Market watchdog Sebi has proposed a ‘safety-net’ provision for hedging the downside risk of a retail shareholder who has invested in an initial public offer (IPO). In a nut-shell, the provision will call upon the promoter of the company going public to ensure a compulsory buyback of shares from retail investors if the share price tanks within three months of listing.
The proposal, which is aimed at boosting retail investors participation at the primary market, seeks to create a clause which shall protect retail investors, who have invested during the IPO of a firm, if the share price of the company shrinks more than a fifth from the issue price, adjusted for swings in the broader market index.
Sebi has floated a discussion paper for creating mandatory safety-net mechanism and has called for comments from the public.
This followed an empirical finding which tracked the price performance of the scrips listed during 2008 to 2011. It revealed that out of 117 scrips, 72 (around 62 per cent issues) were trading below the issue price after 6-months of their listing. Out of those 72 scrips which witnessed fall in price, in 55 scrips the fall was more than 20 per cent of the issue price. Sebi noted that if the trend continues, the sentiment of the investors would get affected and they may lose confidence in the capital market.
Many stocks crash soon after listing as HNIs and other institutional investors cash out after propping up an issue. The proposal floated by Sebi would tend to arrest this volatility in a stock soon after listing in which typically a retail investors ends up with loss.
As per the proposal, the safety net provision shall trigger only in cases where the price of the shares depreciate by more than 20 per cent from the issue price. The price for this provision shall be calculated as the volume-weighted average market price of such shares for a period of three months from the date of listing.
This 20 per cent would be calculated over and above the general fall, if any, in market index. The market index for this purpose may be BSE-500 or S&P CNX 500, as per the Sebi draft proposal. It has added that the market index to be considered for this purpose shall be disclosed, in advance, in the offer document.
The provision will encompass all the allotted securities to original resident retail individual allottees who had made an application for up to Rs 50,000. This, in effect, also narrows the definition of a retail investor. As per current norms, listed companies distinguish between retail and large individual shareholders on the basis of value of holding above Rs 1 lakh.
However, Sebi has added that the total obligation on the ‘safety net provider’ will be capped at five per cent of the issue size. If the total number of shares offered under the safety net scheme works out to be more than five per cent of issue size, the purchase of securities from original resident retail individual allottees shall be done on proportionate basis such that total obligation does not exceed five per cent of the issue size.
The proposal has set a time period of three months for the safety net. The issuer or the merchant banker to the IPO would need to announce, within three working days from the date of completion of three months from listing date, whether the safety net provisions have been triggered and invite eligible shareholders to tender their shares.
Eligible investors may tender their shares to safety net provider under the scheme during the 10 working days period from the date of announcement and the shares, so tendered, shall be kept in escrow account till successful settlement of shares and funds. The settlement of shares and funds shall be completed within another ten days.
Sebi has said the eligible investors may tender their shares through a separate exchange window (similar to buyback of shares) and clarified that the primary safety net obligation would rest with the promoters of the issue. However, they may choose to fulfil the same, directly or through BRLMs/any other safety net provider. This arrangement would need to be disclosed in the offer document.
Any acquisition of shares under the scheme of safety net shall be exempt from the provisions of SEBI (SAST) Regulations, 2011.
(Edited by Prem Udayabhanu)