SEBI’s compensation mechanism for small investors creates roadblock for IPOs

For quite some time now, SEBI has been working to shorten the timeline for IPOs. Since 2019, it has made the Unified Payment Interface (UPI) mandatory for retail investors to apply in IPOs. When retail investors apply for IPOs, the required amount of funds gets blocked. Later, depending on the number of shares allotted, the necessary funds are debited from the bank account and the rest is unblocked.

However, this system hasn’t been working as smoothly as anticipated and the regulator has identified multiple issues.

Investor complaints galore

Investors have complained that there have been delays in the receipt of their mandate to block funds. In some cases, banks have failed to unblock funds when issues have been cancelled or withdrawn. There have been cases of delays in the unblocking of funds in the case of partial allotment of shares. Sometimes, banks have blocked multiple amounts for the same UPI application or blocked an amount higher than the application amount.

“The regulator has received complaints that an investor’s money is blocked for more than 1.5-2 years. It is unfair to investors that their money is blocked,” said a member of SEBI’s primary market advisory committee responsible for clearing the new compensation mechanism.

SEBI’s rules stipulate that unblocking of funds should be done within four days of the issue closing date (which is also one day after allotments have been decided.)

The new compensation mechanism

SEBI has tried to streamline this process by issuing a set of instructions to streamline the application process.

In a circular issued on March 16, it has asked intermediary banks (called self-certified syndicate banks or SCSBs) to identify a nodal officer for IPO applications processed through UPI to address investor grievances. It wants them to send SMS alerts to investors when funds and blocked and unblocked.

In cases where IPO applications are cancelled or withdrawn or deleted, registrars to an issue have been asked to submit the details on a daily basis within 60 minutes of bid closing time to banks. These banks, in turn, have to unblock funds by the closing hours of the bank day.

Similarly, in the case of non-allotment or partial allotment, funds have to be unblocked within the prescribed time (one day after allotment of shares is finalised).

These all are procedural measures, but the sticking point for investment bankers is that the lead managers to an IPO have been made responsible for adherence to these rules and timelines. Further, both intermediary banks and lead managers have been asked to compensate investors in case of delays in funds unblocking.

Let's say, an issue closed on April 4 for which funds of an investor have to be unblocked by April 8. Let's say the investor complained to the intermediary bank on April 17 and the unblock happens on April 22. In this case, the intermediary bank has to compensate the investor Rs 100 per day or 15 percent of the application amount (whichever is higher) for April 8 to 17. The lead manager has to pay the same compensation for April 17 to 22 when the funds are finally unblocked.

Unhappy investment bankers

Investment banks (the lead managers to an issue) are unhappy because of the additional burden. While historically, they have had to ensure compliance for various requirements in the IPO process, this new responsibility – for things that are purely procedural in nature – will only increase compliance burden and costs, they complain.

“It is difficult for investment bankers to keep a track of investors’ money, especially when allotment is less but application numbers are high. On the other hand, SEBI will also take action if we fail to do our duty,” an investment banker told Moneycontrol on the condition of anonymity:

In its circular, SEBI tried to address this problem by asking intermediaries from banks to the registrar and transfer agents to share data with investment banks.

This argument also doesn’t wash with the primary market advisory member cited earlier.

“When the merchant banker knows who has given money, then what is the problem in returning the money back to the investor?” this person said.

A timeline extension in the works

Perhaps, the larger problem is the requirement of robust IT systems which will allow a seamless collation and sharing of information between the large number of intermediaries involved in an IPO starting from exchanges where bids are placed.

Such an ecosystem “will require necessary modifications at respective intermediaries’ end, which would take time to implement,” said Ravi Dubey, Partner with Indus Law. “These timelines would become critical in case of heavily oversubscribed IPOs, as we have seen in the recent past, owing to a large number of applications for unblocking of funds.”

Investment bankers have asked SEBI to extend this timeline for the implementation of these rules.

“SEBI is ready to extend the timeline for this circular. We have sought four weeks’ time for suggesting a new timeline,” said another banker who didn’t wish to be identified.

SEBI had not responded to a query from Moneycontrol at the time of publishing this article.