Securities and Exchange Board of India (Sebi) chairman M. Damodaran says he feels strongly that the grading of initial public offers will help investors take more informed decisions while not reducing the responsibility of merchant bankers. Conceding that nowhere else in the world has this kind of rating been attempted, he says that precedence should not be the determining factor.
Over time, the capital market regulator also wants all investment analysts to be registered with Sebi. He is also determined to bring hedge funds, which have been playing in the Indian market through the promissory note route, through the front door. “Since they are already present in the market, how can they destabilize it further as those who oppose this move fear?” he asks.
In a rare interview with a newspaper, Damodaran, 59, talked with Mint on a wide range of issues, from revision of delisting norms to putting a price band for new issues on their listing day.
Is the grading of initial public offerings (IPOs) nothing but yet another artificial hurdle imposed by Sebi in the name of investor protection?
Sebi’s mandate is to protect investors’ interest. Who is expected to speak on behalf of investors? There are investors’ associations that are supposed to articulate the expectations of the investors and Sebi is required to meet, or to attempt to meet, their expectations. For several years, the investors’ associations have been asking for something like this. In the early 1990s, we had a phenomenon of companies that came to the market, raised funds and did not invest the money in projects for which the money was meant. They are now called ‘vanishing companies’. The ministry of company affairs and Sebi tried to deal with these firms by taking corrective action wherever possible.
We have learnt enough from these vanishing companies. With the economy doing very well and markets on the rise, the number of firms in the market to raise capital has been increasing. Taking into consideration the long-pending demand of investors’ associations and the fact that many companies are in the market to raise funds, Sebi thought it would be worthwhile to put in place a system of rating IPOs. This is not meant to be a substitute for the research reports put out by brokerage firms. This is not meant to be a buy, sell or hold recommendation, which is price-related—at what price one should buy or exit a stock. What we are seeking to do is to get an “additional” input for the investors to capture the essence of an IPO.
Put simply, it will help the investors’ process of decision making. And, mind you, this wasn’t introduced overnight. The primary markets advisory committee of Sebi, which has representatives from all interest groups—issuers, intermediaries, investors—recommended that a pilot project might be put in place and a limited number of IPOs might be graded. Based on the findings of the pilot project, the primary markets advisory committee recommended that it would be useful to mandate this for all IPOs. On the basis of this recommendation, we have taken the decision for grading IPOs.
We recognize that nowhere else in the world has this kind of exercise been attempted. But that should not be the determining factor. Yes, we are doing something for the first time, without any precedent anywhere, but why should we not act for this reason alone? This is not an ad hoc knee-jerk decision; this is the result of a long consultative process.
Equity is not an asset that should be graded. What is good at a particular price may not be good at another price and prices keep changing every minute. Therefore, how can one give a recommendation?
But this is not a recommendation. Rating agencies will assess an IPO, based on a set of parameters and assign a grade between one and five, with five being the best and one the worst. The critics are either expecting too much from this particular instrument or not understanding the rationale. Our belief is after the grading exercise stabilizes, people will see its merit and not consider it one more hurdle. This exercise will not take long and the cost is not prohibitive. We are holding a meeting with three rating agencies involved in the process to refine it further.
We have not arrived at a perfect product yet. Based on experience, it can be fine-tuned as we go forward but, even before we start, criticizing the product because it has not been seen elsewhere or it does not give buy/sale recommendations is clearly a bit premature.
Won’t this confuse investors?
The issuers themselves today are approaching the agencies for rating their IPOs. I must add that rating agencies do not do an office-based exercise. They discuss things with promoters and merchant bankers, and ask questions on certain assumptions made in the offer document of an IPO. This brings more clarity, disclosure and better articulation of what has been stated in the offer document. Somebody who wants to come to the market to raise money and vanish is unlikely to do that if he has to engage with a rating agency as he has to satisfy the agency to get a good grade. So, it is an additional comfort.
Our task is to protect the investors and grow the market by bringing in more investors to the market. We believe that on the basis of the comfort that such instruments create, more investors will come to the market. We are not seeking to influence the investors to buy or sell stocks. We are not seeking to substitute his or her judgement by our judgement or the rating agencies judgement. We are only offering an additional input to help an investor’s decision-making process.
Does this reduce the responsibility of merchant bankers?
No, it doesn’t. Merchant bankers bring the issues to us. They are responsible for ensuring full disclosures. If they have decided on a particular price and after fixing that if the concerned IPO gets a lower grading, they may like to re-price the issue. So, merchant bankers, too, will use this as an input.
You now plan to keep a tab on investment advisors?
Now all sorts of people give investment advice and use all media, including short messaging services on mobile phones. In a rising market, some investors do not give adequate attention to the process of decision-making. What we are saying is that only those people who are qualified to give investment advice should give advice to a particular investor who is seeking such advice. To give advice to the world at large is inappropriate because you are speaking to people who are not placed similarly and their risk appetite as well as time horizons for investment are different. We also need to see the interest of the person who is giving the advice. Is he doing something in order to shore up the value of his own investment portfolio? We had a case in the past where somebody gave advice to investors at large to buy one stock while he himself was selling the stock!
We are looking for a process of registration and regulation over a period of time. Investment advice as a commodity should be dealt with by people who understand the business and are qualified to do it as professionals for a fee and not the people whose objectives are shrouded in mystery. This is not an easy task. Over time, we expect that all those who give investment advice must be registered with Sebi. An investor needs to distribute his investible funds among capital markets, banks, etc., and across assets, and hence an investment advisor should understand all these. He can’t be a single-product pusher to the exclusion of other products either because he is earning more by way of commission or does not know about other products.
We have attempted a consultative paper on this and sought people’s opinion on this. This will be among the most consultative exercises that we have undertaken, as we want to so something which is sustainable. The paper has been placed on the Sebi website for public comments.
You are planning to put a band on a stock price on its listing day?
So far, we do not have any price band of a stock on its listing day, as there must be a method to facilitate the price discovery. Thereafter, the stocks face circuit filters (that stop a free fall as well as a huge rise). We found that some of the shares on their listing day ran up very significantly and the volumes that were traded were exceptionally large. In all these cases, we have issued notices to persons to understand what happened and if, prima facie, we suspect any foul play, we have initiated action. We have asked for additional information in a couple of cases.
There has been a demand for a price band on day one—maybe a higher price band which ensures price discovery and at the same time prevents market manipulation. We have already introduced the price band for relisted shares. We have some recommendations for new listings and will take them through the primary markets advisory committee. We are also talking to exchanges to find out what kind of band can be put in place. In the name of price discovery we cannot allow market manipulation.
You seem to be ready to welcome hedge funds with open arms?
I have not said that we will allow hedge funds to come here. The FII regulations today do not say that hedge funds cannot come to our market. At the same time, there are applications from entities which are either declaring themselves hedge funds or have some connections with hedge funds. We have kept all of them out of our market. Worldwide, there is a lot of discomfort about the hedge funds because they are not regulated. As our regulations do not specifically prohibit hedge funds, and as some of them are already present in the market through offshore derivative instruments, we thought if they want to be present in the market and if we do not have discomfort (about them), either because they have lock-in periods or their track record is good, we must persuade them to come to our market and disclose their identities rather than be present here through the promissory note route.
It is not that we are allowing hedge funds to come in, but we are planning to tell those who are already present in the market to be here disclosing their identity. Since they are already present in the market, how can they destabilize it further as those who oppose this move fear? We want to bring them through the front door rather have them play in our market but not in their own names. We will not open the door to all hedge funds tomorrow morning.
How many of them have applied so far?
Could be 10 or 15 but more important than the numbers is the fact that they are already present in the market. We can pretend that they are not in the market. Ultimately their job is to make money for their investors and they will partake of the prosperity of the market if necessary through promissory notes. Now, if they are already present here, why not allow them to register themselves?. We are talking to them... Some of them had applied earlier and got rejected and now may apply again. We will look at every application on merit. So, there is no big-bang opening of the door and a lot of guys walking in. That’s for certain.
You are planning to tell promoters to buy back up to 95% of their stake to delist stocks?
There is no proposal with Sebi to push up the level of buyback from 90% to 95% and it is unlikely that there will be a proposal of this nature. This is certainly not on our agenda. However, we have, for quite some time, been looking at the present de-listing procedures and checking whether they are adequate. We must keep in mind the interest of investors as well as the promoters who want to exit the market. The debate on delisting and the companies leaving the public space should not be based on the assumption that all these are sound companies. There are stocks that are not traded and those which should never have been listed in the first place.
There is a belief that reverse book-building stands on the way of delisting of small companies. If we do away with reverse book-building, we could harm the investors and at the same time if we insist on reverse book-building some people may indicate a very high exit price and it may hold up the entire process. People might say if we do away with the reverse book-building, investors may not get the right price, but if the prices are very high and the delisting does not take place and if there is no trading of the stock, then investors will get trapped without an exit route. We will take a decision on this in the next couple of months.
It seems you are wearing the hats of both police and judge. When you’re in a hurry to punish a market player, the appellate authority sets aside your order. You also inordinately delay some cases. For instance, the Rupalben Panchal case has not yet been solved.
All the roles that Sebi has been playing are legitimate and their validity has been upheld by courts. Sebi has executive power, regulation-making power and also the power of enforcement. We need that in order to be effective in the business of regulation.
Are we doing things in haste? Now, regulation is such a business that whatever you do, some people will think you’re too slow and others will say you’re too fast. It is for us to take a call on what is the right time to act.
We decide to act to prevent continuing mischief in the market and we collect information based on which our action can be sustainable. On grounds of urgency and to prevent continuing malpractices in the market, we often pass interim orders. This prevents parties from continuing to act in a manner that we think is not in the best interest of the market. We follow this up with inquiry or adjudication. If a party is not happy with our interim order, it goes to the Securities Appellate Tribunal (SAT). You will not find too many instances where SAT has set aside a Sebi order in toto. Either it has been upheld entirely or the findings have been upheld and punishment reduced, or we have been asked to complete the proceedings in a certain time frame. We have numbers to prove our claim and have in fact made it available to parliamentary committees.
If you say that we are taking too long to conclude cases, I would only urge you to look at what regulators in other countries do, how long they take before they pass a final order. We would like to collect as much evidence as possible and present a case that can survive appeals. If you look at the recent orders of regulators in some of the mature markets, you will find in terms of speed we are much better off than many of them.
You spoke about the Rupalben Panchal case. These are transactions related to several IPOs over several years. We are proud of the fact that our officers on scrutiny of raw data made available found that something was wrong, went into the details, and identified those who had financed the transactions as well as cleaned up some of the practices that had been going on in the market place for long.
They also gave leads that other regulators can act on. We are not sitting back, we are trying hard to bring this matter to its logical end soon.
Aren’t some of the spoilsports getting away through SAT?
No. It is extremely unfair to say that somebody is getting away because there is an appellate authority. In any system that is based on natural justice, it is extremely important that a person must have an opportunity to go in appeal and test the validity and legitimacy of the order passed by the first-level authority. SAT is doing its job exceptionally well and whenever SAT passes an order that is not upholding our order, we take that as a great learning experience and try to ensure that the next time round a similar thing does not happen.
Your future agenda?
The long-term agenda is to bring in more and more people in the market. All the new products that we have brought in help in this effort. We are signalling that the market is a safer place than it was earlier. Now, we are focusing on how to rewrite regulations in simple language and make it understandable to lay investors. This will bring down transgression on account of ignorance. We want to create a bigger market, a better market and a more informed market where investors are willing to take reasonable risk and get reasonable return.
Your take on the markets?
I attach least importance to the extent of movement of indices. Orderly conduct in the market place is all I am concerned about.