Will SEBI be successful in restoring investor faith in IPOs?

Fri, 27 Feb Pre-Open

   Previous Close   

   09:30 am   

   11:30 am   

   01:30 pm   

   Closing   

Retail investors have been losing faith in India's IPO (initial public offering) market, since many companies going the IPO route have not stayed true to its spirit. There are good reasons for the growing distaste for IPOs. IPOs are often prone to wild swings in share prices on the day of listing. There have been cases of share price manipulation, resulting in huge losses to investors. On the whole, IPOs haven't made money for retail investors. Indeed, since some time, the IPO market seems to be in a state of crisis. Even the year 2014 was quite a dull one for IPOs.

This trend has certainly worried the capital markets regulator Securities and Exchange Board of India (SEBI). Hence to restore the investor’s trust SEBI is in process of setting up some new rules to protect the downside for small investors. As reported in Economic Times, the companies coming out with IPOs might have to offer optionally fully convertible debentures (OFCDs) instead of plain vanilla shares to this category.

So how will this option help small investors?

The IPO-bound company will issue OFCD bonds to retail investors in the public issue. These bonds will have fixed tenure. The investors will have an option to convert their debentures into shares if the stock price falls below the issue price after six months of listing. Thus, if the price of a script falls below the pre-determined price, after IPO gets listed, the investor will be able to withdraw money along with the interest, taking the benefit of OFCD. On the other hand, if the price shoots up, the investor can convert it into shares.

The said proposal might look to be an appealing option as is it protects the wealth of the investors who tend to see huge erosion in the stocks post the company listing. However here too, one cannot discount the risks involved since the companies have speculative tendencies, which can wipe out the sole purpose of this exercise. For example, OFCD might give an artificial sense of safety to retail investors and make them complacent about investing but this does not warrant any security even after the lock in period. Over and above, this route seems to distort the very nature of equity investment, which involves high risk and high returns. Hence it would be more worthwhile if SEBI takes greater precautions while vetting IPOs and have very strict norms in place in terms of the track record of the company and the quality of its management team.

However, we would like to point out here that the discipline that one needs to follow when investing in listed stocks also applies to IPOs. For investors it would be more important to judge the moat of the business, the sustainability of profits and management quality of the businesses before committing their money.

Because if the fundamentals themselves are shaky, then even OFCDs cannot come to the rescue of investors.