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Qualified institutional placements

India's economy has grown by more than 9% for three years running and has seen a decade of growth above 7%. This has been supported by market reforms, large inflows of FDI, rising foreign exchange reserves, the IT and real estate surge and a flourishing capital market.

However, as for most of the world, 2008 has been a testing year for the Indian growth story. The Reserve Bank of India had set an inflation target of 4%, but by the middle of the year it was running at 11%, the highest level seen for a decade. The markets are also suffering, with the Indian stock market having fallen by more than 40% in six months from its January 2008 high. $6 billion of foreign funds have flowed out of the country in that period, reacting to slowing economic growth and perceptions that the market was over-valued. The weakening Indian rupee, high inflation rates, political instability and the global energy and credit crises have also dampened the flow of domestic and foreign investment.

In turbulent times such as these, characterised by falling stock prices, the prices of qualified institutional placements (QIPs) and preferential allotments to qualified institutional buyers (QIBs) typically exceed the current market price, making investors reluctant to pay a premium for shares available at significantly discounted prices on the open market. The situation is no different in India, where the floor prices of QIPs and preferential allotments are based on the higher of the average of the weekly high and low of the closing prices of the shares during the two weeks or six months preceding the relevant date, as prescribed under Chapters XIII and XIII-A of the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2002 (SEBI DIP Guidelines). The relevant date is 30 days before the date when the issue is approved at a meeting of the shareholders. Due to the vast differences in market prices over the last two quarters, the price of a QIP or a preferential allotment, arrived at by applying this pricing formula, is invariably much higher than prevailing market prices.

Due to this disparity between the market price and the QIP and preferential allotment price as determined by the prescribed pricing formula, investors are compelled to pay a hefty premium in the present market conditions, thus discouraging further investments. In 2008, QIP issues were the most affected, with only seven issues from January to July compared to 17 in the corresponding period last year, and it has been reported that industry sources estimate that 35 to 40 QIP issues are stuck on pricing issues. In order to align pricing norms with present market conditions, SEBI has, in the recent meeting of its board held on August 13 2008, proposed certain changes.

It has decided to amend the present pricing formula to base it on the average of the weekly high and low of the closing prices of shares during the two weeks preceding the relevant date for making a QIP or for making preferential allotments to QIBs.

Under the proposed amendments, the relevant date for QIPs would be the date on which the board of directors of the company or the committee of directors, duly authorised by the board of the company, meets to take the decision to authorise the QIP. However, no changes have been envisaged in relation to the relevant date for preferential allotments, where the resolution remains valid for only 15 days, as opposed to one year for a QIP.

The changes in the pricing of QIPs and preferential allotments to QIBs are significant and pragmatic, making these processes closer to market reality and a more lucrative fundraising option for Indian companies because of the boost that these amendments are likely to give to investors. Moreover, since preferential allotments, ADRs/GDRs and QIPs were initially designed to function at the same floor price level, such pricing reforms, along with the pricing changes that the government has proposed for the issue of ADRs/GDRs, will not only close out existing loopholes but also bring all these capital raising routes in line, as originally envisaged.

While the proposed amendments are yet to be transcribed into the SEBI DIP Guidelines, market experts and investors foresee that these revised pricing norms will give an impetus to investments through QIPs and preferential allotments to QIBs, thereby putting the Indian economy back on the road to success.

Vandana Shroff

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