Explained | How will revised IPO rules affect the market?

The story so far: The Securities and Exchange Board of India (SEBI) on Tuesday came out with some fresh rules for initial public offerings (IPOs).

The new rules will oversee how companies price their shares, how they use the money that they receive from investors, how much of their stake promoters of a company can sell during an IPO, and how soon anchor investors can sell the stakes they picked up before the IPO.

What is it?

According to the new SEBI rules, the price band of an IPO should be set in such a way that the ceiling price is at least 105% of the floor price.

Secondly, companies will not be allowed to use more than 35% of the money that they collect through IPOs to fund the purchase of other businesses, unless they offer sufficient details.

Thirdly, promoters with a stake of over 20% in a company cannot sell more than half of their stake in an IPO.

And lastly, anchor investors will not be able to sell more than half their shares before 90 days from the date of the IPO, against the current time stipulation of 30 days.

Why has SEBI come up with these new regulations?

Stock markets across the world have witnessed a boom in IPO offerings with a record amount of capital being raised by companies. In India alone, capital worth over ₹1 trillion has been mopped up through IPOs this year. It is natural for both the number and the size of IPOs to rise during a bull market. Companies see bull markets, in which usually a lot of investor money is chasing stocks and causing them to be overvalued, as an opportunity to collect the necessary funds for their growth. The owners of many companies may also see the IPO boom as an opportunity to sell their stake in the business at an attractive price.

Notably, a lot of companies that raised funds through IPOs this year, such as Zomato, Paytm etc., are loss-making. This puts investors who have invested in these IPOs at the risk of huge losses if the prices of these shares witness a sharp correction. Paytm, for instance, has lost more than one-third of its value since it was listed for trading. SEBI believes that the new regulations will ensure that promoters of companies will have more skin in the game. Its price band rule, on the other hand, seems to be aimed to tackle the trend among companies of setting a narrow price band for their issues. SEBI believes that a narrow price band impedes the price discovery process.

Will the new regulations help?

SEBI’s new rules have been widely welcomed for trying to protect retail investors from risks in the booming IPO market. However, some fear that the new rules may hinder the raising of fresh capital by companies to fuel growth.

For instance, mandating companies to be specific about how they will use the money that they collect through IPOs can affect flexibility as business conditions can change fast in the real world. Further, the restriction on anchor investors can affect liquidity in the market as many large investors may not be willing to hold their investments over 90 days and thus decide to completely abstain from participating in IPOs.

Some critics also raise the question of whether SEBI should be trying to handhold investors at all when it comes to making investment decisions. They believe investors, who have the most to lose or gain from their investment decisions, are best equipped to conduct the necessary due diligence before investing in IPOs. The same goes for how companies decide to price their IPOs. Companies would generally avoid under-pricing or over-pricing their issues since it would affect how much capital they can raise. In fact, setting narrow price bands could be a way to avoid valuation uncertainties that can affect fundraising.