Chapter 3: Primary Market — Comprehensive Short Notes (Part 2 of 3)

3.4 Initial Public Offer (IPO) and Pricing Mechanisms

3.4.1 Concept of an Initial Public Offer

• Definition: An Initial Public Offer (IPO) refers to the process of selling securities to the public in the primary market for the first time.
• Issuer Structure: An IPO occurs when an unlisted company makes either a fresh issue of securities, an offer for sale (OFS) of its existing securities by present shareholders, or a combined package of both to the public.
• Listing Gateway: Conducting an IPO paves the way for the official listing and subsequent trading of the company's securities on recognized stock exchanges.
• Issuance Formats: The sale of securities through an IPO can be executed either via the book building mechanism or through a traditional fixed price public issue.

3.4.2 Price Fixation and Free Pricing Regime

• Free Pricing Era: The Indian primary capital market entered an era of free pricing in 1992.
• Deciding Authority: Under regulatory guidelines, the issuing company, in direct consultation with its Lead Merchant Banker, determines the issue price.
• Regulatory Exemption: The Securities and Exchange Board of India (SEBI) does not stipulate any price formula nor does it play any direct role in price fixation.
• Mandatory Disclosures: Issuers and lead merchant bankers are legally required to provide comprehensive disclosures in the offer document regarding the underlying parameters considered when deciding the issue price.
• Primary Pricing Routes:
  • Fixed Price Route: The company and Lead Merchant Banker determine and fix a specific, pre-announced issue price. Today, this route is primarily retained to allow small and medium enterprises (SMEs) to offer shares on the SME platform of stock exchanges.
  • Book Building Route: The issuing entity and Lead Manager specify a floor price or a price band and leave the final price determination to market demand forces.

3.4.3 Price Discovery through Book Building

• Mechanic Definition: Book building is an institutional mechanism utilized during an IPO for efficient price discovery.
• Bidding Process: While the IPO remains open, bids are gathered from prospective investors at various price points at or above a designated floor price.
• Final Price Determination: The final offer price for allotment is determined strictly after the official bid closing date after evaluating investor demand across price points.

Key Comparison: Book Built Issue vs. Fixed Price Issue

3.5 Price Parameters in Book Built Issues

3.5.1 Key Price Concepts

• Floor Price: The minimum threshold price set by the issuer at or above which investor bids can be validly submitted.
• Cut-Off Price: The final discovered issue price determined by the issuer and lead manager after evaluating the bid book and market appetite for the stock.
• Price Band: A price range specified in the prospectus containing a floor price at the bottom and a cap price at the top within which investors place bids.

3.5.2 Price Band Rules and Revision Timelines

• Spread Constraint: The spread between the floor price and the cap price in a price band cannot exceed 20%.

• Cap Price Line Formula:

  Cap Price <= 1.20 * Floor Price

• Mandatory Dissemination of Revisions: Any official revision in the price band must be widely disseminated by informing stock exchanges, issuing press releases, and updating trading terminals and websites of participating members.

• Bidding Period Extension Rule: If the price band is revised, the bidding window must be extended for a minimum of 3 additional days.

• Maximum Total Bidding Window: The total extended bidding period cannot exceed a cumulative maximum of 10 days.

3.6 Operational Framework of IPO Bidding and Allotment

3.6.1 Bidding Rules and Facilities

• Minimum Bidding Duration: The bidding book must remain open for a minimum of 3 working days.
• Mandatory Electronic Facility: Bidding via an open outcry system is prohibited. SEBI mandates the sole use of an electronically linked, transparent screen-based facility provided by stock exchanges.
• Individual Investor Participation: Individual retail investors are fully eligible to utilize the electronic book building system to submit IPO applications.

3.6.2 Application Supported by Blocked Amount (ASBA)

• Definition: ASBA represents an application mechanism containing an explicit authorization to block the required application money in the applicant's bank account for subscribing to an issue.
• Fund Debit Rule: Funds are debited from the applicant's bank account only if the application is selected for allotment upon finalization of the basis of allotment, or unblocked if the issue fails or is withdrawn.
• Application Procedure: Investors submit the ASBA form to designated branches of Self Certified Syndicated Banks (SCSBs) containing details including applicant name, PAN number, demat account number, bid quantity, and bid price. The bank then uploads these bid details directly into the bidding platform.
• Mandatory Status: Effective from January 1, 2016, SEBI made ASBA mandatory for all investors subscribing to public issues.

3.6.3 Allotment and Listing Timelines

• Basis of Allotment: Governed by SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, the Basis of Allotment must be finalized within 4 working days from the issue close date.
• Dispatch & Demat Credit: Credit of shares to demat accounts or dispatch of refund orders must be completed within 1 working day following allotment finalization.
• Investor Status Awareness: Applicants can ascertain their allotment status within approximately 5 working days from issue closure.
• Secondary Market Listing: Securities must be listed on stock exchanges within 6 working days after the closure of a book built issue.

3.7 Intermediaries and Systems in Primary Market Issues

3.7.1 Role of the Registrar to an Issue

• Allottee Finalization: The Registrar processes applications, purges invalid or incomplete forms, and finalizes the list of eligible allottees.
• Corporate Action Execution: Ensures corporate actions are filed to credit allotted shares directly to investors' demat accounts.
• Refund Oversight: Manages the dispatch of refund orders to unsuccessful or partially allotted applicants.
• Intermediary Coordination: Works under the supervision of the Lead Manager to ensure seamless flow of application forms from bank branches through to final listing.

3.7.2 NSE NEAT IPO Automated Bidding System

• Infrastructure: National Stock Exchange of India (NSE) offers a fully automated, nationwide screen-based system called NEAT IPO for online bidding in public issues.
• Operational Advantages:
  • Provides a nationwide electronic bidding network covering remote geographic locations.
  • Ensures a fair, efficient, and transparent method for collecting online bids.
  • Reduces overall issue costs compared to traditional physical public issues.
  • Significantly accelerates the overall time required to complete the issue lifecycle.
• System Operating Timings: The NEAT IPO bidding platform operates standard market timings from 10:00 a.m. to 5:00 p.m..

Key Exam-Relevant Terms

• Initial Public Offer (IPO): The maiden offering of equity or convertible securities by an unlisted corporate entity to the public.
• Free Pricing Regime: The regulatory framework established in 1992 allowing issuers and merchant bankers to freely determine issue pricing without SEBI price formulas.
• Book Building: A price discovery mechanism where investor bids are collected across price points to determine the final offer price.
• Price Band: The range between the floor price and cap price within which investors bid, where the cap cannot exceed 120% of the floor.
• Cut-Off Price: The final issue price discovered and selected by the issuer and lead manager based on bid demand.
• ASBA (Application Supported by Blocked Amount): A mandatory payment mechanism where application money remains blocked in the investor's bank account until allotment.
• SCSB (Self Certified Syndicated Bank): A bank authorized by SEBI to accept ASBA forms, block funds, and upload bid data to exchange engines.
• NEAT IPO: NSE's screen-based automated bidding platform operating nationwide between 10:00 a.m. and 5:00 p.m..