Why was SEBI so keen to scrap mandatory IPO grading (as demanded by corporates) instead of making them effective and pulling up rating companies for shoddy rating?
Market regulator Securities & Exchange Board of India (SEBI) has scrapped the idea of mandatory grading for initial public offering (IPO). As Moneylife has pointed out, this move by SEBI is anti-investor. The market regulator has responded to this by saying, "...the decision (to make IPO grading voluntary) was taken in its board meeting on 24 December 2013 and to allege that SEBI did not bother to consult investor association is baseless, erroneous and misleading".
As Moneylife has pointed out IPO grading was advocated by investor activists and associations around 2003 and was reluctantly mandated by SEBI in 2007, only to be dropped six years later. This shows how powerful companies and market intermediaries, once again, used a depressed primary market to successfully lobby for a dilution of investor protection measures.
Here is the article of Sucheta Dalal, managing editor of Moneylife SEBI Scraps IPO Grading, the clarification from SEBI and reply from Ms Dalal...
The Moneylife article argued that Indian institutions have scant regard for history, so SEBI did not bother to consult investor associations who had fought long and hard for IPO grading. Nor did it bother to examine whether the grading process could be made more meaningful or adequately publicised. Thanks to pressure from powerful corporate lobbies, the IPO grading process was hobbled at the very inception. Investor groups wanted IPO grading to be independent and rating agencies to be paid from the large pool of badly utilised investor protection funds with stock exchanges and the ministry of corporate affairs. This did not happen.
SEBI has written to clarify that the issue of IPO grading was discussed in the meeting of the investor associations held at SEBI on August 21, 2013, in which the investor associations opined that mandatory IPO grading should be discontinued, as it is not serving any purpose in the present form and may be made optional. In fact it was one of the agenda items for the meeting, proposed by an investor association, reads: "Whether GRADING given to IPO/FPO by credit rating agencies is of any help to investor?..... OR should such grading not be altogether done away with?"
While SEBI’s clarification is helpful, the IPO grading issue is a much bigger and SEBI has too many questions to answer. On this issue, Sucheta Dalal has replied as follows:
1. I was among the activists who worked hard for the introduction of IPO grading. The IPO grading was supposed to be funded through the Investor Education & Protection Fund of Ministry of Corporate Affairs. It was shot down at the last stage by the powerful corporate lobby which influences the MCA. I was a member of the MCA's Investor Education & Protection Fund for six years since its inception and had a ringside view to this lobbying.
2. I then worked at having it introduced through SEBI. The resistance from corporate India was clear all through. I was a member of SEBI's primary market advisory committee for several years and had a ringside view to this too.
3. To counter corporate objections, the IEPF had discussed with CRISIL, when the late Ravi Mohan was its CEO, how to keep costs low and ensure that grading will not require any further work from the corporate house but will be based entirely on the IPO document. After all, the IPO prospectus is a legal document and is expected to contain all information that an investor needs in a comprehensible manner. Any details that are not available in this manner would impact the grading. Thus, we had worked at countering two issues: First that IPO grading would involve more work by companies and more clearances. Second, that IPO grading would involve an expense by companies.
4. Those days the IEPF had over Rs385 crore (it is Rs1,000 crore plus today) of unclaimed investor funds, which is being squandered away in advertisements or on seminars and workshops conducted by lobbying associations of chartered accountants and company secretaries. In fact, investor associations have been thrown out of IEPF, underlining the poor state of investor protection and activism in India. Ravi Mohan had agreed to charge as little as Rs2 lakh per rating. All this was junked.
5. When SEBI finally passed the IPO grading idea, it mischievously ensured that companies will have to pay for the ratings and there was no check on costs. SEBI itself set up an investor protection fund and the two national stock exchanges have a few hundred crores each in their investor protection funds. This money is used to fund and sponsor seminars and workshops, usually to the benefit of media and not investors. There is no cost-benefit analysis of these events. Only a small part of such huge funds was needed to make the IPO grading independent but this was avoided. Instead, SEBI has been spending a lot of time in marshalling research and arguments to drop the IPO grading idea. As a student of statistics, I know that research can always be arranged to give you the conclusions that are wanted.
6. The rating agencies justify their fees by asking questions and add to the time element too. After SEBI started suspecting that IPO grading is useless, did it pull up the rating agencies for the quality of grading? Was such action, if any, shared with the investors? Did it make an attempt to improve the quality of ratings or make them independent of companies who paid the rating agencies? Surely SEBI is aware that independence of rating agencies is a matter of international debate! Were the above facts presented to your board?
7. Given the events described above, clearly, SEBI is primarily and wholly responsible for ensuring that IPO grading idea was hobbled from the start.
Moneylife: SEBI’s excuse for scrapping mandatory grading is the reported findings of ‘various studies’ that a large number of investors are ‘not influenced by grades’; that plenty of low-grade IPOs received a big response from retail and institutional investors and, thirdly, that IPOs with high grades yielded more losses. In a clear contradiction of these claims, media reports also say that SEBI’s action was ‘a move to uplift the dormant primary market’. It is also unclear how SEBI rejected yet another study which shows that, over time, IPOs with higher grades yielded better price multiples.
The fact is under SEBI’s flawed system, companies were paying for their own rating—leading to charges about shoddy ratings—especially when India’s top rating agency, CRISIL gave Reliance Power a 5-star grade at the peak of the bull run of January 2008.
However, the grading did protect genuine investors, who had no time, or ability, to wade through bulky offer documents to find out what the companies wanted to hide. The simple 5-point grade, based on an expert evaluation of fundamentals by a rating agency, at least, acted as a fact check, even if it did not cover price risk.
SEBI: In this connection it is clarified that SEBI had examined the said study which stated higher grades yielded better price multiples and also noted that the organisation which undertook the said study also highlighted that "IPO grading should not be 'mandatory', but 'recommended' or 'encouraged'.
About 'grading did not protect investors...', it is clarified that the author has not presented any facts in this regard. However, one of the studies on IPO grading highlighted the following:
"The retail investors, for whom IPO grading was introduced, subscribed fully or overwhelmingly subscribed to their portion in as many as 73 out of 86 (85%) 'lower grade' IPOs (IPOs with Grade 1 or 2 were referred as 'lower grade' IPOs). Thus, the study shows that the retail investors are not taking any cues from grading and even QIBs have refused to acknowledge grades. The QIBs have subscribed fully their portion in as many 'lower grade' IPOs. This indicates that grading has not been a factor in investors' decision making process".
1. It must also be remembered that SEBI’s mishandling of IPO market in mid-1990s led to hundreds of vanishing companies all after they had raised hundreds of crores form the IPO riddled with false and misleading statements. The vanishing companies scam led to the demand for IPO grading so that fundamental facts and details will, at least, be checked out.
2. With just about three IPOs in the entire calendar year 2013, shouldn’t SEBI be trying to FIND retail investors and understand why they have lost faith in the equity markets? Surely this was more important than dropping IPO grading which was introduced as an investor protection measure after five years of hard work by investor associations?
3. Did SEBI consider way to make IPO grading meaningful and independent by paying raters through its own Investor Protection Fund? Did it consider asking rating agencies to look at price and timing so that the rating is more meaningful? Did SEBI ever question high ratings such as CRISIL’s 5-star rating for the Reliance Power IPO, which killed the credibility of IPO ratings? Your letter indicates that quality of ratings was the issue rather than the need for ratings.
The fact is, SEBI has too many questions to answer for systematically burying IPO grading instead of trying to make it work.
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