Here is why IPO price bands have attracted SEBI’s attention

by 5paisa Research Team 07/10/2021

Earlier this week, the Securities and Exchange Board of India floated a consultation paper wherein it proposed a few changes to how initial public offerings (IPOs) are priced in the country.

The capital markets regulator said that it proposes to fix a minimum price band for IPOs. It said its primary market advisory committee has recommended that a minimum price band in case of all public issues through the book-building process may be 5%. Essentially, this means that the upper price of the range should be at least 5% more than the floor price.

“The objective of fair and transparent price discovery mechanism in a book-built issue appears to have been diluted over time due to evolving market practices,” SEBI said in the consultation paper.

The regulator has sought comments if there is a need for a minimum price band in IPO and, if so, what should it be.

So, what prompted SEBI to come out with these proposals?

The SEBI proposals come at the time when India’s capital markets are seeing a boom in IPOs. A large number of companies have already floated IPOs and several dozen companies are planning to do.

However, in this euphoria, what has gone unnoticed is how ‘book building’ issues are losing their character.

Book building is basically a process used in IPOs for efficient price discovery. It is a mechanism where, during the period for which the IPO is open, bids are collected from investors at various prices and then determine the price at which the company actually sells the shares.

The book-building IPOs are different from fixed-price issues where shares are offered at a single price. Most IPOs are book-built issues.

Over time, the price band – the range of price at which investors can bid during the IPO to make it a truly price discovery mechanism – has got muddled.

A decade ago, book-built issues had a difference of 8-10% on average between the upper and lower ends of the price band. That difference has narrowed to less than 2% over the last few years.

In 2011, for instance, this difference was 9.8% among the 36 book-built IPOs. This touched a high of 10% two years later. Since then, the price band has been narrowing. In 2021, the 36 book-built issues so far had a difference of 1.5% in the upper and low ends of the price band.

This is what prompted SEBI to come out with the consultation paper. “A narrow price band presents an opportunity to an issuer company to camouflage a fixed-price issue as book-built issue,” the regulator said.

As a result, companies can circumvent the conditions and regulations attached to the fixed-price method, especially related to the allocation methodology, it added.

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