SEBI: BOOK BUILDING

BUSINESS LAW
Mohit Shah Roll no 45 Ranjeet Mishra Roll no 31 Vastupaal Shah Roll no 49 Arth Shah Roll no 39 Pritesh Mehta Roll no 30 Vinil Jain Roll no 23

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ACKNOWLEDGEMENT
We would like to express our gratitude to Prof. Thomas for giving us this topic for our project as it gave me the opportunity to go beyond the book and look at the topic from a more practical point of view. It broadened my horizons and improved my understanding of this topic.

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Contents Serial No
1 2 3 4 5 6 7 8 9 10 11 12

Topic
Book Building: Introduction Cut off price Types of investors Need for book building Process of book building Procedure for book building SEBI framework for Book building Recent changes in book building mechanism Reverse book building Recent trends in book building issues in India Limitations of book building Bibliography

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Introduction: Book Building

To keep pace with the globalization and liberalization process, the government of India was very keen to bring the capital market in line with international practices through gradual deregulation of the economy. It led to liberalization of capital market in the country with more expectations from primary market to meet the growing needs for funds for investment in trade and industry. Therefore, there was a vital need to strengthen the capital market which, it felt, could only be achieved through structural modifications, introducing new mechanism and instruments, and by taking steps for safeguarding the interest of the investors through more disclosures and transparency. SEBI guidelines recognized book building as an alternative mechanism of pricing.

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Under this approach, a portion of the issue is reserved for institutional and corporate investors. SEBI guidelines, 1995 defines book building as a process undertaken by which demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document. Book building process is a common practice used in most developed countries for marketing a public offer of equity shares of a company. However, book building is transparent and flexible price discovery method of initial public offerings (IPOs) in which price of securities is fixed by the issuer company along with the Book Running Lead Manager (BRLM) on the basis of feedback received from investors as well as market intermediaries during a certain period. Presently, the book building process is monitored under two schemes75% book building process and 100% book building process.

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Cut-off price
Once the issue period is over and the book has been built, the BRLM along with the issuer arrives at a cut-off price. The cut-off price is the price discovered by the market. It is the price at which the shares are issued to the investors. Investors bidding at a price below the cut-off price are ignored. So those investors who apply at a price higher than the cut-off price have a higher chance of getting the stock. So the question that arises is: How is the cut-off price fixed? The cut-off price is arrived at by the method of Dutch auction. In a Dutch auction the price of an item is lowered, until it gets its first bid and then the item is sold at that price.
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Let's say a company wants to issue one million shares. The floor price for one share of face value, Rs 10, is Rs 48 and the band is between Rs 48 and Rs 55. At Rs 55, on the basis of the bids received, the investors are ready to buy 200,000 shares. So the cut-off price cannot be set at Rs 55 as only 200,000 shares will be sold. So as a next step, the price is lowered to Rs 54. At Rs 54, investors are ready to buy 400,000 shares. So if the cut-off price is set at Rs 54, 600,000 shares will be sold. This still leaves 400,000 shares to be sold. The price is now lowered to Rs 53. At Rs53, investors are ready to buy 400,000 shares. Now if the cut-off price is set at Rs 53, all one million shares will be sold. Investors who had applied for shares at Rs 55 and Rs 54 will also be issued shares at Rs 53. The extra money paid by these investors while applying will be returned to them.

Types of investors
There are three kinds of investors in a book-building issue: The retail individual investor (RII), the non-institutional investor (NII) and the Qualified Institutional Buyers (QIBs). RII is an investor who applies for stocks for a value of not more than Rs 100,000. Any bid exceeding this amount is considered in the NII category. NIIs are commonly referred to as high net-worth individuals. On the other hand QIBs are institutional investors who possess the expertise and the financial muscle to invest in the securities market.

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Mutual funds, financial institutions, scheduled commercial banks, insurance companies, provident funds, state industrial development corporations, et cetera fall under the definition of being a QIB. Each of these categories is allocated a certain percentage of the total issue. The total allotment to the RII category has to be at least 35% of the total issue. RIIs also have an option of applying at the cut-off price. This option is not available to other classes of investors. NIIs are to be given at least 15% of the total issue. And the QIBs are to be issued not more than 50% of the total issue. Allotment to RIIs and NIIs is made through a proportionate allotment system. The allotment to the QIBs is at the discretion of the BRLM. Let's suppose, A Ltd, makes an offer for 200,000 shares. The issue is oversubscribed -- i.e. there is demand for more shares than the issuer plans to issue. Further, a minimum allotment of 100 shares is to be made for every investor. The cut-off price has been decided and now the allotments are to be made. In the RII category, 1,500 applicants have applied for 100 shares each, i.e. there is a demand for 150,000 shares. A Ltd plans to issue 35% of the total issue to this category, i.e. 70,000 shares. In the NII category, 200 applicants have applied for 500 shares each, i.e. 100,000 shares. A Ltd plans to issue 15% of the total issue to this category, i.e. 30,000 shares. The cut-off price has already been decided, so adjusting the quantity remains the only way of reaching the equilibrium. Applying the proportionate allotment system each investor in the RII category will get 46.67 shares [(70,000/ 150,000) x 100)]. But the minimum allotment has to be 100 shares. So through a lottery, 700 investors are chosen and allotted 100 shares each, making a total of 70,000 shares. In the NII category every investor

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will get 150 shares [(30,000/100,000) x 500)]. And that is how equilibrium is reached.
ISSUE TYPE Fixed Price *Issues OFFER PRICE Price at which the securities are offered and would be allotted is made known in advance to the investors DEMAND Demand for the securities offered is known only after the closure of the issue PAYMENT 100 % advance payment is required to be made by the investors at the time of application. RESERVATIONS 50 % of the shares offered are reserved for applications below Rs. 1 lakh and the balance for higher amount applications.

Book Building A 20 % Issues price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding.

Demand for the securities offered, and at various prices, is available on a real time basis on the BSE website during the bidding period...

10 % advance payment is required to be made by the QIBs along with the application, while other categories of investors have to pay 100 % advance along with the application.

50 % of shares offered are reserved for QIBS, 35 % for small investors and the balance for all other investors.

Need for Book Building

The abolition of the Capital Issue Control Act, 1947 has brought a new era in the primary capital markets in India. Controls over the pricing of the issues, designing and tenure of the capital issues were abolished. The issuers, at present, are free to make the price of the issues. Before establishment of SEBI in 1992, the quality of disclosures in the offer documents was very poor. SEBI has also formulated and prescribed stringent disclosure norms in conformity to global standards. The main drawback of free
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pricing was the process of pricing of issues. The issue price was determined around 60-70 days before the opening of the issue and the issuer had no clear idea about the market perception of the price determined. The traditional fixed price method of tapping individual investors suffered from two defects: (a) delays in the IPO process and (b) under-pricing of issue. In fixed price method, public offers do not have any flexibility in terms of price as well as number of issues. From experience it can be stated that a majority of the public issues coming through the fixed price method are either under-priced or over-priced. Individual investors (i.e. retail investors), as such, are unable to distinguish good issues from bad one. This is because the issuer Company and the merchant banker as lead manager do not have the exact idea on the fixed pricing of public issues. Thus it is required to find out a new mechanism for fair price discovery and to help the least informed investors. Thats why, Book Building mechanism, a new process of price discovery, has been introduced to overcome this limitation and determine issue price effectively. Public offers in fixed price method involve a pre issue cost of 2-3% and carry the risk of failure if it does not receive 90% of the total subscription. In Book Building such cost and risks can be avoided because the issuer company can withdraw from the market if demand for the security does not exist.

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Process of Book Building

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1. The issuer company proposing an IPO appoints a lead merchant banker as a BRLM. 2. Initially, the issuer company consults with the BRLM in drawing up a draft prospectus (i.e. offer document) which does not mention the price of the issues, but includes other details about the size of the issue, past history of the company, and a price band. The securities available to the public are separately identified as net offer to the public. 3. The draft prospectus is filed with SEBI which gives it a legal standing. 4. A definite period is fixed as the bid period and BRLM conducts awareness campaigns like advertisement, road shows etc. 5. The BRLM appoints a syndicate member, a SEBI registered intermediary to underwrite the issues to the extent of net offer to the public. 6. The BRLM is entitled to remuneration for conducting the Book Building process. 7. The copy of the draft prospectus may be circulated by the BRLM to the institutional investors as well as to the syndicate members. 8. The syndicate members create demand and ask each investor for the number of shares and the offer price. 9. The BRLM receives the feedback about the investors bids through syndicate members. 10. The prospective investors may revise their bids at any time during the bid period.

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11. The BRLM on receipts of the feedback from the syndicate members about the bid price and the quantity of shares applied has to build up an order book showing the demand for the shares of the company at various prices. The syndicate members must also maintain a record book for orders received from institutional investors for subscribing to the issue out of the placement portion. 12. On receipts of the above information, the BRLM and the issuer company determine the issue price. This is known as the marketclearing price. 13. The BRLM then closes the book in consultation with the issuer company and determine the issue size of (a) placement portion and (b) public offer portion. 14. Once the final price is determined, the allocation of securities should be made byte BRLM based on prior commitment, investors quality, price aggression, earliness of bids etc. The bid of an institutional bidder, even if he has paid full amount may be rejected without being assigned any reason as the Book Building portion of institutional investors is left entirely at the discretion of the issuer company and the BRLM. 15. The Final prospectus is filed with the registrar of companies within 2 days of determination of issue price and receipts of acknowledgement card from SEBI. 16. Two different accounts for collection of application money, one for the private placement portion and the other for the public subscription should be opened by the issuer company. 17. The placement portion is closed a day before the opening of the public issue through fixed price method. The BRLM is required to have the application forms along with the application money from the
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institutional buyers and the underwriters to the private placement portion. 18. The allotment for the private placement portion shall be made on the 2nd day from the closure of the issue and the private placement portion is ready to be listed. 19. The allotment and listing of issues under the public portion (i.e. fixed price portion) must be as per the existing statutory requirements. 20. Finally, the SEBI has the right to inspect such records and books which are maintained by the BRLM and other intermediaries involved in the Book Building process

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Procedure for bidding

The process of bidding should be in compliance of the following requirements: (a) Bidding process shall be only through an electronically linked transparent bidding facility provided by recognized stock exchange (s). (b) The lead book runner shall ensure the availability of adequate infrastructure with syndicate members for data entry of the bids in a timely manner. (c) The syndicate members shall be present at the bidding centers so that at least one electronically linked computer terminal at all the bidding centers is available for the purpose of bidding. (d) During the period the issue is open to the public for bidding, the applicants may approach the stock brokers of the stock exchange/s through which the securities are offered under on-line system or Self Certified Syndicate Banks, as the case may be, to place an order for bidding for the specified securities. (e) Every stock broker shall accept orders from all clients/investors who place orders through him and every Self Certified Syndicate Bank shall
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accept Applications Supported by Blocked Amount from ASBA investors. (f) Applicants who are qualified institutional buyers shall place their bids only through the stock brokers who shall have the right to vet the bids; (g) The bidding terminals shall contain an online graphical display of demand and bid prices updated at periodic intervals, not exceeding thirty minutes. (h) At the end of each day of the bidding period, the demand including allocation made to anchor investors, shall be shown graphically on the bidding terminals of syndicate members and websites of recognized stock exchanges offering electronically linked transparent bidding facility, for information of public. (i) The investors may revise their bids; (j) The issuer may decide to close the bidding by qualified institutional buyers one day prior to the closure of the issue subject to the following conditions: (i) Bidding shall be kept open for a minimum of three days for all categories of applicants; (ii) disclosures are made in the red herring prospectus regarding the issuers decision to close the bidding by qualified institutional buyers one day prior to closure of issue. (k) The qualified institutional buyers shall not withdraw their bids after closure of bidding.
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SEBI FRAMEWORK FOR BOOK BUILDING

1. In January 2000, SEBI has issued a guidelines, circulars and instructions to merchant bankers relating to issue of capital, including those on the book-building mechanism. They include a model time frame formbook-building: After the price has been determined on the basis of bidding, statutory public advertisements for a continuous three days containing the price as well as a table showing the number of securities and the amount payable by an investor, based on the price determined, shall be issued and the interval between the advertisement and issue opening date should be a minimum of five days. 2. The draft prospectus to be circulated has to indicate the price band within which the securities are being offered for subscription. The bids have to be within the price bands. Bidding is permissible only if an electronically- linked transparent facility is used. An issuing company can also fix a minimum bid size. An initial bid can be changed before the final rate is determined. 3. The Prospective bidders were advised to read the Red herring prospectus carefully. According to the Act, a Red herring prospectus means a prospectus that does not have complete particulars on the price and the quantum of securities offered. 4. The year 2000, Amendment to the Act gave legal cloak to the book-building route by allowing circulation of the information memorandum and the red herring prospectus. According to the Act, a process is to be undertaken prior to the filing of a prospectus by which a demand for the securities proposed to be issued by accompany is elicited, the price and the terms of the issue of such securities are assessed by means of a notice, circular, advertisement or document. Incidentally, the working group on the Comprehensive Companies Bill, 1997 (since lapsed) had advocated introduction of book-building. It defined the term as an international practice that refers to collecting orders from
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investment bankers and large investors based on an indicative price range. In capital markets, with sufficient width and depth, such a pre-issue exercise often allows the issue to get a better idea of the demand and the final offer price of an intended public offer. 5. SEBI (Disclosure and Investor Protection) Guidelines, 2000 contains provisions for book building under chapter XI that includes guidelines for 75 per cent book-building process, 100 per cent book-building process, disclosure requirements, allocation/allotment procedure and maintenance of books and records.

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Recent changes in Book Building mechanism

The Securities and Exchange Board of India on March 29, 2005 announced sweeping changes in the IPO norms. They are as follows: 1- Increased allocation for retail investors in book-built issue from 25 per cent to 35per cent and has also changed the definition of the retail category. 2- The market regulator has now permitted retail investors to apply for Rs. 1 lakh worth of shares in a book-built issue against Rs. 50,000 earlier. For this purpose, SEBI has redefined the retail individual investor as one who applies or bids for securities of or for a value not exceeding Rs. 1 lakh. 3- It has reduced the non institutional category, popularly known as high net worth individuals (HNI), allocation from 25 per cent to 15 per cent. 4- Institutional investors include foreign financial institutions (FII) banks, mutual funds and Indian financial institutions like LIC or IDBI. 5- The changes have been made in the SEBI (DIP) Guidelines, 2000 on the basis of recommendations made by SEBIs primary market advisory committee. 6- The new norms will be applicable to all public issues whose draft offers documents are filed with SEBI on or after April 4, 2005.
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7- SEBI has decided to reduce the bidding period from the current 5 to 10 days (including holidays) to 3 to 7 working days. 8- It has also provided more flexibility for listed companies to disclose price band/floor price for public issues one day before bid opening. 9- SEBI has decided to give an option to listed issuers to either disclose price band in RHP/application form/abridged prospectus (current practice) or to disclose the price band/ floor price at least one day before bid opening. 10It is proposed to amend the guidelines to improve contents and ensure uniformity in data display on the websites of the stock exchanges. The date will be made available for a further period of three days after the closure of the bids/issue.

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Reverse book building

Securities and Exchange Board of India has issued the SEBI (Delisting of Securities) Guidelines 2003 for delisting of shares from stock exchanges which provide the overall framework for voluntary delisting by a promoter or acquirer through a process referred to as Reverse Book Building.

Procedure-The promoter or acquirer shall appoint trading members for placing bids on the online electronic system. Investors may approach trading members for placing offers on the on-line electronic system. The shareholders desirous of availing the exit opportunity shall deposit the shares offered with the trading members prior to placement of orders. Alternately, they may mark a pledge for the same to the trading member. The final offer price shall be determined as the price at which the maximum number of shares have been offered. The promoter / acquirer shall have the choice to accept the price. If the price is accepted, the acquirer shall be required to accept all offers upto and including the final price. If the quantity eligible for acquiring securities at the final price offered does not result in public shareholding falling below the required level of public holding for continuous listing, the company shall remain listed. At the end of the book building period, the merchant banker to the book building exercise shall announce the final price and the acceptance (or not) of the price by the promoter / acquirer.
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Recent trends in book building issues in India

1. The book-building process in India is very transparent. All investors (including small investors) can see on an hourly basis where the book is being built before applying. Therefore, no asymmetry as far as information dissemination is concerned. 2. The year 2004 was a significant and bumper because companies have raised Rs. 30,511 crore through public issue and 99 per cent of this being good quality securities from established companies and almost all issues were through book-building. 3.The practice of bookbuilding is new to the Indian capital market and the procedure is still evolving. ICICI was the first company to use Book-building method for its Rs. 1000 crore bond issue in April 1996 followed by Rs. 4,323crore Larsen & Toubro issue and Rs. 5,878 crore TISCO bond issue for the placement portion. 4. The recent issue of Hughes Software made history in more than oneway. It was the first Indian IPO in IT industries to adopt the Book-Building process and the issue was highly over subscribed. 5. In November 1999 the HCL technologies has raised capital through IPO Book-building method, investors gave an enthusiastic response.The issue got over subscribed by 27 times. This was despite the fact that the company revised its original price band Rs. 450-540 to Rs. 500-580. The final price offered was Rs. 580 for the shares.
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Limitations
1.Book-building is appropriate for mega issues only. In the case of the potential investors, the companies can adjust the attributes of the offer according to the preferences of the potential investors . may not be possible in big issues since the risk return preference of the INVESTOR cannot be estimated. 2. The issuer company should be fundamentally strong and well known to the investors. 3. The book-building system works very efficiently in matured market conditions.In such circumstances,the investors are aware of the various parameters affecting the market price of the securities. But, such conditions are not commonly found in practice. 4. There is a possibility of price rigging as promoters may try to bail out syndicate members.

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Bibliography
1-Company Secretary Book on Securities Laws and Compliances Module II, Paper 6 2-www.rediff.com/money 3-www.icai.org/resource_file

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