Make it 100 "Big" steps, Dr.Rajan !

So, Planning Commission's Committee on Financial Sector Reforms Chaired by Dr.Raghuram Rajan is out with its report for comments. Looks like it suggests a primary shift in focus. Instead of mouthing cliches like Bank privatization, Capital account convertibility and priority sector norms that usually make a lot of noise and end up in a whimper, it gets down to micro issues like easing restrictions to open up bond markets for foreigners, tradeable warehousing receipts to collateralize farm credit, securitization of SME receivables and the like.

I see opposition from traditionalists citing meltdown in the US debt markets. They will argue that India has been pretty much resilient because we never had liberal bond markets. As usual, wrong reading of the situation that misses the point - the crisis have been in high yield mortgage paper or subprime (junk) bonds where regulation was lax ; the US equity, treasury and corporate debt markets, despite being close to the epicentre of the crisis, have remained far more resilient than markets in faraway countries.

Liquidity is the key, there is no denying that. Here India has a lot of ground to cover. NBFCs today pass on the credit/ default risk to Banks and Financial Institutions indirectly because they are not allowed a free play by themselves in certain areas (IPO financing, CLO, factoring, hedging etc.). So why not let these risks be absorbed by investors in NBFCs rather than by their creditors/benefactors? That will be an additional line of credit, a far better way to channelise savings to productive avenues instead of locking them up in time deposits.

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The Government and the RBI should quit micro managing investment decisions – exposure norms of Banks, Provident Funds, Superannuation funds and other statutory collections that are now forced to invest in very low yield T-bills or AAA paper. Worse, they manage even PSU bank pay scales! Put in place regulations that ensure a close watch over ROI, encourage “stop loss” culture. Aberrations may occur, but in the long run, focus on optimal returns take the load off the back of government itself, when it’s time to pay back. In that, the government does a great service to itself, in whittling away all that contributes to the escalation of our budget deficits.

Who ever said conservative markets and regulatory caps on participation guarantee protection from risks? In fact, they go to cap rewards than containing risks. Try ceding control and stick with selective yet effective macro regulation for a change. Let RBI target inflation, not exchange rates. It’s an illusion to believe the world can regulate its way out of crises.

I would welcome Dr.Rajan’s 100 small, sorry, Big steps. Indeed in gathering political will and scale of execution, it is bigger still.

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Dance of the bands

SEBI lifts price bands for non-IPO listings here.

Currently, the stock exchanges impose a price band on first day of trading / resumption of trading post corporate actions like merger, de-merger, capital reduction, CDR / capital restructuring, revocation of suspension, direct listing on another exchange etc. Now SEBI feels that in such cases there is no need for price bands because they restrict normal price discovery.

This has been my pet peeve too. Why not open up price bands for IPO as well? SEBI has been mulling over this for quite some time. In a free market, nobody can wish away volatility and price discovery can only be a function of demand and supply. There could be scope for manipulation by some operators but their span of control is limited. Driving the stock prices up or down by artificial intervention of operators come at a high cost and associated risk. The best way is to let a few players suffer the carnage. Mostly these operators are funded by promoters of companies to see their net worth zoom on the listing day. When a few get scalded, caution will rule and normalcy shall prevail. Allow some casualties.

It also seeks to extinguish the perilous grey market for securities – regarded as one of the primary concerns of Mr.C.B.Bhave, the new SEBI chief as soon as he assumed office recently. He seems to be a fast cat, having already enabled short selling by acting out lending and borrowing mechanism. Now it’s time he pays attention to my no-band philosophy on IPO price discovery as well.

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Who is SEBI trying to protect? The small investor? Nobody is a saint. Everyone big or small, comes here because she is greedy. Regulation is welcome to the extent anarchy doesn't get a reception. Taking regulation too far by imposing price bands is meddling. Let the markets rule.

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Case for a market mashup

So I say if IPOs are a game of chance, why wouldn't the regulators pass over the primary market and allow direct listing into the secondary market? The expression `secondary’ would be redundant then. SEBI might as well silence the grey market rumor mills that emit misleading signals to trap gullible investors. Let Book Running Lead Managers (BRLM) morph into Market Makers. The mechanism could be something like this –

1. The issuer approaches a merchant banker who shall prepare an offer document in compliance with regulations and ensuring adequate disclosures.
2. The draft offer document shall be filed with SEBI for vetting and the final document shall be filed with Registrar. (No need for application forms with non-readable disclosures necessary. Imagine printing cost savings.)
3. The market makers (BRLM in new avatar) shall provisionally register the securities with the depositories and offer a mandatory online two way quote to interested investors for a five day period.
4. If there is enough demand for the security, the entire issue will be subscribed and if not, the unsubscribed portion (above a minimum watermark of say 70% of issue size/volume) shall be extinguished.
5. Issuer shall have the option to pull out the issue at this stage if it is not happy with 70% subscription and credit the sums back to investors online/offline. Alternatively, if the market makers have agreed in advance (hard underwriting) to absorb the 30% unsubscribed portion at the closing price of the 5th day, they can.
   

Advantages are –

• Significant reduction in issue expenses;
  
• Online access to offer document. Facts don’t get mired in fine print;
• No categorization of QIB, HNI and Retail;
  
• The whole issue completed in 5 days, unlike 8-9 weeks that it takes now;
  
• All category of investors to pay the full price they bid; No question of revised bids. Make a mistake, you just will have to buy/sell.
  
• Being a transparent online mechanism, no scope for payment default since there is an instant direct debit to investor’s bank account;
  
• Case for refund only if the IPO is subscribed below 70% or if the issuer chooses to pullout;
  
• Efficient price discovery since price is what an investor is willing to pay and grey market operators get edged out;
  
• Investors don't get sucked in by the media blitz following QIB oversubscription figures;
• The reduced effort of BRLM would enable them to charge lower fee from issuers.
  

In essence, by applying the excellent secondary market infrastructure that we have now (with T+2 settlement) and the prevailing low brokerages, this mechanism is significantly more efficient, issuer and investor friendly and certainly a game of surety than of chance. No more bad listings; No more sudden pullouts.

Mr.Damodaran, if you need help, you know whom to call. Here are some more perspectives from Samir Barua (IIM-A), Rashesh Shah (Edelweiss) and Alok Vajpeyi (Dawnay Day AV).

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