Deep Dive into Indian Primary Markets: Part 3

The primary market's integrity and efficiency are upheld by a robust regulatory framework designed to protect investors while facilitating capital formation. This third installment of our guide to Chapter 3 of the NISM Securities Markets Foundation Workbook explores the regulatory environment, the classifications of equity issues, pricing mechanisms, and the detailed operational process of "going public."

3.7 Regulatory Framework for Primary Markets

The primary markets in India are governed by a multi-layered legal structure to ensure transparency, accountability, and investor protection.

Governing Acts and Regulations

Several key pieces of legislation regulate primary market activities:

• Companies Act, 2013: Provides the fundamental legal requirements for a company to raise capital through securities.
• Securities Contracts (Regulation) Act (SCRA), 1956: Defines what constitutes a "security" and regulates the listing of these instruments.
• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR): The primary set of rules for public and rights issues, including eligibility norms and disclosure standards.
• Government Securities Act, 2006 & Regulations, 2007: Govern the issuance of debt by the Central and State governments.

Regulatory Oversight by Asset Class

• Equity Shares: Regulated primarily by SEBI. Issuers must meet specific eligibility and disclosure norms.
• Government Securities (G-Secs): Regulated by the Reserve Bank of India (RBI), which acts as the government's treasury manager.
• Corporate Bonds: Regulated by SEBI through the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021.
• Depository Receipts (ADRs/GDRs): Regulated by SEBI and governed by FEMA regulations regarding foreign holdings.

Eligibility Norms for an Initial Public Offer (IPO)

An issuer must meet the following financial criteria to launch an IPO:

1. Net Tangible Assets: At least Rs. 3 crores in each of the preceding three full years (of 12 months each), with no more than 50 percent held in monetary assets.
2. Operating Profit: An average operating profit of at least Rs. 15 crores (calculated on a restated and consolidated basis) during the preceding three years, with a profit in each of those years.
3. Net Worth: At least Rs. 1 crore in each of the preceding three full years.
4. Alternative Route: If an issuer does not meet these criteria, they may still launch an IPO if it is conducted via a book-building process, where at least 75 percent of the net offer is allotted to Qualified Institutional Buyers (QIBs).

Promoters’ Contribution and Lock-in

To ensure "skin in the game," SEBI requires promoters to maintain a minimum stake:

• Minimum Contribution: Promoters must hold at least 20 percent of the post-issue capital.
• Lock-in Period: The minimum 20 percent contribution is locked in for 18 months from the date of allotment (or 3 years if the project has specific capital expenditure requirements).
• Excess Holding: Any promoter stake exceeding the 20 percent minimum is locked in for 6 months (or 1 year for specific project types).

Minimum Public Offer Requirements

The percentage of equity a company must offer to the public depends on its post-issue capital:

• Post-issue capital <= Rs. 1,600 crore: At least 25 percent must be offered to the public.
• Post-issue capital between Rs. 1,600 and Rs. 4,000 crore: At least Rs. 400 crore worth of shares must be offered.
• Post-issue capital > Rs. 4,000 crore: At least 10 percent must be offered, with a requirement to reach 25 percent public holding within three years of listing.

3.8 Types of Public Issue of Equity Shares

Public offerings are broadly categorized based on whether it is the company's first time raising capital or a subsequent round.

1. Initial Public Offer (IPO)

The first time a company offers its shares to the public. It can take two forms:

• Fresh Issue: New shares are issued by the company, increasing the total issued share capital. This brings new money into the company's balance sheet.
• Offer for Sale (OFS): Existing shareholders (like promoters or venture capitalists) sell their shares to the public. The company's total capital remains unchanged, and the proceeds go to the selling shareholders.

2. Further Public Offer (FPO)

A subsequent offer of shares by a company that is already listed on a stock exchange. FPOs are used for growth capital, debt retirement, or to meet minimum public shareholding requirements.

3.9 Pricing a Public Issue of Shares

SEBI allows issuers to determine the price of their shares through two primary methods.

Fixed Price Issue

The issuer and the lead manager set a specific price before the issue opens. This price is justified in the offer document, and investors know exactly what they will pay at the time of application.

Book Built Issue

This is a market-driven discovery process where a price band or floor price is provided.

• Bidding: Investors place bids for a specific number of shares at a specific price within the band.
• Cut-off Price: After the bidding closes, the issuer determines the final price based on demand. All bidders at or above this price are successful.
• Allocation Pattern: For eligible issuers, the standard allocation is:
  • Retail Individual Investors (RII): Not less than 35 percent.
  • Non-Institutional Investors (NIB): Not less than 15 percent.
  • Qualified Institutional Buyers (QIB): Not more than 50 percent.

3.10 Public Issue Process of Equities

The journey from a private entity to a listed company involves a series of rigorous internal and external steps.

Key Steps in the IPO Process

1. Resolution: Passing board and shareholder resolutions to authorize the issue.
2. Appointment: Hiring a Lead Manager (Merchant Banker) to manage the entire process.
3. Vetting Intermediaries: Appointing RTAs, bankers, and underwriters in consultation with the Lead Manager.
4. Exchange Approval: Obtaining "in-principle" approval for listing from the stock exchanges (NSE/BSE).
5. Filing: Submitting the Draft Red Herring Prospectus (DRHP) to SEBI for vetting.
6. Grading (Optional): Obtaining an IPO grade from a credit rating agency to assess the company's fundamentals.
7. Marketing: Conducting roadshows, analyst meetings, and publishing advertisements to build investor interest.
8. Bidding/Subscription: The issue opens for 3 to 10 working days. Investors must use the ASBA (Application Supported by Blocked Amount) facility.
9. Allotment: Finalizing the basis of allotment in consultation with the exchange and crediting shares to demat accounts.
10. Listing: Shares commence trading on the exchange.

Primary Constituents (Intermediaries)

• Registrar and Transfer Agents (RTA): Handle application processing, reconciliation, and the finalization of allotment.
• Bankers to the Issue: Collect application funds and manage the movement of money from escrow accounts.
• Brokers to the Issue: Act as syndicate members who collect bid forms and facilitate investor participation.
• Underwriters: Guarantee to buy the shares if the issue does not meet the minimum 90 percent subscription requirement.

Critical Definitions and Rules

• ASBA (Application Supported by Blocked Amount): An authorization to a bank to block application money in an investor's account rather than transferring it immediately; funds are only debited upon successful allotment.
• Minimum Subscription Rule: An issue must receive at least 90 percent of the net offer to the public to proceed. If it fails, all money must be refunded within 4 days.
• Green Shoe Option: Allows the company to allot up to 15 percent additional shares to stabilize the post-listing price in the secondary market.