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Sebi’s giant leap to revive the Indian capital markets

The Securities and Exchange Board of India (Sebi), the Indian capital markets regulator, has recently amended the Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2009. The stated purpose of some of these amendments is to introduce so-called reformatory measures to revive the primary capital markets in India. These measures, according to the minutes of the Sebi's board meeting, are to encourage enhanced retail investors' participation, impose a higher standard of accountability on companies and intermediaries, and ensure greater transparency in the initial public offering (IPO) process.

As a step toward increasing investor participation, Sebi has mandated allotment of at least a minimum bid lot to the retail investors subject to the availability of shares, in case of over subscription of the issue. Before this, retail investors were allotted shares on a proportionate basis.

Other investor-friendly norms include introduction of a cap on the use of issue proceeds for the object under the head General Corporate Purpose (25% of the total proceeds), mechanisms for monitoring the use of issue proceeds, and a prohibition on certain investor classes from withdrawing their bid. Furthermore, the issuer is now required to update every year the disclosures made in the offer documents.

Sebi has relaxed the norms relating to minimum promoter contribution by allowing the promoters to meet this requirement by taking contributions from Sebi-registered alternate investment funds.

The regulator has also imposed restrictions on the role to be played by merchant bankers associated with the issuer. It also requires merchant bankers to certify that the profits of the issuer from related-party transactions come from legitimate transactions. This lays tremendous accountability on the merchant bankers while conducting the due diligence and may well result in quite a few disputes.

Another important change made by Sebi is the introduction of a general order dated October 9 2012: the Sebi (Framework for Rejection of Draft Offer Documents) Order, 2012. This provides for criteria based on which the draft offer documents filed with Sebi may be rejected. To some this may appear as micro-management or worse. Sebi has clearly stated that the main objective behind the new mechanism is to ensure that quality disclosures are made enabling the investors to assess the risks associated with the issue.

The Order lays down a broad range of indicative reasons – such as vagueness in issue details, questionable business models, lack of clarity as regard identification of ultimate promoters, a sudden spurt in business just before filings, qualified audit reports and existence of any litigation which has the potential to impact the issuer's survival – as grounds for Sebi to reject the offer document. While the Order clearly stipulates that such scrutiny by Sebi would be based on information relating to the period of the last five years, Sebi can seek information for any other period. The most contentious provision in the Order is the consequences contemplated on rejection of the offer documents. The entities whose offer documents have been rejected will not be allowed to access the capital markets for a minimum of a year and a maximum time at Sebi's discretion.

This new mechanism is a huge departure from Sebi's earlier role of merely making observations on offer documents.

The new regime has received mixed reactions from the market. Some view it as an attempt on Sebi's part to ensure that only genuine and good-quality companies come to the primary market, with many drawing parallel with the licence raj, harking back to the so-called glorious regime of socialism in India. At that time, it was the controller of capital issues (which Sebi replaced) which not only regulated but actually controlled IPOs. It determined the IPO pricing which used to be so low that listings used to happen at multiples.

All in all, whether these changes are likely to have a positive impact or not, only time will tell, though a tremendous impact of some kind will be felt.

Nitu Agarwal and Deepti Wani

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