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Primary Market - The New Issues Market

The industrial securities market in India consists of New Issue Market and Stock
Exchange. The new issue market deals with the new securities which were not
previously available to the investing public, i.e., the securities that are offered to the
investing public for the first time. It is also known as Primary Market. We cover the the
various methods of floating New issue, the guidelines followed, and steps involved in
various cases.

by Siddharth Jogani
1 year, 3 months ago

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Introduction
The new issue market deals with the new securities which were not previously available to
the investing public, i.e., the securities that are offered to the investing public for the first
time. The market, therefore, makes available a new block of securities for public
subscription. All financial institutions which contribute, underwrite and directly subscribe to
the securities are part of new issue market.There are various intermediaries like registrars,
custodians and merchant bankers that are involved in this activity of issuing new securities.
We now have a look at the functions of New issue market and methods of floating these
new issues.
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Functions of New Issue Market

The main function of a new issue market is to facilitate transfer of resources from savers to
the users. The savers are individuals, commercial banks, insurance companies etc. The
users are public limited companies and the government. It is not only a platform for raising
finance to establish new enterprises but also for expansion/ diversification/ modernization of
existing units.
In this basis the new issue market can be classified as:1. Market where firms go to the public for the first time through initial public offering
(IPO).
2. Market where firms which are already trading raise additional capital through
seasoned equity offering (SEO).
The main functions of a new issue market can be divided into a triple service functions:
1. Origination: It refers to the work of investigation, analysis and processing of new
project proposals. It starts before an issue is actually floated in the market. This
function is done by merchant bankers who may be commercial banks, all India
financial institutions or private firms. At present, financial institutions and private
firms also perform this service. Though this service is highly important, the
success of the issue depends, to a large extent, on the efficiency of the market.
2. Underwriting: It is an agreement whereby the underwriter promises
to subscribe to a specified number of shares or debentures or a specified amount
of stock in the event of public not subscribing to the issue. If the issue is fully
subscribed, then there is no liability for the underwriter. If a part of share issues
remains unsold, the underwriter will buy the shares. Thus, underwriting is a

guarantee for marketability of shares. There are two types of underwriters in

India - Institutional ( LIC, UTI, IDBI, ICICI) and Non-institutional are brokers.
3. Distribution: It is the function of sale of securities to ultimate investors. This
service is performed by brokers and agents who maintain a regular and direct
contact with the ultimate investors.
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Methods of Floating New Issue

The various methods which are used in the flotation of securities in the new issue market
are :
1. Public issues
2. Offer for sale
3. Placement
4. Rights issues

1. Public Issues
Under this method, this issuing company directly offers to the general public/ institutions a
fixed number of shares at a stated price through a document called prospectus. This is the
most common method followed by joint stock companies to raise capital through the issue of
securities. The prospectus must state the following:
* Name of the company
* Address of the registered office
* Existing and proposed activities
* Location of the industry
* Names of Directors
* Minimum subscription
* Names of brokers/ underwriters/ bankers/ managers and registrars to the issue.
2. Offer For Sale
This method of offer of sale consists in outright sale of securities through the intermediary of
Issue Houses or share-brokers. In other words, the shares are not offered to the public
directly. This method consists of two stages: The first stage is a direct sale by the issuing
company to the issue house and brokers at an agreed price. In the second stage, the

intermediaries resell the above securities to the ultimate investors. The issue houses or
stock brokers purchase the securities at a negotiated price and resell at a higher price. The
difference in the purchase and sale price is called spread. It is otherwise called Bought out
deals (BOD).
This method is used generally in two instances:
1. Offer by a foreign company of a part of it to Indian investors.
2. Promoters diluting their stake to comply with requirements of Stock exchange at the time
of listing of shares.
3. Placement
Under this method, the issue houses or brokers buy the securities outright with the intention
of placing them with their clients afterwards. Here the brokers act as almost wholesalers
selling them in retail to the public. The brokers would make profit in the process of reselling
to the public. The issue houses or brokers maintain their own list of
clients and through customer contact sell the securities. There is no need for a formal
prospectus as well as underwriting agreement.
4. Rights Issue
It is a method of raising funds in the market by an existing company. A right means an
option to buy certain securities at a certain privileged price within a certain specified period.
Shares, so offered to the existing shareholders are called rights shares. Rights
shares are offered to the existing shareholders in a particular proportion to their existing
share ownership. The ratio in which the new shares or debentures are offered to the existing
share capital would depend upon the requirement of capital. The rights themselves are
transferable and sale-able in the market. Section 81 of the Companies Act deals with rights
issue.
The cost of issue is minimum. There is no underwriting, brokerage, advertising and printing
of prospectus expenses. It prevents the directors from issuing new shares in their own name
or to their relatives at a lower price and get controlling right.
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General Guidelines For New Issue

All issues by a new company have to be made at par and for existing companies the issue
price should be justified as per Malegam Committee's recommendations which are as
follows:
The issue price is justified by 1. The earnings per share (EPS) for the last 3 years and comparison of pre-issue
price to earnings ratio to the P/E of the industry.
2. The latest Net Asset Value (NAV).
3. The minimum return on increased networth to maintain pre-issue EPS. A
company may also raise funds from the international markets by issuing Global
Depository Receipts (GDR) and American Depository Receipts (ADR).
SEBI does not play any role in price fixation. In face the issuers in consultation with the
Merchant Bankers will decide the price. However, they are required to give full disclosures of
the parameters which they had considered while deciding the issue price. In actual practice,
there are two types of issue pricing namely - Fixed price and book building price. Lead
manager fixes the price under fixed price. Under book building pricing method, the company
and lead manager stipulate a floor price and cap price or a price band and leaves it on
market forces to determine the final price (book building price).
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Principal Steps in Public Issue

Now, we see the main steps involved in Public issue. They are in following order:
1. Draft Prospectus
It is prepared giving all details that have been stated earlier under public issue. Any
company or a listed company making a public issue or a rights issue of value more than Rs.
50 lakhs has to file a draft offer document with SEBI for its observation. The company can
proceed further only after getting observations from the SEBI. The company has to open its
issue within three months from the date of SEBI's observation letter.
2. Fulfillment of Entry Norms
The SEBI has laid down certain parameters for accessing the primary market. If a company
fulfills these parameters (entry norms), then only it can enter into the primary market.
The Entry norms are as follows Entry norm I :

The company should have Net Tangible Assets of at least Rs. 3 crores for three
full years.

It should have distributable profits in at least three years.

It should possess Net Worth of atleast Rs.1 crore in 3 years.

The issue size should not exceed 5 times the pre-issue net worth.

If it has to change its name, at least 50% revenue for the preceding one year
should be from the new activity.

To ensure that genuine companies don't suffer due to the rigidity of those parameters, the
SEBI has laid down two more alternative routes for accessing the primary market.
Entry Norm II
If the issue is through book building route, at least 50% of the issue should be allotted to
Qualified Institutional Buyers (QIBs)

The minimum post-issue face value capital shall be Rs. 10 crore or there shall be
a compulsory market-making for at least two years.

Entry Norm III

The company should have at least 1000 prospective allottees

The project should be appraised and participated to the extent of 15% by

Financial Institutions and scheduled commercial banks of which at least 10%
comes from the appraisers.

The minimum post-issue face value capital shall be Rs. 10 crore or there shall be
a compulsory market-making for at least 2 years.

The above entry norms are not applicable to the private and public sector banks, listed
companies right issue and an infrastructure company whose project has been appraised by
a financial institution or a bank and not less than 5% of the project cost is financed by these
institutions.

3. Appointment of Underwriters
They are appointed to shoulder the liability and subscribe to the shortfall in case the issue is
under-subscribed. For this commitment they are entitled to get a maximum commission of
2.5% on the amount undertaken.
4. Appointment of Bankers
Bankers act as collecting agents I.e., the banks along with their branch network act as
collecting agencies and process the funds during the public issue.
5. Initiating Allotment Procedure
The next step is that the Registrars process the application forms, tabulate the amounts
collected during the issue and initiate the allotment procedures
6. Brokers to the issue
They are recodnised members of the stock exchange and are appointed as brokers to the
issue for marketing the issue. They are eligible for a maximum brokerage of 1.5%.
7. Filing of Documents

The draft prospectus, along with the copies of the agreements entered into with the lead
manager, underwriters, bankers, registrars and brokers to the issue have to be filed with the
Registrar of companies of state where the registered office of the company is located.
8. Printing of Prospectus And Application Forms
9. Listing the Issue
10. Publication in Newspapers
11. Allotment of shares
12. Underwriters liability
13. Optional Listing
Example
The Justdial IPO dated 20th May 2013. The unique feature about their IPO was of the safety
Net I.e., the ownders said they would BuyBack shares from retail investors at the IPO price
if stocks falls sharply within first 6 months.
Grading of IPO Mandatory SEBI had made the grading of all IPOs by a credit rating agency mandatory from May 1,
2007. SEBI is the only regulator in the world to mandate the grading of IPOs.
/resource/untitled%7E265/
Source: http://m.business-standard.com/wapnew/storypage_content.php
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Principal Steps Of Private Placement

It may be done in respect of equity shares, preference shares, bonds and debentures.
Generally, the private placement of bonds and debentures is very popular.
The following steps are involved 1. Terms and conditions
They include the value of the instrument, maturity period, yield rate, issue and redemption
details, etc.
2. Credit rating
It is mandatory to obtain credit rating from a recognised credit rating agency who will
evaluate the various aspects concerned with the instrument.
3. Confidential Information Memorandum (CIM)
It is just like the offer document in the case of shares. An investor can have a thorough
knowledge about the issue by going through this document.
4. Trustees to the issue
The next step is to appoint trustees (usually banks or other financial institutions) to the issue
to protect the interest of investors.
5. Pre-launching formalities
Just one or two days before the launching date, the CIM is sent to the prospective investors
inviting them to subscribe to the issue.
6. Pricing the issue
Sometimes pre-marketing campaign may be conducted by the issue houses to ascertain the
investors towards private placement and the probable prices. Since book building method is
adopted by many companies, this campaign is not generally resorted to.
7. Post-issue Steps
Decision is taken on allotment and the certificates are issued. Over subscriptions are
refunded. The details of the issue are sent to the stock exchange where it is likely to be
listed.
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Principal Steps Involved in The case of Offer For Sale

1. Agreement with the merchant banker or sponsor group laying down the terms
and conditions of the issue.
2. Registration of the agreement with the stock exchange concerned.
3. Default - It is default is committed by the sponsor, it will be referred to an
arbitrage committee set up by the stock exchange.
4. Offloading - Sponsor can Offload his position provided the promoter's post-issue
holding will not be less than 20% with a 3 year lock in period.
5. Market Maker - The sponsor should agree to act as a market maker for the
companies share for 18 months and should also identify another market maker
for such compulsory market making.
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Players In The Primary Market

There are many players in the new issue or primary market. The important of them are:
1. Merchant Bankers - They are the issue managers, co-managers, and are
responsible to the company and SEBI. They are registered by SEBI under
category I, II, III and IV based on the capital adequacy and track record.
2. Registrars to the issue - They are an important category of intermediaries who
undertake all activities connected with new issue management. They are
appointed in consultation with the merchant bankers. A networth of Rs. 6 Lakhs
is essential for Registrars.
3. Collecting and Co-ordinating Bankers - They collect information on
subscriptions and co-ordinate the collection work.
4. Underwriters and Brokers - Brokers along with the network of sub-brokers
market the new issues. They send their own circulars and applications to the
clients and do follow up work to market securities.
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Advantages & Disadvantages of Primary Market

Advantages :1. Mobilisation of savings
2. Channelising savings for productive use
3. Source of large supply of funds
4. Rapid Industrial growth due to increase in production and productivity in the economy.
Disadvantages :-

1. Possibility of deceiving investors

2. No fixed norms for project appraisal
3. Lack of post issue seriousness eg. Facebook IPO
4. Ineffective rold of merchant bankers
5. Delay in allotment process

Subir Gokarn: India Needs Strong Debt Markets

"The key is to have the ability within the market to absorb large quantities of ...
Source: http://www.youtube.com/watch?v=0tFhgcVdSLk
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Conclusion
Over the years , SEBI and government have come up with a series of regulatory measures
to give boost to new issue market. A lot of merchant bankers don't follow the code of
conduct and as a result are debarred, however these cases have reduced. As per the 1997
amendment to the SEBI Rules and Regulations, 1992 only corporate bodies will be allowed
to function as merchant bankers.
These measures and also the new policy where SEBI has made the safety net compulsory (
Refer article - Justdial IPO). SEBI had put out draft norms for safety net after its study
showed that 62% of the 117 companies listed between 2008 and 2011 fell below IPO price
within the 1st six months of listing. SEBI would be the 1st regulator around the world, to
making such a proposal mandatory. However it met with strong criticism from investment
bankers.