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UNIT II INDIAN CAPITAL MARKET- PRIMARY MARKET
Primary Market - Primary market system - Types of scripts - Issue
of capital: process, regulation pricing of issue, – Methods of floating new
issues, Book building- Primary markets intermediaries: commercial banks,
development banks, Merchant banker, issue managers, rating agencies etc – Role
of primary market – Regulation of primary market
The
primary market is a market for new issues. It is also called the new issues
market. It is a market for fresh capital. Funds are mobilised in the primary
market through prospectus,
rights issues, and private placement.
Bonus
issue is also one of the ways to raise capital but it does not bring in any
fresh capital. Some companies distribute profit to existing shareholders by the
way of fully paid bonus shares instead of paying them a dividend. Bonus shares
are issued in the ratio of the existing shares held. The shareholders do not
have to pay for bonus shares but the retained earnings are converted into
capital. Thus, bonus shares enable the company to restructure its capital.
In
India, new capital issues are floated through prospectus, rights, and private
placement by government companies, non-government public limited companies (private
sector), public sector undertakings, banks, and financial institutions. A scrip issue, also known as capitalisation
issue or bonus issue, is the process of creating new
shares which are given free of charge to existing shareholders. It is a form
of secondary issue where a company's cash reserves are converted into new shares and given to
existing shareholders, or
an issue of additional shares to shareholders in proportion to the shares
already held. A scrip issue is usually done when a company does not have
sufficient liquidity to pay a cash dividend
There
are three categories of participants in the primary market. They are the
issuers of securities, investors in securities, and intermediaries. The last
named render services to both the issuers and investors to enable the sale and
purchase of securities.
Intermediaries to an Issue
There are different
intermediaries to an issue such as merchant bankers or book running lead
managers (BRLM), syndicate members, registrars to the issue, bankers to the
issue, auditors of the company and solicitors. The issuer discloses the
addresses, telephone, fax numbers and email addresses of these intermediaries.
The major new issue Market
intermediaries are:-
1. Merchant Banker A merchant
banker should be registered with the SEBI as per the SEBI (Merchant Bankers)
Regulations, 1992 to act as a book running lead manager (BRLM) to an issue. The
lead merchant banker performs most of the pre-issue and post-issue activities.
The pre-issue activities of the lead manager include due diligence of company’s
operations/management/business plans/legal etc., drafting and designing offer document, finalising
the prospectus, drawing up marketing strategies for the issue, and ensuring
compliance with stipulated requirements and completion of prescribed
formalities with the stock exchanges and the Registrar of Companies (ROC).
The
post-issue activities include management of escrow accounts, coordinating,
non-institutional allocation, intimation of allocation, coordination with the
registrar for dispatching of refunds, demateralising of securities, listing and
trading of securities, and coordinating the work of other intermediaries
involved in the issue process.
2. Registrar to the
Issue The
role of the registrar is to finalise the list of eligible allottees, ensure
crediting of shares to the demat accounts of the eligible allottees, and
dispatch refund orders.
3. Bankers to the
Issue They
are appointed in all the mandatory collection centres, and by the lead merchant
banker to carry out activities relating to collection of application amounts,
transfer of this amount to escrow accounts, and dispatching refund amounts. It
is now mandatory to issue all new initial public offerings (IPOs) in
dematerialised form as they are compulsorily traded in dematerialised form.
4. Lead
Managers : “In a syndicate, an underwriting firm
immediately subordinate to the managing underwriter.
A syndicate is a group of underwriters responsible for placing a
new issue of a security with investors. Every
syndicate is a temporary arrangement. The lead manager is assigned the
second-largest part of the new issue for placement. A lead manager is also
called an arranger”. As per the SEBI regulations all issues should be managed
by at least one authorized Merchant Banker functioning as Sole manager or Lead
manager.
Responsibilities of Lead Managers
·
Every
Lead Manager must sign an agreement with the issuing companies. The agreement
must contain the matters regarding mutual rights, liabilities and obligations
relating to issues which must necessarily include disclosures, allotment and
refund.
·
Merchant
banker should furnish a statement specifying the details in the agreement to
SEBI. Such statement should be sent at least one month before the opening of
the issue for subscription. The statements should also contain the details
about all lead managers and their respective responsibilities if there were
more than one Lead Manager/Merchant Banker.
·
There
should be no association between the lead manager and the issuing company.
·
There
should be no association with other merchant bankers who do not hold a certificate
of registration with SEBI.
5. Underwriters : Underwriters
to issue of capital are one of the important intermediaries in the new
issue/primary market. They agree to take up securities which are not fully
subscribed. They make a commitment to get the issue subscribed either by others
or themselves. After 1995, underwriting is not mandatory.
·
To
protect the interests of its clients.
·
To
maintain high standards of integrity, dignity and fairness in the conduct of
business.
·
To
render high standards of service and maintain professional ethics.
·
To
exercise due diligence.
·
To
ensure proper care and professional judgment.
·
To
avoid conflict of interest
·
To
make adequate disclosure of his interest.
·
To
treat equally all its clients without discrimination.
·
To
maintain appropriate level of knowledge and competence.
·
To
abide by the provisions of the SEBI Act, regulations, circulars and guidelines
issued by the SEBI.
·
To
furnish true and complete statement, material fact in any documents reports
papers without suppressing any fact or making untrue statement.
·
Should
not have insider trading activity.
·
Should
not engage in unfair competition harmful to the interest of other underwriters.
Types
of Primary Market Issuance
After the issuance of
securities, investors can purchase such securities in various ways.
There
are 5 types of primary market issues.
1. Public
issue
Public issue is the
most common method of issuing securities of a company to the public at large.
It is mainly done via Initial Public Offering (IPO) resulting in companies
raising funds from the capital market. These securities are listed in the stock
exchanges for trading.
A privately held
company converts into a publicly-traded company when its shares are offered to
the public initially through IPO. Such public offer allows a company to raise
funds for expansion of business, improving infrastructure, and repay its debts,
among others. Trading in an open market also increases a company’s liquidity
and provides a scope for issuance of more shares in raising further capital for
business.
The Securities and
Exchange Board of India is the regulatory body that monitors IPO. As per its
guidelines, a requisite due enquiry is conducted for a company’s authenticity,
and the company is required to mention its necessary details in the prospectus
for a public issue.
2. Private
placement
When a company offers
its securities to a small group of investors, it is called private placement.
Such securities may be bonds, stocks or other securities, and the
investors can be both individual and institutional.
Private placements are
easier to issue than initial public offerings as the regulatory stipulations
are significantly less. It also incurs reduced cost and time, and the company
can remain private. Such issuance is suitable for start-ups or companies which
are in their early stages. The company may place this issuance to an investment
bank or a hedge fund or place before ultra-high net worth individuals (HNIs) to
raise capital.
3. Preferential issue
A preferential issue
is one of the quickest methods available to companies for raising capital. Both
listed and unlisted companies can issue shares or convertible securities to a
select group of investors. However, the preferential issue is neither a public issue
nor a rights issue. The shareholders in possession of preference shares stand
to receive the dividend before the ordinary shareholders are paid.
4. Qualified
institutional placement
Qualified
institutional placement is another kind of private placement where a listed
company issues securities in the form of equity shares or partly or wholly
convertible debentures apart from such warrants convertible to equity shares
and purchased by a Qualified Institutional Buyer (QIB).
QIBs are primarily
such investors who have the requisite financial knowledge and expertise to
invest in the capital market. Some QIBs are –
Foreign Institutional
Investors registered with the Securities and Exchange Board of India.
Foreign Venture
Capital Investors.
Alternate Investment
Funds.
Mutual Funds.
Public Financial
Institutions.
Insurers.
Scheduled Commercial
Banks.
Pension Funds.
Issuance of qualified
institutional placement is simpler than preferential allotment as the former
does not attract standard procedural regulations like submitting pre-issue
filings to SEBI. The process thus becomes much easier and less time-consuming.
5. Rights and bonus issues
Another issuance in
the primary market is rights and bonus issue, in which the company issues
securities to existing investors by offering them to purchase more securities
at a predetermined price (in case of rights issue) or avail allotment of
additional free shares (in case of bonus issue).
For rights issues,
investors retain the choice of buying stocks at discounted prices within a stipulated period. Rights
issue enhances control of existing shareholders of the company, and also there
are no costs involved in the issuance of these kinds of shares. For bonus
issues, stocks are issued by a company as a gift to its existing shareholders.
However, the issuance of bonus shares does not infuse fresh capital.
Book building is a recognised
mechanism for capital raising. Book building is a mechanism through which an
offer price for IPOs based on the investors’ demand is determined. The aim of
the process is to have the issue presold and preclude chances of
under-subscription/devolvement. The cost and time for making public issues is
lowered; the procedures are also simplified.
The SEBI reintroduced the moving
price band concept in the book built IPOs. The price band can be revised and
this revision has to be informed to the stock exchanges. The SEBI lowered the
mandatory participation.
Book building is a process by
which demand for the proposed issue is elicited and built-up and the price at
which the securities will be issued is determined on the basis of the bids
received.
Following the inefficient
functioning of the capital market system, an alternative method, called the
book building method, is slowly becoming popular in India. Book building is a
mechanism through which an offer price for IPOs based on the investors’ demand
is determined. In the fixed price method, the investors’ demand is not taken
into account; the book building method explicitly uses investors’ demand for
shares at various prices as an important input to arrive at an offer price.
Globally, book building is a
recognised mechanism for capital raising. It was book building which built the
US market almost entirely in the 1940s and 1950s.
The SEBI guidelines define book
building as a process undertaken by which a demand for the securities proposed
to be issued by a corporate body is elicited and built-up and the price for
such securities is assessed for the determination of the quantum of such
securities to be issued by means of a notice, circular, advertisement, document
or information, memoranda or offer document.
The book building is basically an auction of shares. Book building
essentially means that the ‘book is being built.’ During the process on both
the NSE and the BSE, investors can watch the book being built– a chart shown
indicates the bid price and the number of shares being bid for. This helps the
investor to know the market price. It offers investors the opportunity to bid
collectively. It then uses the bids to arrive at a consensus price.
The issue of securities through
book building prior to August 2009 could be done in either of the following two
ways: 75 per cent book building known as partial book building and 100 per cent
known as one-stage book building. The SEBI allowed partial book building with
only 75 per cent of the total issue allotted for the book built portion; the
remaining 25 per cent has to be compulsorily offloaded in the general market at
a fixed price discovered during the book building process. The IPOs of Hughes
Software and HCL Technologies are examples of partial book building which were
successful. A 100 per cent book building issue implies that the entire issue is
completed in a single stage, without having to make a mandatory fixed price
offering. The option of 100 per cent book building was available only to those
issuer companies which are to make an issue of capital of and above Rs. 100
crore. Due to these restrictive guidelines, no issue was floated using this
mechanism. These guidelines were modified in 1998–99. The ceiling of issue size
for book building was reduced from Rs. 100 crore to Rs. 25 crore
ROLE OF PRIMARY MARKETS IN INDIA
The key function of the
primary market is to facilitate capital growth by enabling individuals to
convert savings into investments. It facilitates companies to issue new stocks
to raise money directly from households for business expansion or to meet
financial obligations. It provides a channel for the government to raise funds
from the public to finance public sector projects. Unlike the secondary market,
such as the stock market which trades listed shares between buyers and sellers,
the primary market exists for the issuance of new securities by corporations
and the government directly to investors.
·
IPOs and the Role of New
Issue Markets
Companies
raise funds in the primary market by issuing initial public offerings (IPOs).
These stock offerings authorize a share of ownership in the company to the extent
of the stock value. Companies can issue IPOs at par (market value) or above par
(a premium), depending on past performance and future prospectus.
In
a booming economy, a greater number of corporations float IPOs since more
investors have surplus funds for investment purposes. Thus, the number of IPOs
issued is indicative of the health of the economy. Invariably, smaller
companies seeking funds for business expansion are the ones typically that
float IPOs. But large, well-established firms also become publicly traded
companies to gain visibility and to expand. Companies can raise an additional
round of funding in the primary market by floating a secondary public offering.
·
Role of New Issue Markets
in Global Investments
The primary market
enables business expansion and growth for domestic and foreign companies.
International firms issue new stocks--American Depository Receipts (ADRs)--to
investors in the U.S., which are listed
in American stock exchanges. By investing in ADRs, which are
dollar-denominated, you can diversify the risk associated with putting all your
savings in just one geographical market.
·
Sale of Government
Securities
The
government directly issues securities to the public via the primary market to
fund public works projects such as the construction of roads, building schools
etc. These securities are offered in the form of short-term bills, notes that
mature in two to seven years, longer-term bonds and treasury
inflation-protected securities (TIPS) linked to the Consumer Price Index. Government-issued
U.S. Treasury bonds are free of credit risk.
Primary Market
Participants
An
investment bank sets the offer price of the corporate security as opposed to
market forces, which determines the price in the secondary market. While
brokerage firms and online licensed dealers sell IPOs to the public, you may
not be allotted IPO shares because of the large demand for a small number of
shares typically issued by the company. Moreover, institutional investors
(large mutual funds and banks) usually get the lion's share of much anticipated
IPOs.
·
Market Risk
The securities and
exchange commission cautions investors that IPOs are inherently risky and
therefore unsuited for low network individuals who typically are risk-averse.
This should be noted as something to be cautious about for two reasons. As an
investor, of course, you'll want to weigh the risk with the potential earnings.
If your small corporation is considering going public, you'll need a sufficient
budget to plan and market your IPO to ensure it gets some traction from
investors – in addition to all of the other costs inherent to an IPO.
What is the role of the new issue
market?
The roles of a new issue market
or a primary market are Origination, underwriting, distribution and mechanics
of floating new issues.
·
Origination:
It is the work that is before the issue is actually floated into the market. It
is the stage where the initial groundwork is done. Through this, the issues can
understand the investment climate and whether the investors would subscribe to
it or not. The underlying condition for
this role is the time of floating of an issue, type of issue and price of the
issue.
·
Underwriting:
It is an undertaking or guarantee by brokers ensuring the marketability of the
issue. The institution of the broker promises to purchase a specified number of
shares if the public is not investing in the shares.
·
Distribution
and Mechanics of Floating New Issues: Distribution is the process of floatation
of new issues and all their pre and post allotment procedures. Brokers and
agents are in charge of this. They maintain a client list and contact them
directly for securities purchases and sales.
Concepts
related to the primary market
·
Offer
document: The offer document means prospectus.
This document covers all the relevant information about the company. The
data is about the company, its promoters, the project, financial details and
past performance, objects of raising money, terms of issue, etc. This helps the
investor to make their investment decision. Companies issue offer document
while raising capital from the public. Companies issue offer document in case
of a public issue or offer for sale. For a rights issue, a letter of offer is
issued. The company files the offer document with the Registrar of Companies
(ROC) and stock exchanges.
·
Price
band: The price band of an IPO is the offer price of the company’s shares. The
lead manager decides the price band for any IPO. There is no specific or
standard calculation for it. It is determined by looking at the company’s
valuation and prospects. The company announces its price band, and then
investors make their bid. Once the company receives the requests, it decides a
particular price for the listing of shares. For example, the IPO of an XYZ
company opens on 20th September 2019 and closes on 23rd September 2019. The
company fixes the share price band at Rs.1000-Rs.1010. The spread between the
floor price and the cap price shall not be more than 20%. The price band can be
revised. If the price revises, then the bidding period also extends for three
more days.
·
Cut
off price: A cut off price is any price that an investor can bid. In other
words, the investor is ready to pay whatever price the company decides at the
end of the book-building process. The retail investors pay the highest price
while placing the bid at cut-off price. If the company chooses the final price
lower than the highest price, the remaining amount is returned to the investor.
The company’s employees are eligible to bid in the employee reservation portion.
Also, the retail investors are allowed to bid at the cut-off price. However,
QIBs (including anchor investors) and non-institutional investors are not
allowed to bid at the cut off price.
·
Floor
price : The floor price is the lowest price in the share price band. It is the
price at and above which investors can place their bids. On the other hand, the
highest price in the price band is called the cap price.
·
Face
value: The face value of a share is the value at which the share is listed on
the stock market. Face value is also called par value. The face value is
determined when the company issues shares to raise capital. Hence, one cannot
calculate the face value. It remains fixed and never changes. However, if a
company decides to split the shares, then the face value can change.
Mostly,
Indian company shares have a face value of Rs.10. The face value is significant
in the stock market for legal and accounting reasons. When a shareholder buys a
stock, the company issues a share certificate that has face value mentioned.
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