IPO funding ban is a boon
In the old days, applying for shares in an IPO was akin to buying a lottery ticket. Pricing was regulated and there was value in many IPOs. Companies without track record had to issue shares at ‘ par’.
Then came the era of ‘ free’ pricing which essentially means that anyone can price the shares at whatever the market can bear. Investment bankers get their mandates for an issue based on what price they think an issue can fetch. They work for the issuer ( who is the seller of the shares) and hence they are loyal to their paymasters, by getting them the highest possible price. They owe the investor nothing.
In such a situation, the aggression in the pricing has to be supported with some initial prices on the floor. This means that there has to be someone with deep pockets supporting the trading or there has to be so much noise created that everyone feels that he has to get a piece and the level of oversubscription ensures post listing demand till the next quarterly result comes in.
So the investment banker has to create huge demand. One of the biggest supports was in the form of ‘ IPO financing” where many NBFCs offered loans to applicants. The margin was low and was a function of the oversubscription.
If the NBFCs estimate oversubscription to be 20 times, the lending would be with a five per cent margin. The logic was that an applicant would get only one twentieth of what he applied and the rest would be refunded. The lender had full control over the demat and the bank account, so he ran a zero risk. And with ` 1 lakh in your pocket, you could bung in an application for ` 20 lakh.
This created a clear distortion in the market place. Your ` 1 lakh cre- ated an illusion of a demand for ` 20 lakh. So on listing there was this temporary premium that held till the leveraged buyers had squared off their positions. I rarely came across someone who held on to what he had applied for.
And in this affair, we see that the smallest portion of the IPO was reserved for the ‘ retail’ investor or those whose application value is under ` 1 lakh.
He was facing the combined might of the institutional investor plus the bogus might of the ‘non-institutional’ investor. The IPO financing played havoc with price discovery on listing, as there were too many ‘ deals’ to be squared off.
Now, the RBI has put an end to it and has ruled that NBFCs cannot lend more than 50 per cent against shares. In other words, they have to keep a minimum margin of 50 per cent.
NBFCs lend against shares to promoters or traders in shares and for IPOs. Promoter funding is generally done with 50 per cent or more margins, so may not be impacted. Traders used to get financing against select shares at margins lower than 50 per cent, so that will be impacted.
However, the highest impact would be on the IPO financing. The game in the IPO financing will not be interesting if someone can only get a two times funding. In the past, the margin would be the inverse of the number of times an issue was subscribed. For instance, if the oversubscription was estimated at 10 times, the margin would be a mere ten per cent.
Thus, if you are smart, now you will put in your application backed with full money in the ‘ non institutional’ category. Instead of ` 1 lakh, you can put the next highest number possible and improve your chances.
It is possible that the merchant bankers get smart and merge the retail and the non institutional category. In either case, the abolition of IPO financing is a boon to the investor.
The other fallout of this is that the listing gains may also vanish since the element of manipulation that went on to ensure a listing premium sufficient to cover financing costs would now be absent.
In short, this is a welcome move by the RBI and makes the IPO market and the post listing price discovery to real demand and supply. Of course no one can take away manipulation from the markets, but this move by RBI is a big positive for the genuine IPO investor. The writer is an independent analyst and can be contacted at balakrishnanr
@ gmail. com