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Mumbai: The capital markets regulator’s bid to impose a safety net for retail investors in initial public offerings (IPOs) appears to have got stuck in the face of resistance on the part of investment bankers, companies and brokerage firms, according to two persons with direct knowledge of the matter.

The industry view came in response to a 28 September discussion paper floated by the Securities and Exchange Board of India, or Sebi, that proposed draft regulations on mandatory safety net mechanism.

“The matter is before the primary market advisory committee. They are yet to draw a conclusion on the matter. There is no hurry, so it is difficult to say when it will be introduced," said one of the people on condition of anonymity as he is not authorized to talk to the media directly.

The process involves the issuer or its merchant bankers committing to buy shares back from investors at the offer price if the stock falls below a particular level within a certain period.

Currently, offering a safety net for retail investors is up to the issuer.

The initial share sale of apparel retailer Sai Silks (Kalamandir) Ltd pledged this protection in the event of the stock falling below the issue price upon listing. Sebi has proposed that such protection for retail investors be made mandatory for IPOs.

“Also, most of the IPOs have started doing well now and some of the issuers have offered safety net option (on their own). So, there is more time to discuss on the matter before its introduction. The proposal to make safety net mandatory was not discussed in the recent Sebi board meet in February," he said.

An e-mail sent to Sebi did not elicit a response.

After Sebi circulated the discussion paper on a mandatory safety net for retail investors, 15 IPOs have taken place. Of these, nine are trading above their offer price and doing better than the benchmark. The 30-share Sensex was trading down 0.76% at 18,681.42 points from its level on 1 October.

Sebi’s primary market advisory committee, or PMAC, studied the industry comments on the discussion paper at a meeting in February.

“Most of the comments are against the introduction of mandatory safety net," said the second person, who is aware of what happens at the PMAC.

At a banking conference late last year, Sebi chairman U.K. Sinha called for introspection on the pricing of public issues. Two thirds of all public issues in the past three years were trading below their issue price, he said at the time.

Under the proposed mandatory safety norms, the regulator suggested that the protection kicks in if, within three months of the share sale, the stock drops from the issue price by at least 20% compared with the broader market. When that happens, the company is obliged to buy back shares worth up to 5% of the issue size from retail investors, and at the issue price, the discussion paper said.

However, according to securities market lawyers, introducing a safety net is not the solution to address the issues of pricing and credibility in public offers. “No mature market has such a mechanism. It should simply not be introduced. There is no place for it in a market," said Somasekhar Sundaresan, partner, J. Sagar Associates.

At least 35% of an initial offering of shares is reserved for retail investors. The paper added that the facility be made available only to those retail investors buying stock for a maximum 50,000, putting the focus on small investors.

The safety net mechanism had been considered in the 1990s when in the early days of Sebi’s evolution, according to Sundaresan. Such a mechanism will erode the foundation of a good market in which informed investors know how to value equity, he said.

“Today, it is an anachronism. Equity investments are about the risk of losing everything. If someone has unfairly treated investors or has duped investors, regulations prohibiting fraudulent and unfair trade practices should be used to bring the violators to book. Introducing safety net would harm and erode the very market in the name of protecting the market," he said.

At least 13 IPO applications were pending with Sebi on 15 March. Most of them are likely to launch their issues without a safety net, said the head of equity capital markets at a multinational investment banking firm.

The first person cited above said the matter has not been included on the agenda of the forthcoming board meeting in May. Mint reported on 18 February that bankers were not keen to offer a safety net as equity investments are inherently risky by nature and offering any form of guarantee may send the wrong signals to investors.

To be sure, there was a wide variety of opinion in the comments made in response to the discussion paper.

“Some suggested that mandatory safety net should offer more benefits to retail investors and make rules tighter for bankers, while others suggested that safety net should be scrapped completely. Even without discussing the matter in a board meeting, draft norms could be formalized if PMAC arrives at a logical conclusion," added the first person.

Sandeep Parekh, a former Sebi official and founder of Finsec Law Advisors, said the regulator was trying to prevent the rigging of prices that crash soon after the listing. However, a safety net may not be the best way to deal with this, he said.

“Risk is a factor which is intrinsic to the equity market. That is risk of market movement, rather than the risk of fraud," he said. “I sympathise with Sebi as I understand why it is trying to attempt this feat."

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