The Current State of Issue of Shares: Will it make or Break

Since last one year there were very few IPO in Indian Market, but there were many changes which has taken place in terms of Rules, Regulation and Guidelines by SEBI / FMO on public issues. We will discuss these laws and how it will impact investors, its sentiments and how it may impact price discovery process?

The Major changes in the guidelines are

Increase in application size of retail investors from Rs 1,00,000/- to Rs 2,00,000/- (already discussed in my previous blog) : As discussed in my previous blog it will reduce the returns on IPO market and may shy away investors. These has already taken place in market where there are no new issues and investors also do not have appetite and when good issue came in market the returns on investment in IPO was dismal (MCX). 

Finance minister has said that it will reduce the application time and it intend to do it by bringing in  IPO through stock exchanges: Finance Minister has gone on record to say that IPO process will be streamlined which will reduce application and allotment time and also it will streamline whole IPO process. They intend to do it by selling shares on Stock Exchange. In this process the investor will be expected to apply for shares on stock Exchange terminal using brokers, the allotment would be done as trade confirmation and shares will be credited in investor account using clearing house mechanism. So maybe by evening you will know your allotment and listing may happen in few days. Seems simple what will change?

a)       The issuer will save money on commission as they won’t be obliged to pay to brokers soliciting clients (There are many people who make a living on IPO forms, they will be heavily impacted and maybe the marketing of issue will be impacted)

b)      You will have to pay brokerage for applying through brokers.

c)       Now if you apply in shares you can apply it through ASBA (Wherein you can earn interest on that money till the date of allotment), but if you apply through broker you will have to give money to him in full and then only he will be eligible to apply on your behalf (It may happen that clients would be expected to pay before few days to avoid last minute rush) and will also put question on risk management of broker.

These may not impact much to investors apart from brokerage but these will be that way you apply in future.

New category of “Offer for sale” introduced by SEBI using Stock Exchange Platform: To bring IPO process under the ambit of stock exchange SEBI has created a new category of IPO “Offer for Sale” . In this category the promoters or Major stake holders can sell shares directly to investors.

The mode of application for these shares is same as discussed i.e. by putting bids through brokers, these offer is open only for one day and on listed top 100 stocks. So you know the allotment by 3.30 pm

What’s the difference in this category?

a)       We pay brokerage to apply for these shares, but we also may get allotment at discounted prices.

b)      The sellers would be promoters who want to reduce their holdings to meet SEBI guideline of Maximum 75% promoter holding by June 2013.

c)       The best part of this segment is the seller pays STT and can save capital gains tax.

d)      You can trade on those shares in 2 trading days.

There are successful, unsuccessful and controversial issue in this segment which includes ONGC flip flop.

New category of “Institutional Placement Programme” introduced by SEBI using Stock Exchange Platform : There is also a category like above but wherein only the Institutional Investors can apply. Other rules and guidelines are same as offer for sale but I have my reservation of this category. These can be misused by promoters to place their holdings with these Institutional investors maybe with some arrangement, which may be detrimental to interest of minority investors. I am sure SEBI can plug the holes in it.

SEBI law says any IPO with issue size of up to 25 crores would have pre opening session for price discovery and will be traded in T2T segment of 10 trading days post listing: SEBI say that all IPO below Rs 250 crores would be traded in T2T segment (Compulsory delivery, No Squaring off allowed) for first 10 trading days, Also on day of listing the stock will be in pre opening session for 1 hour for price discovery process.

Such steps were taken by SEBI to reduce huge volatility on the day of listing, but in turn it has taken the essence of trading from these stocks, Lets discuss what is happening?

a)       As there is no square off, traders keep away from these stocks.

b)      Because of that it reduces liquidity on the counter, it increase the cost of entry and exit.

c)       People apply in IPO is earn price appreciation on allotment but if traders move away, it reduces the probability of higher price (As there will be many investors who want to sell at the open and buyer may shy away knowing that or it may reduced its bid price)

d)      Because of these I believe listing gains would get capped and in short run its flavor.

SEBI law says any relisting and scheme of arrangement (Except for stocks in F&O segment) would have pre opening session for price discovery and will be traded in T2T segment of 10 trading days post listing: These stock will also trade in T2T segment which will hamper price discovery process in short run.

The above rules changes the way we trade in newly listed stocks and It will definitely impact the price discovery of these stocks on lower side,

But needless to say, that price discovery process and its impact on stock price will be there in short run but longer term performance of these stocks will only depends on its fundamentals.

I welcome your suggestion and comments.

Introduction of Futures and Options on Global Indices on NSE

As per SEBI guideline and permission, NSE is set to launch Futures and Options contracts on " S&P 500" and only futures contracts on "Dow Jones Industrial Average" (DJIA).

Now instead of Tracking these indices and taking queue over here, we might as well trade on such indices or hedge on such indices.

Before discussing the impact of such indices, let us understand its features.

S & P 500 DJIA How it will show on NSE F&O Screen FUTIDX S&P500 FUTIDX DJIA Lot Size 250 25 No of Contracts available 6 6 M1, M2, M3,Q2,Q3,Q4 M1, M2, M3, Q2,Q3,Q4 Expiry 3rd Friday of Every Month 3rd Friday of Every Month Last Trading Day Same day as Expiration Same day as Expiration Settlement Cash Settlement Cash Settlement Underlying Currency Indian Rupees Indian Rupees Types of Option European Not available Margins Span Margin Span Margin Settlement Price Opening Price of S&P 500 on CME Opening Price of DJIA on CME There are several Advantages of trading in Global Indices in India They are mentioned as below a) S&P 500 would be traded on stock Exchange outside USA for the first time. This would also enable many FII to take position in India but as of now only Resident Indians as per SEBI guidelines can trade. b) This will enable investors to take positions or Hedge on International markets. c) Simplicity : It is simple as we trade in nifty as the underlying is traded in Indian rupees. There is no currency exposure. d) Easy Access : It will give easy access to all investors in every part of the country. e) There is a facility to see live quotes of CME to take position. f) There is trade and settlement guarantee fund of NSE, which will enable security of our settlement. g) New strategies can be introduced in market based on Nifty, DJIA & S&P 500 and its movement and correlation h) Updates on development in these index will help up see broad trends of industry globally. i) There are benefits of cross-margin between  DJIA and S&P 500. There are some thing to be understood before trading a) You will have to pay taxes and STT as per Indian law only. It may lead to price distortion between prices in India and abroad. b) The Settlement price of these contracts are computed based on opening price of all its stocks. That is termed as SOQ( Special Opening Quotations). Please understand that opening price of Index is not same as SOQ price. there is a slight difference.      Normally when market opens we get quotes and opening prices at the open of trading but there would be some stocks which will trade after some time may be minutes or after an hour. In the meantime there may be many prices which would have been derived on DJIA and S&P 500. What SOQ does is, it considers opening prices of all its constituents, (though they may have been traded after some time) and derive a opening price such price is called as SOQ prices which would be the final settlement (we will discuss more on rationale of SOQ later).     What it also means that if you have position at the close of settlement, you are not aware of the settlement price till the opening of American markets and then only you will know the settlement price which may be different from Dow futures or S&P futures which you may see our market times. c) Initially there wont be participation of FII in these segment of market and as such there wont be a live trading on underlying which may result in illiquidity, higher bid-ask spread, outlier trades. d) Trading in DJIA and S&P is almost 23 hours, because there are 2 types of trading on CME. a) Pit Trading and Globex (Electronic Trading. These electronic trading system is open for 23 hours.) but there will be problem of liquidity on these exchanges at odd hours (when there is night is USA and we Trade.) To sum it up, it add one more tool for trading in our arsenal but we may play blind bets on overnight positions where there will be volatility in that market and the price will change over there and we will only be the price taker at the open of trade over here. Some more FAQ, if you are not bored : a) How do we trade : It is on individual preference, but as mentioned price discovery on underlying will take place only in American markets, when our markets will be closed. The initial strategy would be to trade by taking positional view on these index (may be for 3 - 4 days) or create a hedge for position in Indian assets. b) Why is the final settlement at the opening price ?                                              There are market makers / Specialist in that markets appointed by the companies and Exchanges. These market makers / Specialist are obliged to give quotes during the day and absorb all demand and supply of individual stocks. So when the market opens these people absorb all demand and supply at the opening price with the obligation to make sure that there is lowest possible drift from previous closing price. Because of these, arbitrageurs in that market who have positions between underlying and Index buy / Sells at opening price to track SOQ prices. Opening price in such markets is a good indicator.(of overnight information change, overnight  liquidity needs and Noise (Fama))These prices are equilibrium price as it absorbs all demand and supply at the open.and If we compute the opening prices of all such underlying stock we get SOQ which is perceived to be a good and equilibrium opening price. Many other exchanges in America (like CBOE) use SOQ prices for settlement. c) How about trading in Options : You can trade in options only on S&P500. The queue of Implied volatility will come from CME only and the would be little higher in India (because of Illiquid Indian markets for these products)  .     In the Money calls will be cheaper (because of higher STT on Exercise). Also the cost of adjustment will be higher because of bid  ask -  spread. I welcome your comment, suggestions and queries.

Hike in Investors application amount in retail category : A Boon or Bane ?

SEBI has reserved 35 % of the IPO for Retail Investors. An Investor intending to apply under the category of Retail Investors can apply for not more than Rs 1 lakh. but Since November, 2010 SEBI has increased the limit to Rs 2 lakhs. Now Investors can apply in IPO under Retail category for up to Rs 2 lakhs.

The biggest appeals in applying under retail category are

a) Investors may get discount of 5% on IPO price in case of PSU IPO.

b) With recent SEBI guideline, IPO is open for one extra day for only retail Investors to apply. Hence Retail Investors can apply after looking at the appetite on HNI and Institutional Investors.

c) There is probability of getting higher allotment.

SEBI has increased these limits after 5 years, to cater to demand of investors for higher participation in IPO. 

The advantages perceived by SEBI with increase in Retail limit are

a) Higher amount of participation by Retail Investor.

b) Higher Allotment in retail category.

c) Wider appeal to Investors.

d) Option to Apply after closing of bids for HNI and Institutions.

But does it mean that doubling the limit will lead to doubling of absolute returns ?

Below is the application status of recent IPO with Retail  application limit of Rs 2,00,000/-. Along with is the  probability of allotment, in case the application amount would have been Rs 1,00,000/- only

Name of Co	Issue size (Retail)	Retail Limit	Subscription	Prob of Shares allotted	Cost of Fund @8% for 15 days	Retail Limit	Subscription	Prob of Shares allotted	Cost of Fund @8% for 15 days
MOIL	11524800	2lacs	32.86 times	17	657.53	1lac	18 times	17	328.7
SCI	29493547	2lacs	6.56 times	600	657.53	1lac	4 times	550	328.7

In above table, We find that increase in Retails limit leads to no increase in allotment or there is marginal increase, wherein there is also rise in interest cost whereas Opportunity cost is not considered.

I would request you to read below mentioned points for the answer

a) Who will take advantage of this limit hike ?

I think the Investors who were investing for Rs 1,00,000/- will only hike their limit to 2,00,000/-. We will get the rationale of this view by looking at the subscription pattern in retail segment. Most of the applications are at upper limit leading us to infer that most of such investors have surplus and they invest up to maximum limit and thus when the limit is hiked many of them would apply for higher amount.

I also don't think that Investors applying for Rs 2,00,000/- in HNI category will apply in Retail category (Because looking at past data , the returns by applying for Rs 1,00,000/- was more than applying in HNI for Rs 2,00,000/-.)

There is a grey market for application where the investor applying in retail category get lump sum amount irrespective of returns for IPO. The prevalence of such market indicates that there is appetite for higher amount of retail category. so if the limit is hike people would put in higher amount.

b) After inferring that people who were applying in IPO in retail category for Rs 1,00,000/- will in all probability apply for Rs 2,00,000/-.

But would that mean that allotment will be double with increase in limit. but I really feel that allotment would be somewhat more than half of what was allotted previously. To understand this rationale we will look at some examples

i) In past 6 months most of the IPO are over - subscribed by more than 1 time in retail category except in few cases where it was under subscribed because of lower quality of issue and not because the size was big and limits of Investors were exhausted.

ii) The MOIL issue was oversubscribed 32.86 times in retail category. The Investment limit in retail was Rs 2,00,000

iii) The SCI issue was oversubscribed 6.56 times in retail category. The Investment limit in retail was Rs 2,00,000

iv) The Claris Life Science issue was oversubscribed 1.60 times in retail category. The Investment limit in retail was Rs 2,00,000. This issue was not subscribed because of Higher IPO price, in fact they have reduced the IPO price.

In the above scenario if the Limit would have been 1,00,000 /- I guess the subscription times would be almost 50 % (Eg 18 times for MOIL, SCI at 4 times). but the number of shares allotted would have been same.

In fact we are blocking twice the amount and receiving the same quantity of shares thereby reducing our returns in percentage terms by 50%.

d) We should also consider the opportunity cost of extra 1,00,000/-. Funds are scarce resource, if that amount is invested in another issue,maybe the returns would be higher.

Does that mean Such Limits should not have been relaxed ?

No, The limits should have been relaxed in Slabs. If the Issue size is large enough to handle bigger amount, than only 2,00,000 / - limits should be applicable. For Example issue for more than Rs 2000 Cr or 3000 Cr in Retail category. Such Slabs will ensure higher retail participation for bigger issues and smaller issues will ensure lesser blockage of funds. Also leading to lesser logistical hurdles.

I welcome your critical comments and suggestions.