IPO Financing | Its colourful past, and RBI’s tightening grip

The recent BharatPe-Kotak controversy is understandably viral for the abusive call allegedly made. But the underlying subject — viz., IPO (Initial Public Offers) financing — got sidelined, and needs a closer look. This is particularly since it has seen, over the years, multiple interesting developments. The most recent is the Reserve Bank of India’s mandate to NBFCs to severely restrict such financing.

IPO financing, to simplify, is providing finance to a person seeking to subscribe to an IPO. It is finance for a very short period, usually just a week or so. The borrower uses the finance to subscribe for the IPO. The subscriber comes to know the outcome of their application within days — thanks to an ever-shortening period which, in turn, is thanks to SEBI’s relentless simplifying of procedure, and improving technology. The subscriber usually sells the shares allotted and returns the amount borrowed with interest after pocketing the profits (or coughs up the loss).

IPO Financing

IPOs have been heavily pursued in recent months, with many IPOs being subscribed multiple times. IPO financing then is sought not just to obtain money to subscribe, but also to increase one’s chances by subscribing for a much higher quantity. Avid believers of the efficient market hypothesis would rightly wonder why IPOs should be so heavily over-subscribed at all, and why should there be expectation of hefty profits. This is more so since pricing of IPOs is carefully calibrated using expert advice of merchant bankers.

Unlike the CCI era, today there are no restrictions on pricing of IPOs, and SEBI has instead relied on more and more information to be disclosed. This should result in the issuer setting the best price it can get, leaving, at least in theory, just a bare reasonable margin for profit, and that too for the long-term investor. Yet handsome profits are being made, and thus IPO financing is increasingly sought.

It is no surprise that there would be serious disappointment, and even legal cases, if promised IPO finance does not materialise.

Grey Market And Mules

The craze for IPOs ‘financing’ has seen controversies earlier too, though of a different kind. In the heyday of the Harshad Mehta boom times, there was a flood of IPOs, with many giving handsome returns, while many being fly-by-night operations.

There was even a flourishing grey market for upcoming IPOs, with the grey market quotes actually being circulated along with ‘bhav copies’ (pamphlets giving closing market prices of shares). People resorted to multiple applications in their own name, and of their family and even staff, which was multiplied even further by applying under multiple combinations of each name. The technology those days did not enable easy weeding out of such multiple applications.

Dematerialisation more or less eliminated this, but brought a new ‘innovation’. Demat accounts in lakhs were opened, even in fake names. An amusing aspect here was that fake names and photos were picked up even from matrimonial sites!

Applications were made in the name of such persons (such name-lenders were called ‘mules’) financed by others. When shares were allotted, they were sold, and the profits pocketed by the financier, with a fee presumably going to the mule. The case of Rupalben Panchal became a kind of flag bearer by which this scam became known.

These methods were seen as a blatant abuse of the retail allocation rule for IPOs. Then, generally, there have regularly been cases of companies covertly financing their own IPOs, which is an offence under the Companies Act, 2013. Even GDR issues were found to be allegedly the subject of such manipulative financing.

Control Risk

Coming back to recent times, the question again is why should IPOs be a craze at all? If there is one, isn’t it very likely that yet again there is a bubble which could leave investors, and their financiers, at a loss? SEBI has refused, and rightly so, to meddle, and has done just some tweaking of the law relating to IPOs.

However, it is the Reserve Bank of India that has made a far more impactful change, which could reduce IPO finance to a miniscule of what it is today. It can even be seen as arbitrary. The RBI has decided that from April 1, the NBFCs shall provide a maximum of Rs 1 crore of IPO financing per borrower. Contrast this with the Rs 500 crore of IPO finance allegedly involved in just one case of BharatPe founders, and that too for just one IPO.

The objective of RBI's mandate seems to be to control risk to the financial sector. To be fair, IPO financing does see huge leverage, which results in huge risks. In comparison with financing purchase of shares, where a fair margin is kept, IPO financing is often multiple times the amount put in by the investor.

On the other hand, this unreasonably low and absolute limit placed will prevent even well secured borrowings. A better step could have been tweaking the margin requirements for such financing. A 50 percent margin, for example, could be fairly sufficient for a week’s risk.

SEBI has also recently started the process of recognising ‘accredited investors’ who are expected to be financially literate, and strong enough to take on more risky investments. An exemption for such persons from this limit would have made sense. Be as it may be, the fears of the industry seem to be well justified — that the RBI may well have delivered a near fatal blow to IPO financing.

Jayant Thakur is a chartered accountant.

Views are personal and do not represent the stand of this publication.