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Explained: New SEBI rules for IPOs, preferential allotments, and what they seek to achieve

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SEBI has made some changes to the rules relating to IPOs and preferential allotment of shares. Here are the answers to some of the key questions around the revised rules and the objectives of the new SEBI norms.

Explained: New SEBI rules for IPOs, preferential allotments, and what they seek to achieve
Capital and commodities market regulator SEBI on Tuesday amended the rules for initial public offerings, both for investors as well as the issuing companies. The regulator also made changes to the rules relating to preferential allotment of shares. We look at some of the revised rules, and the objectives behind SEBI’s decision to introduce them.
Fund raising by companies through IPOs:
Previous rule: Companies did not have to specify how much of the funds raised would be earmarked for acquisitions, and/or for routine investments.
New rule: If the company has not identified any acquisition or investment target, the amount for this and the amount for general corporate purpose (GCP) cannot exceed 35 percent of the total amount being raised. Also, if the acquisition target is not identified, the amount cannot exceed 25 percent of the total amount raised.
Reason: Many companies were raising money not because they had any specific requirement, but only because the market was hot and demand for IPOs was strong. Also, companies could be vague about how they would be using the funds raised through IPOs.
Impact: With closer scrutiny, companies may be a bit more judicious about how much money they want to raise.
Anchor investors
Previous rule: All anchor investors in an IPO had a lock-in period of 30 days from the date of allotment.
Revised rule: Anchor investors can sell half their shares after the 30-day lock-in, but can sell the remaining shares only after 90 days from the date of allotment.
Reason: Many companies were allotting shares to big name anchor investors to ensure that their IPOs got a good response from other institutional and retail investors. Many anchor investors would play along, since they could exit their investment in 30 days. This often hurt the non-institutional investors who had bought shares in the IPO and were still holding them.
Impact: Won’t affect the genuine anchor investors, but the less serious investors will think twice before investing just for the sake of endorsing the issue.
Non-institutional investors or HNIs
Previous rule: 35 percent of the IPO would be earmarked for NIIs.
Revised rule: One third of the portion available to NIIs shall be reserved for applicants with application size of more than Rs 2 lakh and up to Rs 10 lakh rupees.
Reason: To create a sub-category for individual investors who are no longer small investors, but don’t exactly fit the tag of an HNI either. Also previously, those HNIs who bid using their own funds were at a disadvantage to those HNIs who borrowed heavily and made large bids. When an issue got massively subscribed, those who made more bids always stood a better chance of allotment.
Impact: Won’t exactly make it a level playing field, but will reduce the edge that the big HNIs enjoy right now because of their ability to borrow heavily and bid.
Price band for book built IPOs
Previous rule: Companies going public could set a price band as they chose.
New rule: The upper price band has to be at least 105 percent of the lower price band. For example, if the lower price band is Rs 100, then then the upper price band has to be Rs 205 at least.
Reason: Price bands in book-built issues exist for a reason; to ensure proper price discovery. But this was being followed only on paper and not in the true spirit of the law. Sometimes the difference between the upper and lower end of the price band was so narrow that it made a mockery of price discovery. It would appear that the promoter and the merchant bankers had already decided on a price and then set a meaningless price band just to comply with the rule. Given the strong demand, most investors were forced to bid at the upper end to ensure that they don’t miss out.
Impact: Companies will be forced to price their issues more realistically, and there will be better price discovery as well.
Offer for sale
Previous rule: No limits on sale of shares by existing shareholders
New rule: Existing shareholders owning more than 20 percent of pre-issue cannot offer more than 50 percent of their shares in an IPO. Those holding less than 20 percent of pre-issue, cannot sell more than 10 percent of their shares.
Reason: Many companies were coming out with IPOs not because they needed capital, but more with an aim to offer an exit to existing shareholders, especially private equity funds. Also, because of the exuberance in the IPO market, the shares would be offered at high valuations. This often worked to the advantage of early investors, at the expense of investors who came in through the IPO.
Impact: Early investors will be forced to have some ‘skin-in-the-game’. This could indirectly result in better pricing of the IPO, because a debacle in the secondary market would make it difficult for these investors to sell their remaining stake.
Preferential allotment pricing formula:
Previous rule: Floor price to be higher of the volume weighted average price (VWAP) of the last two weeks or the last 26 weeks.
New rule: Floor price to be higher than VWAP of last 90 days or 10 days.
Reason: Many companies were issuing shares cheap to investors of their choice, and there were reasons to believe that such deals had some quid pro quo arrangements between the companies and investors not known to public shareholders.
Impact: Companies will now have to price their preferential issues closer to market prices.
Change in control/more than 5 percent offered through preferential allotment
Previous rule: No valuation report required from a registered independent valuer.
New rule: Valuation report from a registered independent valuer required.
Reason: To ensure that minority shareholders don’t get shortchanged. Recently, PNB Housing Finance tried to give a controlling stake to private equity investor Carlyle at a price seen as unfair to minority shareholders of PNB Housing Finance.
Impact: Companies will be forced to price preferential allotments fairly.
Utilisation of IPO proceeds
Previous rule: Funds raised through IPOs were not monitored by rating agencies.
Revised rules: Rating agencies to monitor use of IPO proceeds till 100 percent of it is spent.
Reason: Many companies are known to misuse funds raised through IPOs
Impact: Remains to be seen how the rule will be enforced. Some market watchers feel the new rule adds to the compliance layers, and will have limited impact.
Settlement proceedings
Previous rule: There was no deadline for filing of settlement applications by companies charged with violating SEBI rules
New rule: If companies want to settle a case through consent plea, they will have to apply for it within 60 days from the date of receipt of the show cause notice or a supplementary notice, whichever is later.
Reason: Many entities, especially large companies and wealthy individuals would file for settlement after prolonged litigation. This was an indirect way of wearing down the regulator which would be fighting multiple such cases.
Impact: This could help SEBI save time and money on costly legal battles.
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