Decoded: Grey market in IPOs and how it influences listing day price

What does the grey market price denote?

The price quoted in the grey market is the ‘premium’ over the likely issue price. So when brokers say the IPO is quoting at Rs 20 in the grey market, it means that the appetite for the issue is Rs 20 above what the issue is likely to be priced at.

How is the price arrived at? 

Usually, it the merchant banker, company promoter and market operators connected to the promoters who set the initial price in the grey market. This is done to create an impression of a strong demand for the issue.

Does this strategy always work?

Like the official market, the grey market too pays attention to fundamentals. If the company’s fundamentals are good, players are willing to pay a decent premium. If not, merchant bankers cannot influence the price beyond a point.

Are there other factors which decide the grey market price?

The grey market price also factors in the cost of funding for high networth individuals, who make big bets using borrowed money. Remember, it is the market operators and HNIs who are the biggest players in the grey market.

Also, the pricing of the issue and overall market sentiment also influences grey market trends. If the issue is perceived to be overpriced, grey market premium will shrink. That is because of the assumption that there may not be too many takers for the stock on listing day if it is seen to be expensive. Also, if the overall market trend is downward, follow-up buying on listing day may not be much.

If the shares are yet to be allotted, then how are the trades done?

The trades are done purely on faith, and then ‘regularised’ on listing day by entering the orders into the trading system.

Sellers in the grey market are usually those who feel that the shares are overvalued. The moment they get their allotment, they hand it over to their brokers through whom they had sold in the grey market.

How did the grey market in IPOs come about?

In case they are not allotted the same number of shares they had sold in the grey market, they will have to buy the shares from the market and give it to their broker.

In majority of the cases, they give the power of attorney to their brokers to sell the shares as soon as it lands in their demat accounts.

What if somebody refuses to honour a grey market commitment?

The counterparty has no recourse, because this arrangement is not legal in the first place.

How did the grey market in IPOs come about?

In the early days of IPOs in the late 70s and 80s, promoters would struggle to get their issue fully subscribed. To ensure that their issues sold, promoters would create a premium on their shares to get investors interested. If an issue priced at Rs 10 was quoting for Rs 11 in the grey market, the public would naturally develop an interest in those shares. The operator willing to buy the shares for Rs 11 in the grey market was backed by the promoter or the investment banker to the issue.

Who were the buyers in the grey market then?

Surprisingly, retail investors were very active in the grey market back then. Also, there was no separate classification of investor categories.

The staggered payment structure too helped generate interest in the grey market.

Investors subscribing to an IPO or rights issue had to pay 25 percent at the time of application, 25 percent on allotment and the balance 50 percent when the company would call for it, which would usually be a month or two after listing.

Retail investors were usually assured of allotment of the full quantity they had applied for. So, they could sell an equivalent quantity in the grey market at a premium and deliver the shares once they got allotment.