected by the syndicate and sent to specified bank branches with

payment authorisations. The process could however become less complex and

therefore less fraught with operational risk if it moved to a 'bank ASBA' process wherein

investors give their applications directly to banks. If the ASBA application form requires

the broker’s code to be mentioned, the interest of brokers selling a primary issue is

taken care of. The primary issue will then close faster.

4. The Companies Act provision that payments need to be made by cheque could

however constitute a legal hurdle to dispensing with cheques and making ASBA and

other on-line payment channels mandatory. This would need to be resolved by SEBI in

discussion with the Central Government.

5. An alternative way of widening distribution reach is to ensure the emergence of a new

institutional category of 'aggregators' who collect applications and payment instruments

(cheques or ASBA authorisations) from investors and remit aggregate orders to the

BRLMs and make consolidated payments to a stipulated bank account. Selected

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brokers could act as aggregators, and retail investors would be mandated to come in

through such aggregators. However, the evolution of such a system would be based on

trust in brokers, and it is likely that complaints would increase. To begin with, refund

orders would preferably need to go directly into the investors' accounts rather than

through the aggregator, if such a system were to be adopted. share allotments would

also similarly be made directly in the investors' names.

6. The need for compressing time-lines for the closure of an issue once it opens for

subscription is also important. In this respect India's primary market compares

unfavourably with its secondary market, as also with the primary markets in several

other jurisdictions. One of the factors contributing to delayed closure is the large number

of retail applications with associated payment complexities.

7. In the context of the need for a faster closure of primary issues, a portal-based IPO

application facility could also become a competitive channel. Analogies can be drawn of

many websites which facilitate payment transactions for other services, such as IRCTC

for railway tickets, as also airline websites and travel portals for airline and hotel

bookings. Conceptually, stock exchanges could jointly create a portal which could be

linked to banks. In one such model, an investor would enter the portal website, key in

relevant details (bank account, PAN, DP Account, bid details etc.) and apply for an IPO.

A one-time verification would be needed (before the first such investment by each

investor on the portal) to complete a KYC process to validate details. While this channel

of investing holds great promise, it would need to grapple with two problems listed

below.

8. First, there would be highly fluctuating margin call requirements to the exchanges

across different offerings. The risk management of this would be more complex than in

the case of secondary market trading. A risk-tested viable model could however expand

retail participation in the primary market significantly, and lead to much faster closure of

issues.

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9. Second, the manner in which primary issues are to be sold, and the role and

incentives of BRLMs and the syndicate, would need to be defined. Historically, the

distribution of primary issues (through syndicates) has differed from that of secondary

issues (through brokers). By permitting all brokers to sell a primary issue, an individual

broker may be inadequately incentivised to be associated with the issue in a distribution

leadership function. This would need resolution.

Recommendations

1. In the near term, a shift from the present 'syndicate ASBA' to a 'bank ASBA', together

with making ASBA mandatory for all primary issue payments, would bring significant

efficiencies in the time taken to close issues, and extend the geographical and retail

reach of the market.

2. In the medium term, portal-based investing could provide a competitive alternative.

The problems of risk management and of distributor incentives would need handling,

and are more complex than in secondary markets.

3. In addition, distribution of IPOs through the broker network of stock exchanges

should be permitted subject to legal feasibility.

4. It would be desirable to view the three channels for investing, indicated above, as

part of a composite menu of choices available to investors, phased in sequentially if

necessary.

VIII. Allocation to various classes of investors

Current Provisions

1. Present regulation requires that in voluntary book-built issues to the public, the

allocation of the net offer shall be not less than 35% to retail investors and not less

than 15% to NIIs. The balance goes to QIBs (5% of which shall be allocated to mutual

funds). In compulsory book-built issues, at least 50% of the net offer to the public is

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required to be allotted to QIBs. In both forms of book-building, shortfalls in categories to

which there are threshold allocations specified can be passed on to other categories.

2. In most other jurisdictions, retail investors do not generally participate directly in

primary market offerings. There is a separate category of institutional/broker investors,

who act as aggregators for retail investors. An aggregator receives payment from retail

investors, makes a consolidated application and, upon allocation, undertakes the re-

distribution of allotted securities as well as refunds, if any. Such a process simplifies

and speeds up the closure of an issue, involving as it does just institutional investors.

3. While retail investors in other jurisdictions typically invest indirectly (through

aggregators) in primary issues, India has had a history of direct retail participation. This

acquired momentum during the FERA dilution years under the regulation of issues of

the Controller of Capital Issues. These issues were generally priced at a discount to

intrinsic value, with the expectation of sizable capital gains upon listing. The cult of the

retail investor in India's markets got born, and a study by Prime Database estimates that

about 70% of today's retail investors entered the equity market through IPOs.

Deliberations

1. Defining just two investor allocation categories, retail and non-retail (with the latter

comprising QIBs & NIIs) might also have merit. Presently, NIIs have a 15% allocation,

which gets crowded out in heavily subscribed issues. NIIs are also known to bid for an

allotment size strategically (depending on their expectations of how heavily

oversubscribed the issue will be). They must therefore be regarded as sophisticated

investors, in some ways similar to QIBs in the level of scrutiny and due diligence

exercised.

2. Investor allocation guidelines for FPOs might also need to differ from those applicable

to IPOs, as FPOs have some differing characteristics, particularly as the stock being

offered is available in the secondary market. In such cases, the rationale of having

distinct investor allocation categories such as retail and non-retail, lose their relevance.

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This is reinforced by empirical evidence which demonstrates that retail participation in

FPOs in recent years has been low.

3. The minimum application size also needs to be increased, from Rs 5,000-7000 which

was fixed in May 2004. It is observed that the GDP Deflator has increased from 100 in

2004 to 162.12 in 2012. Further, CPI-IW in May 2004 was at 508, and has risen to 954

in May 2012. This increase justifies an upward adjustment in the minimum application

size. Besides, unlike bank deposits, the equity market has a risk-characteristic which

makes it unsuitable for financial inclusion and, hence, very small investors who are

unable to invest even to the extent of the minimum application size should be dissuaded

from investing in equities as they bear risks disproportionate to their income and wealth.

4. In heavily, over-subscribed issues, there is merit in permitting a method of allotment

which ensures that all applicants receive at least a certain quantum of shares, as

otherwise they will be left with small lots of shares. (In the past, in such heavily

oversubscribed issues, several investors who had bid at the 'cut-off' price had not been

allotted any shares, as allotments were based on a lottery). There are merits therefore

in mandating a minimum application size of allotment to all retail investors, followed by a

proportionate allotment.

Recommendations

1. It is recommended that the three current investor allocation categories be reduced to

two – retail and non-retail. The non-retail category would club together NIIs and QIBs.

However, for the purpose of disclosure during the offer period, a break-up of QIB and

NII subscription shall be provided, so as to enable retail investors to note the extent of

QIB subscription before investing.

2. With all IPOs being structured as voluntary book-built issues, the retail allocation

would need to be at least 35% of the net public offer, as at present. An issuer could opt

for a higher retail allocation if it chooses, subject to disclosure in the offer document. An

under-subscription in either category could be compensated by the other.

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3. Retail subscriptions will continue to be capped at Rs. 2 lakh per investor.


15,000.

5. All retail applicants shall be given allotments no less than the minimum bid lot

computed in this manner, subject to availability of shares. The remaining shares shall

be allotted on a proportionate basis. For non-retail applicants, the existing system shall

continue.

6. No withdrawal or lowering the size of bids shall be permitted for non-retail investors at

any stage. Such restrictions shall be clearly spelt out as a condition precedent in the

offer document. However, retail investors will be permitted to withdraw or downsize their

bids until finalisation of allotment.

IX. Two-stage issuance process

Current Provisions

1. There are two modes of issuance – fixed price and book-built. In a fixed price issue,

allotments are made at that fixed price (decided jointly by the issuer and the BRLMs

before the issue opens) on a proportionate basis. In a book-built issue either a floor

price or a specified price band is specified, and investor demand sought from different

investor categories (QIBs, NIIs, retail investors) through an open book. Based on the

prices at which the bids have been received from investors, the issue price is

determined and securities allotted on a proportionate basis to all classes of investors. In

the book-building process, the roles of various intermediaries involved in the process

such as syndicate/sub-syndicate members, registrars and underwriters, are well spelt

out. The BRLMs elicit demand from the different investor categories alike and 'discover

the price' of the issuance. Most Indian public offerings have adopted the book-built

route.

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2. BRLMs are required to 'soft underwrite' all book-built offerings, in the sense of

ensuring that once the subscription period closes with the required investor demand

having been met, any shortfall in realising the 90% minimum subscription amount on

account of cheque returns and withdrawals are compensated by the BRLMs. Soft

underwriting to prevent such settlement risks is common in most mature markets.

Deliberations

1. There is a perception that issuers and BRLMs collaborate to over-price IPOs,

evidenced by prices of several offerings falling steeply in the secondary market on and

after the day of listing. It has been suggested that pricing would be fairer if a two-stage

IPO issuance process is adopted wherein the entire issue is first subscribed to by the

BRLMs who subsequently sell the shares to other interested investors.

2. Besides going beyond the requirements of soft underwriting, BRLMs would then need

to be adequately capitalised to purchase offerings on their own balance sheets. During

buoyant market periods when large and multiple offerings occur, investment bankers

would need to be extremely well capitalised. This would have implications also for the

structure of the industry, which would then become more oligopolistic.

3. An ex-ante judgment on whether an IPO is overpriced needs investors to exercise

due-diligence based on disclosures made by the issuer, and guided by financial advice.

Regulation should strive to improve the quality of disclosures. Further, an ex-post

evaluation on the extent to which IPOs have been overpriced in recent years must

analyse price falls in relation to the fall in the market, and greater empirical work is

needed. There is extensive empirical finance work in other markets to suggest that IPOs

typically tend to be underpriced (rather than overpriced) in relation to the market index,

on account of the agency (or moral hazard) problem between company managements

and public shareholders.

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4. An eventual call must be taken on the basis of whether BRLMs to IPOs are seen as

performing a predominantly advisory function. This is the function performed in most

other jurisdictions.

5. The Committee was informed that SEBI was separately finalising a paper on

providing a safety-net to investors in primary market issues.

Recommendations

1. The two-stage issue process for IPOs does not merit adoption.

X. Open book vs. closed book

Current Provisions

1. Regulation requires that at the end of each day that an issue is open for subscription

(also known as the bidding period) the aggregate cumulative investment demand

(including allocations made to anchor investors) shall be depicted graphically on the

bidding terminals of syndicate members and websites of recognised stock exchanges.

This information is displayed in a standardised format for at least 3 days after the close

of the offer period, separately for each investor category (QIBs, NIIs and retail). This

information disclosure is termed as an 'open book'.

2. The identity of investors who bid (including QIBs) is however not made public.

3. Regulation also provides the option of closing the offer period for the QIB book a day

ahead of other investor categories.

4. QIBs are permitted to reduce bids which have been entered until the offer period

ends, but not thereafter. Retail investors and NIIs can amend or withdraw their bids until

allotment of shares is made. However aggregate information on any such amendment

or withdrawal after the closure of the offer period is not publicly displayed as part of the

open book.

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Deliberations

1. A consequence of the open book is that large numbers of retail investors have tended

to invest on the basis of information displayed on the extent of QIB investments. This

has prompted companies and BRLMs to induce QIBs to put in large bids early in the

offer period. Some QIBs have been seen to reduce their bids very substantially just

before the offer closure. This gaming, in order to attract retail investors, can leave

inadequately vigilant retail investors trapped in an offering wherein QIBs have

minuscule bids retained.

2. In order to prevent such gaming, which constitutes a reprehensible practice, the

merits of moving to a 'closed book', where evolving bid information is not displayed,

need assessment. Could this be an option provided to issuers?

3. The weakness of a closed book is that no one can be sure that the book is indeed

closed. Select leaks of information on how the book is building can occur to certain

interested bidders. As no one knows for sure, an active grapevine could then develop.

The transition from a transparent to an opaque book could then spawn dishonest

practices, putting a premium on knowing how the book is building. This would be very

undesirable.

4. Retail investors have mitigants under an open book in that they can withdraw their

bids after the closure period and before allotment, if manifest evidence of gaming by

QIBs is thrown up. In an extreme situation, if less than 90% of the issue size is not

allotted, BRLMs' soft underwriting commitment could be invoked. But this presupposes

adequate vigilance on the part of retail investors.

Recommendations

1. The closed book does not merit adoption. The advantages of transparency in an

open book outweigh the disadvantages in terms of unfair practices that could be

spawned.

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2. Other ways of alerting retail investors about unfair practices by QIBs in an issue need

to be devised.

XI. Modification of the bidding period consequent to a revision in the price band

Current Provisions

1. Regulation requires that the bidding period shall be between 3-10 working days.

However, if the price band is revised, bidding needs to be extended for at least another

3 days, subject to the overall offer period not exceeding 10 days.

2. The bidding period cannot be extended if there is no revision in the price band.

Deliberations

1. Shorter offer periods are efficiency-inducing. It would also enhance confidence in the

issue. Efficiencies in the payments process in recent years also make shorter offer

periods feasible.

2. Within the context of such a shorter offer period, a brief extension could be

contemplated even when there is no revision in the price band. For example, an issue

may have collected close to 90% of the issue size (the minimum needed to close the

issue) but needs a brief extension to cross the 90% level.

Recommendations

1. The offer period for an issue is recommended to be shortened to either 2 or 3 working

days, the precise period being indicated in the RHP and the issue-opening

advertisement.

2. One extension for not more than 2 working days could be allowed irrespective of

whether there is change in the price band. Equally, if there is an extension, all investors

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will have the option to withdraw their earlier bids made until the revised issue closure

date.

XII. Price discovery process in book-built issues

Current Provisions

1. In an IPO an issuer may announce the floor price or price band at least two working

days before the opening of the offer period. In the case of an FPO it needs to be

announced at least a day before the offer period opens.

2. As a consequence of this brief period before an issue opens, there is no information

contained in the RHP (which is approved earlier) for the benefit of prospective investors

on the following: category-wise number of shares on offer; minimum bid lot; and the

price band.

Deliberations

1. Introducing the price band at the RHP stage, while desirable in terms of critical

information like the price band and certain financial ratios being available to investors,

has the disadvantage that the price band may get set in a manner which corresponds

poorly with the secondary market valuations after listing. Investors do, in any case, get 5

days from the announcement of the price band (T-2) till the issue closing date (T+3) to

decide on investing after availability of this fuller information. Further, in recent years

about 90% of retail investors have bid at the cut-off price, indicating that they are

generally price followers and do not take a pricing view on the investment.

2. Further, while regulation stipulates that the minimum gap between RHP filing and

issue opening is 3 days, in practice it is longer. The reason is that with the syndicate

being the main channel for retail marketing, application forms and prospectuses have to

be printed and distributed, necessitating adequate time between RHP filing and the

issue opening. This further exacerbates the difficulty of setting a price band in the RHP.

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3. The issue opening advertisement, which is placed in the media just prior to the issue

opening, could also be used for communicating such pricing information. This would be

in addition to the information in the price band advertisement typically released 2 days

prior to the opening of the issue.

4. Although issuers have the option of adopting either a floor price or a price band, they

have opted invariably for the latter. The main reason quoted is the logistical difficulty in

collecting the balance amount from the retail investor after the price is discovered, if a

floor price is adopted. With a price band the difficulty dissolves as the pricing invariably

occurs at the upper end of the band.

5. The merits were assessed of introducing a two-stage IPO process – with bidding by

QIBs in the initial stage, which would facilitate price discovery and a fixed-price issue for

the retail investors at the discovered price. The additional and cumbersome work

involved in operating such a two-stage process did not however appear worthwhile,

given that 90% of retail investors opt for the cut-off price.

Recommendations

1. Disclosure of the price band in the RHP is infeasible and ought not therefore to be

mandated.

2. The basis upon which the issue price, the price band and other related ratios have

been computed, should be disclosed in the price band advertisement and the issue

opening advertisements of the IPO. These should also be available on the stock

exchange websites concerned and on the websites of stock exchanges for the ASBA

interface.

3. The current process of a common offer period for all categories of investors should

continue.

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XIII. Allotment process

Current Provisions

1. The current allotment system is a proportionate-cum-lottery system for all categories

of investors. Each investor gets at least a minimum lot, and where the proportionate

allocation is in excess of this the number of shares allotted is rounded off to the nearest

integer. In this manner, investors get an allotment which is at least a minimum lot size.

2. In order to enable institutional investors to anchor public offerings in IPOs, 30% of the

QIB book is permitted to be allotted to such anchor investors on a discretionary basis,

subject to a 30 day lock-in. Anchor investors come in a day before the issue opens, and

the anchor investor prices are required to be disseminated before the issue opens.

Other QIBs receive a proportionate allotment.

3. Discretionary allotments to anchor investors are permitted in IPOs/FPOs.

Deliberations

1. While discretionary allotment to QIBs is an internationally accepted practice which

helps in the issuer selecting investors, which provide for stability and liquidity in the

after-market (the right mix of long-only and long-short investors), discretionary allotment

beyond the anchor investors could lead to market abuse in terms of BRLMs providing

higher allotments to their favoured clients.

2. Discretionary allotment in FPOs is a more complex issue. In IPOs, anchor investors

provide signals on the quality of the issue, but such signaling is less crucial in an FPO

which already has a set of non-promoter shareholders. In IPOs anchor investors also

facilitate the initial price discovery, which too is unnecessary in FPOs. The qualified

institutional placement route is in any case available as an option to the FPO, which

permits discretionary allotment.

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3. The minimum application size also needs to be increased, from Rs 5,000. Inflation-

indexing over the past decade justifies an upward adjustment. Besides, unlike bank

deposits, the equity market has a risk-characteristic which makes it unsuitable for

financial inclusion, and hence, very small investors who are unable to invest even to the

extent of the minimum application size should be dissuaded from investing in equities

as they bear risks disproportionate to their income and wealth.

4. In heavily, over-subscribed issues, there is merit in permitting a method of allotment

which ensures that all applicants receive at least a certain quantum of shares, as

otherwise they will be left with small lots of shares. (In the past, in such heavily

oversubscribed issues, several investors who had bid at the 'cut-off' price had not been

allotted any shares, as allotments were based on a lottery). There are merits therefore

in mandating a minimum application size of allotment to all retail investors, followed by a

proportionate allotment.

Recommendations

1. Proportionate allotment to non-retail investors, other than to anchor investors, should

continue.

2. Status quo may be maintained as regards discretionary allotment to anchor investors.


15,000.

4. All retail applicants shall be allotted at least the minimum application size, subject to

availability of shares in the aggregate. (If there are an inadequate number of shares to

ensure this, then allotment shall be through lottery). The remaining shares for retail

investors shall be allotted on a proportionate basis. For non-retail applicants, the

existing system shall continue.

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XIV. Investment by BRLMs and their associates in public issues

Current Provisions

1. A BRLM is not permitted to invest in a public issue managed by it. However, there is

no prohibition on the participation of an associate company of the BRLM doing so.

2. A BRLM, which is also an associate company of the issuer, is permitted to participate

in the marketing of the issue but not in the due diligence process. A market practice has

however evolved wherein such a BRLM signs the due diligence certificate so as to

declare itself as one of the BRLMs on the cover page of the offer document.

Deliberations

1. BRLMs are tasked by regulation to conduct due diligence and price the issues. An

associate company of the BRLM of a public issue taking a stake in the issue could

enhance the quality of due diligence conducted, induce realistic pricing and

generally reflect commitment to the issue.

2. A BRLM provides an intrinsically advisory function as a market intermediary, and is

not expected to invariably provide balance-sheet support. Making it mandatory for an

associate company to invest in an IPO it manages would therefore be undesirable.

3. There could moreover be conflicts of interest. Two such conflicts are readily

identified: first, that BRLMs may deliberately under-price an issue so as to benefit its

associate which picks up a stake in the offering; and second, that there could be an

inducement to manipulate the market price upon listing.

Manipulation of this nature after listing is therefore a matter of market concern.

4. The practice adopted in other countries varies. In some markets BRLMs are

permitted only to underwrite the offerings, while in others the associates of BRLMs may

invest in the offerings as well.

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5. While BRLMs which are associates of issuers are presently permitted to only market

the issue, such BRLMs not be comfortable doing so without carrying out the due

diligence process themselves. In order to bring precision to disclosures in such cases, it

appears desirable that such associates be termed as ‘marketing BRLMs’ on the cover

page of the offer document so that a possible conflict of interest is disclosed

prominently. Moreover, such BRLMs would be obliged to sign the due diligence

certificates.

Recommendations

1. Associates of BRLMs managing a public issue may continue to be permitted to invest

in the issue, though such an investment would not be mandatory. While there could be

conflicts of interest, group investment of this nature could signal confidence in the issue.

With the allotment process being proportionate with no discretion in allotment, the

conflict of interest appears contained.

2. A BRLM which is also an associate of the issuer shall have the restricted role of

marketing the issue, and shall accordingly declare itself as a 'marketing lead manger' on

the cover page of the offer document. However, all the BRLMs to the issue, including

the marketing BRLMs, will need to sign the due diligence certificate.

XV. Broad-basing the definition of QIBs

Current Provisions

1. A QIB is presently defined to include, inter-alia, mutual funds, venture capital funds,

foreign venture capital institutions, foreign institutional investors and their sub-accounts,

scheduled commercial banks and provident funds. QIBs are therefore deemed to be

financially sophisticated investors who are legally recognised by securities market

regulators world-wide as needing less protection than other public investors.

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Deliberations

1. There are certain categories of investors, such as family offices of wealthy

individuals, or other non-banking finance companies, which have not hitherto been

included in the definition of a QIB. In order to create added depth to the primary market,

it appears desirable that all major liquidity providers be included in the definition.

2. For IPOs, this Report has separately recommended that there should be just two

categories of investors, retail and non-retail, while for FPOs, there should be no investor

categorisation. As the non-retail category consists of QIBs and NIIs, the QIB definition

continues to retain significance in the context of these two forms of public offerings.

3. The QIB definition also retains significance for QIPs, as the latter can only be

subscribed to by QIBs.

4. A liberal broad-basing of the QIP definition risks bringing in entities which may not

have good market practices. Regulators elsewhere have recognised this and put fetters.

For instance, the US prescribes two criteria for an investor to qualify as a QIB: the first,

which is qualitative, requires the entity to be regulated in its jurisdiction of incorporation.

The second, which is quantitative, imposes tests of a minimum net worth or total assets

under management.

5. The current list of QIBs does not include several entities that may be regulated by

SEBI or RBI or other regulators. A move towards allowing all regulated entities to invest

as QIBs would appear desirable.

6. While this appears desirable, the participation by NBFCs (which are regulated

entities) appears more contentious, as an NBFC could be an associate of the issuing

company and could be used in ways which represent manipulative market practice in a

primary issue. In QIPs, particularly, where allotments are discretionary, such associate

NBFCs could be used to provide price support or even to non-transparently take a

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shareholding which the market may not realise is part of the issuer group, and which

violate the preferential guidelines.

7. There could be several ways of limiting the kind of NBFCs which could participate in

the primary market. One was to confine it to the RBI definition of a systemically

important NBFC. A second way would be to specify a minimum net worth or asset size

criterion. A third way would be to put constraints instead on the amount that NBFCs

could collectively invest, while dealing with market manipulation as an enforcement

issue. A fourth way is to include all NBFCs registered with RBI.

8. Each of the four options above has merits. The first two options also have the demerit

that by imposing threshold limits, a number of smaller NBFCs would be eased out even

though they might have good governance practices. This must also be seen in the

context of RBI having categorised NBFCs. While investment NBFCs have no ceiling

imposed on equity exposures, loan NBFCs are constrained as at least 51% of the

assets need to be in the form of loans.

Recommendations

1. In view of the proposed reclassification of investor categories into retail and non-retail

categories, recommended elsewhere in this report, the QIB share becomes part of the

non-retail category.

2. SEBI shall specify the eligibility criteria for Indian entities to register as QIBs similar to

the practice followed in registering/regulating the overseas entities, such as,

HNIs/Funds/Trusts, who desire to invest in India.

XVI. Revision in pricing for QIPs

Current Provisions

1. Regulation requires that QIPs be priced at not less than the average of the weekly

high and low of the closing prices of the equity shares of the same class quoted on the

stock exchange during the two weeks preceding the relevant date.

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Deliberations

1. In rising markets, QIPs are easier to price in conformity with regulation because the

prevailing price is higher than the two-week average. In falling markets it is -

analogously - sometimes impossible to price the QIP, and pricing has to await an

improvement in the market

2. An appropriate discount to the two-week average would assist in the pricing of a QIP

in a falling market.

Recommendations

1. The minimum price at which a QIP is offered needs greater sensitivity to difficulties

which arise in a falling market. It is recommended that the issuer may offer a maximum

discount of 5% to the price calculated as per the SEBI Regulations.

2. Shareholder approval should be obtained for offering the QIP with this revised

minimum price.

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Annexure - II

IPO Process through Nationwide Broker Network of Stock Exchanges in

Electronic Form

Budget Announcement

The Hon'ble Finance Minister announced the following in his speech while presenting

Union Budget 2012-13:

“Simplifying the process of issuing Initial Public Offers (IPOs), lowering their

costs and helping companies reach more retail investors in small towns. To

achieve this, in addition to the existing IPO process, I propose to make it

mandatory for companies to issue IPOs of Rs.10 crore and above in electronic

form through nationwide broker network of stock exchanges”

Meetings with Market Participants

SEBI has held 7 meetings with market participants such as Stock Exchanges,

Clearing corporation, Registrars to the Issue (RTI), Brokers, BRLMs, and BTI to

discuss the proposed mechanism so as to use the nationwide broker network of

stock exchanges.

The details of the meetings held are specified below:

Sr.

no.

Meeting date Details

1 March 28, 2012 Meeting with Stock Exchanges & Clearing Corporation to

discuss the proposed framework

2 March 29, 2012 Meeting with Bankers to the Issue to discuss the proposed

framework and understand their reach & issues faced

3 March 30, 2012 Meeting with Registrars to the Issue to discuss the

proposed framework and understand their concerns, if any

4 April 20, 2012 Meeting was held with Stock Exchanges to discuss the

revised process flow & to discuss few open points such as

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grievance mechanism, commission payment, etc

5 April 20, 2012 Meeting was held with Stock Exchanges, BTIs & RTIs to

jointly discuss the proposed framework and to identify

concerns, if any

6 June 19, 2012 Meeting was held with Stock Exchanges to discuss

conflicting views amongst stock exchanges with respect to

investor grievance & commission payment

7 July 10, 2012 Meeting was held with Stock Exchanges, RTIs, BTIs,

Investment Bankers Association and Brokers Association to

discuss the finer points and understand their concerns, if

any

Based on the feedback of various market participants in the above meetings, SEBI

has prepared a process flow which is an additional mechanism and will run parallel

to all the existing mechanisms

The process flow involves data stream from non-syndicate member to RTI involving

the BTI

A pictorial representation of the process flow is annexed at the end.

Benefits

The immediate benefit of the proposed mechanism will be the extended geographical

reach of the distribution channel using the brokers’ network of the stock exchanges. The

benefits of curtailing overall process timelines and reduction in cost of issue are

expected to accrue over a period of time. It may, however, be mentioned that the

proposed mechanism will run parallel to the existing system.

Process Schedule

Sr. no. Day Activity

1 T Non syndicate member (i.e. Broker) uploads bids on SE

platform. Prepares electronic schedules

2 T+1 Broker deposits cheque in local branch of the clearing bank(s)

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i.e. BTI & sends electronic schedules to the local branch

3 T+3/4 Local Branch marks for cheque return, updates electronic

schedule and sends it to the controlling branch

4 T+5 Controlling branch consolidates the electronic schedule of all

branches, reconciles the amount received with the bank

balance & sends it to RTI along with Final certificate

5 T+6 RTI follows usual process

Details of the proposed mechanism

Step 1: Investors can submit application to any broker & broker to upload the bid

Exchanges shall provide for download of application forms on their website, so

that any investor or broker can download/print the forms directly

Under the proposed mechanism, an investor can submit the application to any

registered broker of the exchange having its office in any of the collection center

As per the information provided by BSE/NSE, there are around 1038 locations

where atleast one of the clearing banks has a branch. Investors can approach

any of the brokers located in this locations.

Accordingly, only those broker centers where there is a presence of atleast one

of the branches of clearing bank shall be enabled by Stock Exchanges for

uploading bid on the Stock Exchange Platform.

Stock Exchanges shall provide for a separate flag to distinguish applications of

syndicate and non-syndicate members

Similar to Secondary market transactions where the investor can check the

status of its trade on exchange website, Exchanges shall facilitate investors to

view the status of its IPO application on the exchange website

It shall not be mandatory for a broker to accept an application

All accepted applications shall be stamped and thereby acknowledged by the

broker at the time of receipt

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If a broker accepts the application, he shall be made responsible for uploading

the bid on the Exchange platform – Broker shall be made liable for not uploading

the bid even after accepting the application

Stock Exchanges should take action against such Brokers and in case of

repeated offence, stringent action should be taken by the stock exchanges

against those brokers

Step 2: Broker to deposit the cheque, prepare electronic schedule and send it to BTI

If Issue size is less than Rs. 250 crore, issuer shall appoint atleast 5 clearing

banks as BTI

If issue size is more than Rs.250 crore, issuer shall appoint atleast 10 clearing

banks as BTI

Notwithstanding the above, if an issuer wishes to appoint any other SEBI

registered Bank as BTI, it may do so irrespective of the fact that such additional

banks are not clearing bank of any of the exchanges

SEBI shall review the above matter (with respect to BTI) after some time & based

on the performance, SEBI may mandate more banks to be BTI to an issue

All banks which accept the assignment as Banker to an issue, shall make sure

that atleast one of its branches in the collection center should accept cheque &

application for the said issue

Brokers shall deposit the cheque in any of the bank branch of the BTI in the

broker center within 1 day from the close of the issue

Broker shall also prepare the electronic schedule and send it to local branch of

the clearing bank within 1 day from the close of the issue

Brokers shall retain all physical applications initially and send it to Registrar after

6 months

Step 3: Local Branch to mark for cheque return, update electronic schedule and send it

to the controlling branch

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Local branch of the clearing bank shall update the schedule based on cheque

clearance & return cases and send it to controlling branch within 3/4 days from

the close of the issue

Step 4: Controlling branch shall consolidate the electronic schedule of all branches &

send it to RTI

Controlling branch shall consolidate the electronic schedule of all branches,

reconcile the amount received with the bank balance & send the consolidated

schedule to RTI along with Final certificate within 5 days from the close of the

issue

Step 5: RTI to follow the usual process

RTI shall reconcile the schedules received from the bank with the Stock

Exchange data

Registrar to calculate the compensation payable to each broker based on the

terminal from which bid has been uploaded and share the details with the

Exchange

RTI may request for physical application forms directly from Brokers in case of

mis-match in PAN/demat number

RTI to follow the usual process of reconciliation, allotment, refund, etc

Other important points

The proposed mechanism will also enable uploading ASBA applications. Suitable

procedures similar to Syndicate ASBA mechanism would be included in the

proposed mechanism.

Acknowledgement by the broker shall form the basis of any complaint

Brokers shall be made responsible for complaints against the sub-brokers

Stock Exchanges shall specify the complaint & grievance redressal mechanism

along with monetary/non-monetary penalty applicable

Issuer, BRLM & Exchange shall discuss and determine the commission that shall

be payable to the non-syndicate member & disclose it in the offer document

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Commission shall be payable based on applications which have been considered

eligible for the purpose of allotment

Based on the total commission payable as calculated by the Registrar, Issuer

shall disburse the amount to the exchange before listing & exchange in turn shall

pay to the brokers through clearing corporation within 2 days from the receipt of

money from the issuer

Listing shall be withheld by the exchanges till the time issuer pays brokers’

commission to the exchange

Issuer shall be liable to pay to the brokers for their activity even if the issuer

withdraws the issue during the issue period

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T+1

T+3/4

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Annexure - III

Framework for Rejection of Offer Documents

Background

Post-liberalisation, the Indian primary markets witnessed a paradigm shift from a merit

based regime to a disclosure-based regime. While this system has been in force for

about 20 years, some offer documents have, off-late, been filed with inadequate/sketchy

disclosures, raising concerns about the credentials of such issuers. There have been

instances wherein transactions involving the issuer have been carried out typically prior

to the DRHP, merely for a technical compliance with the regulatory requirements rather

than a compliance with the spirit of the law. Such cases have often been supplemented

by vague and circuitous responses from BRLMs to the queries raised, raising doubts on

the permissibility of such issuers to the public issuances market. Therefore, there is a

need to protect the interest of the investors where the investor may not be in a position

to assess the risks associated with a business model due to complexities involved

therein.

Under section 11A of SEBI Act, SEBI may prohibit any company from issuing

prospectus, any offer document, or advertisement soliciting money from the public for

the issue of securities.

Thus, the matter was put up for discussion in PMAC meeting held on July 31, 2012

along with presentation on sample disclosures and draft rejection criteria.

Discussion in PMAC

A presentation was made to the Committee, highlighting the poor quality of

disclosures/financials in some offer documents filed with SEBI. After deliberations, the

Committee unanimously agreed with the need to reject offer documents in such cases.

The Committee was broadly in agreement with the list of criteria that were proposed by

SEBI in this regard.

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The Committee further suggested that these criteria should be made public, so that

BRLMs and companies intending to raise money from public are aware of the same.

The Committee also deliberated as to whether the companies and BRLMs who file such

offer documents with SEBI should be penalized. After deliberations, the Committee

recommended the following:-

a) Companies whose offer documents are rejected should not be allowed to access

capital markets for at least 1 year and the same may be increased depending

upon the materiality of the omissions and commissions.

b) BRLMs shall also be liable for penal action after following due process of law.

c) The list of such offer documents rejected by SEBI along with the details of

issuers and LMs and the reasons for rejection shall be disseminated in public

domain.

While agreeing with the recommendations of PMAC, the following framework is

proposed.

Proposal

Against this backdrop and taking cues from some offer documents that had elements of

concerns which have been raised above, a set of parameters have been drawn up and

placed below, the triggering of which could potentially make the document liable for

rejection by SEBI.

Criteria for Rejection of Offer Document/s

a) Capital Structure:

i. Circular transactions for building up the capital/net worth.

ii. Ultimate promoters unidentifiable.

iii. Promoters’ contribution not complying with ICDR Regulations in letter and in spirit.

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b) Objects of the Issue

i. The object for which a major portion of the issue proceeds are proposed to be

utilized is vague.

ii. In case the object of the issue is “Repayment of Loan/ICD etc.”, where the

company is not in a position to disclose the ultimate purpose for which the loan

was taken and demonstrate utilisation of the same for the said purpose.

iii. The object for which the major portion of the issue proceeds are proposed to be

utilized does not create any tangible asset for a company which does not have an

established business. Expenses such as brand building, advertisement, payment

to consultants, etc.

iv. Where a major object of an issue is to set up a plant and the issuer has not

received clearance/licenses/permissions/approval from the competent authority.

Such approvals are important for commencement of the activity and if not received,

the issue proceeds cannot be utilized towards the stated objects of the issue.

v. If upon examination of the object, the gap between raising the funds and utilization

is unreasonably long.

c) Business:

Exaggerated, complex or misleading business model where the investors may not

be in a position to assess the risk associated with such business models.

d) Financial statements:

i. Sudden spurt in the business just before filing the offer document and reply to

clarifications sought is not satisfactory. Spurt in line items such as Income,

Debtors/Creditors, intangible assets, etc.

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ii. Qualified audit reports where the auditors raise doubt over the truth and fairness of

the books of accounts of Issuer Company or raise doubt on the different

accounting policies followed by the issuer company. This would also be applicable

for the subsidiaries or associate companies which significantly contributes the

business of the issuer company or where the issue proceedings are proposed to

be utilized.

iii. Change in accounting policy with a view to show better prospects for the company.

iv. Majority of the business is with related parties or circular transactions with

connected/group entities with a view to show that the company has better

prospects.

e) Litigation:

Concealment of material litigation/regulatory actions.

f) General:

i. Incomplete documentation in terms of ICDR requirements.

ii. Incorrect/vague/misleading disclosures in offer documents.

iii. Direct or indirect conflict of interest of the BRLM with the issuer beyond certain

limit. The indirect conflict of interest sometimes may not be quantifiable. In such

situations, the concerned Division/RO may take a call on materiality where he/she

feels that such conflict may affect the due diligence activity of the BRLM.

iv. The document may also be liable for rejection if the reply of LM to the queries

raised is not provided in time bound manner or is not satisfactory.

g) Applicability of the criteria

i. The rejection criteria would be applicable to all the offer documents filed with SEBI.

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ii. The above list of criteria are only illustrative/ indicative. In addition, SEBI may

consider any other criteria for rejection where it feels that investors will not be in a

position to assess the risks associated with such public offers.

iii. In all such cases a final view on rejection would be taken by SEBI only after

considering the materiality of the observations, which inter-alia means that merely

triggering the criteria would also not be considered as an automatic case for

rejection.

iv. The rejection criteria may be made public, so that BRLMs and companies

intending to raise money from public are aware of the same.

h) Consequences of rejection of offer documents

i. Companies whose offer documents are rejected should not be allowed to access

capital markets for at least 1 year and the same may be increased depending upon

the materiality of the omissions and commissions.

ii. BRLMs shall also be liable for penal action after following due process of law.

iii. The list of such offer documents rejected by SEBI along with the details of issuers

and LMs and the reasons for rejection shall be disseminated in public domain.