Strength in depth

Author: | Published: 1 Aug 2007
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

The euphoria that marked the crossing of the 10,000 point mark by the BSE Sensex in February 2006 was absent when the index crossed 15,000 in the first week of July 2007 – it had come to be expected. The Indian economy has been growing at an unprecedented rate, defying prophets of doom who feared that economy had overheated and that the bubble would soon burst. Liberalized economic policies coupled with dynamic regulations and regulators have transformed India into a hub of global investment, with global access to the Indian capital markets being at the heart of the transformation.

The Indian capital markets as we know them today were created about 25 years ago, but they were boosted by the liberalization era ushered in by the new industrial policy at the start of the last decade. The corporate sector has, over the years, gained experience in exploiting the capital markets and the domestic markets witnessed substantial integration with the international capital markets. Today, transactions of international ticket size and complexity are not unusual in India. Investors have become familiar with the uniquely Indian book-building mechanism.

The profile of companies accessing the capital markets has also changed. The capital markets have shown enough scope in allowing participation by smaller players. Companies in sectors such as real estate, which had previously shied away from the organized capital markets, have been some of the biggest capital mobilizers in recent times. Pre-IPO investments and qualified institutional placements have inspired greater confidence in the Indian capital markets.

Book building

The book-building process that is followed in Indian public issues through regulatory prescription and market practice is unique. The SEBI DIP Guidelines provide for two models of book building: a 100:0 model, where 100% of the net offer is to the public through the book-building process, and a 75:25 model, where 75% of the net offer is to the public through the book-building process and 25% is at a fixed price determined by the 75% book-building process. The book is broken up into three categories of investors for the purposes of price discovery: qualified institutional buyers (QIBs) (as per the Indian definition), retail investors and non-institutional investors. The retail and non-institutional investors are required to pay the entire bid amount up front; QIBs are required to pay a margin amount of 10% of the bid amount while applying. Allocation to each category of investors depends on the issuer's eligibility. Allotment within categories of investors is made on a proportionate basis. The book in India is transparent. The National Stock Exchange of India (the NSE) and the Bombay Stock Exchange (BSE) offer a screen-based facility for registration of bids, and a graphical representation of the consolidated demand and price is made available at all bidding centres and on the stock exchange's websites.

Public issues by real estate companies

The realty boom in the country and India's growing infrastructure and housing requirements have resulted in strong valuations for real estate companies. Consequently, a large number of these companies have begun raising funds from the capital markets in India. Recently, DLF Limited undertook the largest IPO in the Indian market to date, raising over $2 billion.

Due diligence and disclosure

The disclosure requirements for companies making a public issue of securities are prescribed by the Companies Act 1956, as amended, and the SEBI DIP Guidelines, along with clarifications and notifications issued by SEBI from time to time. In the context of real estate deals, the disclosure requirements have presented their own set of complications. These arise largely out of the disorganized nature of the real estate sector and the complexity of land ownership in the country due to the prevailing law.

Complex land ownership

Typically, in India, land is acquired through several entities directly or indirectly controlled by the promoters, which are incorporated solely for this purpose. This helps to keep the price of land in check and also provides a way around the limits on the extent of land that can be owned by individual entities. The downside of this complex ownership is that it leads to a lack of transparency in real estate transactions. It is difficult to ascertain the actual source of funding for the acquisition of land and to determine whether the transactions have been entered into on an arm's length basis. The state of land records in India also makes it impractical for legal advisers to perform due diligence procedures on several properties on the basis of which the issuer is valued. So preparation of offer documents and ensuring accuracy in disclosures present challenges that are often difficult to meet within the transaction timelines.

SEBI has recently formulated specific disclosure requirements for real estate companies. The land bank of the company must be presented in the prescribed manner, with clear demarcation with respect to the nature of ownership of the properties.

The Indian market has seen a spate of real estate deals in the last two years, which have added to the depth of the primary market. For example, the initial public offering of Parsvnath Developers in 2006, which was the first IPO by a real estate company in India.

An Indian Rule 144A

Before the introduction of Chapter XIII -A in the SEBI DIP Guidelines, an Indian listed company intending to raise further capital from the public markets in India had the option of doing so by offering securities through a follow-on public offering or preferential allotments. Chapter XIII-A, inspired by the US Rule 144A , provides an additional mode for listed Indian companies to raise funds through institutional placements to QIBs. These placements are completed as private placements, but allow price discovery above a market-linked floor price. Securities issued under this route have to be listed and, for one year from issuance, can be traded only on the floor of a stock exchange or in block/bulk deals. This also increases the volume of trade on the exchanges. Convertible instruments may also be issued through the QIP process, but have to be converted into or exchanged with equity shares within 60 months from the date of issuance.

While the issue requires a placement document prepared under the minimum disclosure requirements prescribed by QIP regulations, SEBI approval is not required, unlike domestic follow-on offerings. The placement document is a private document given to select investors, through serially numbered copies. As these QIBs are informed investors, the disclosures and procedural stipulations are less rigorous than the public issue process.

This QIP route is attractive to issuers because of the speed and flexibility of the issuances, the high quality of investors, the absence of a lock-in requirement, and efficient clearing and settlement.

In the maturing Indian capital markets, there exists a large base of QIBs, which are recognized and regulated by the SEBI and which include foreign institutional investors, mutual funds and banks.

The absence of a provision similar to Rule 144A was a critical regulatory gap in the Indian context. Since May 2006, when it was introduced, the QIP regime has bridged this gap. Over 20 deals have taken place in a little over one year. Unlike the follow-on offerings, where the settlement period runs into two weeks, QIPs are now being settled on a T+4 basis. The T+4 settlement period is in line with global depository receipt offerings and illustrates that a QIP can be a suitable substitute.

The Kalpataru Power Transmission QIP was the first of these QIP deals in the Indian market, and Infrastructure Development Finance Company raised over $500 million through this route, making it the largest QIP deal to date.

Pre-IPO placements

Most recent Indian IPOs have been preceded by a placement of equity shares to certain strategic and financial investors close to the offering process. The genesis for such placements was in the amendment to the SEBI DIP Guidelines in September 2005. This amendment removed the provision for discretionary allotment to QIBs and introduced mandatory proportionate allotment within the QIB category in book-built public issues. As a result, issuers could not allot a percentage of the issue to certain financial investors that was not in proportion to their bid size. In addition to attracting certain investors to the company, issuers have also used these pre-IPO placements to benchmark the IPO price.

Before May 2006 companies were could not issue fresh equity after the draft offer documents were filed with SEBI until the securities offered through the public issue were listed. To overcome this shortcoming, the SEBI DIP Guidelines were amended again to permit issue of equity capital even after the draft offer document was filed with SEBI, as long as full disclosures in relation to the capital were made in the draft offer document. This has allowed pre-IPO placements to be made to strategic and financial investors at a price that is often linked to the IPO price.

Foreign issues

In November 1993, the government of India notified a scheme to allow Indian companies to access the global capital markets through the issue of foreign currency convertible bonds and equity shares through the depository receipt mechanism. The scheme provided a tax-efficient structure exempting transfers of GDIs from Indian capital gains tax and providing a special treatment for cost of acquisition in respect of redemption of the depository receipts into Indian shares upon sale into the Indian market. The scheme has been amended several times since then. In August 2005, market-based floor pricing was introduced for these issues. Due to the several amendments to the scheme, it lacks clarity and has become cumbersome. The government of India recently set up a high level committee to review the policy in relation to the issue of foreign currency convertible bonds and equity shares through the depository receipt mechanism. The committee is expected to examine the scheme in the light of the current macroeconomic situation, the current policy on capital flows, the changing market conditions and international practices, and to suggest a revised draft scheme for the government's consideration. Specifically, the committee will consider, among other things, whether Indian companies should be allowed the freedom to choose any foreign/domestic stock exchange to list their securities, whether the listing requirements need to be amended, and the options for issuances of foreign currency convertible bonds by companies unlisted in India.

Indian stock exchanges can also list Indian depository receipts (IDRs), which can be issued by companies outside India. Though the product has not taken off, the regulator is reviewing the existing regime to make it friendlier. Quality issuers from overseas jurisdictions will be able to tap Indian markets through IDRs, which will add to the depth of the Indian capital markets.

Debt market reforms

Though still at a nascent stage, the Indian capital markets are witnessing increased activity in the debt capital markets and structured products. A high level committee was constituted by the Indian Ministry of Finance to examine the legal, regulatory, tax and market design issues in the development of the corporate bond market. The committee has made detailed recommendations for the development of the primary as well as the secondary corporate bond market. Among other things, the recommendations aim to enhance the issuer as well as the investor base, and to rationalize disclosure, reporting, trading and settlement norms, and tax issues. The development of these products could change the profile of the Indian capital markets.

Laws lead the way

The last two years have seen big developments in capital markets in India. Some of the developments in the securities laws are in response to the changing demands of the market, but some changes to the laws have clearly led the market. The introduction of the QIP regime and pre-IPO placements filled critical gaps in the regulatory framework, and initiatives such as IDRs have led the market closer to more developed markets. Indian issuers have been undertaking so-called jumbo deals on a regular basis, including by way of US registered offerings. ICICI Bank undertook the first-ever simultaneous America depository receipt and Indian domestic follow-on offering in December 2005, raising $1.5 billion. It recently undertook a similar offering and raised a total of $5 billion, including a US component of $2.5 billion. Infosys Technologies undertook a $1.5 billion sponsored ADR offering in November 2006. There have also been other domestic offerings where more than $1 billion has been raised, including the domestic IPOs of Reliance Petroleum, Cairn India and DLF, illustrating the depth of the Indian capital markets.