Capital Market of India

8/2/2019 Capital Market of India

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UNIT 8 CAPITAL MARKET I : NEWI SSU ES M A R K ET

Structur8.0 Objectives8.1 Introduction8.2 ,Primary Market and Secondary Market8.3 'Idethods of Floatation of New Issues. . 8.3.1 Public Issue

8.3.2 Rights Issue8.3.3 Private Placement8.4 Entry Norms for New Issues8.5 Fixation of Premium8.5.1 Book Building Process8.6 Reforms in Primary Capital Market

8.7 Recent Trends in New Issues Market in India8.8 Let Us Sum Up8.9 Key Words8.10 Some Useful Books8.1 1 Answers/Hints to Check Your Progress8.0 OBJECTIVESAfter going through this unit you will be able to :

explain the concept of capital market and i ts segments,' describe the various means to raise the capital in the primarymarket,describe the reforms in primary capital market, andstate the recent trends in new issues market in India.

8.1 INTRODUCTIONWe know that Financial markets a re broadly categorizedinto M.). --; --'-et and Capital market. In the previousUnit, we have studied the functioning of money market andits various inst ruments. In this Unit, we will deal with thecapital market.he process of industrial growth ,requires the developmentof the capital market, Which provides ,long-term finance toentrepreneurs. The capital market is a wide term and includesall transactions involving long-term funds. The developmentbanks, commercial banks , financial .institutions and stockexchanges, are its important components. The Securitiesan d Exchange Board of India (SEBI) is the regulator over theCapital Market, Capital market is an organized market for

effective and efficient mobilization of funds from the


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rlrxrlerous savers and transfers thc funds toethose who arein need of money to finance business operations either inthe private sector or in the public sector. In other words,capital market brings together the parties who demand thefun ds (Industry and Business) an d who supply the funds(Investors). Capital Market, therefore, is a link betweensavings su rplus sector (Household) an d saving deficit sector(Industryj.In the Cspital Market, we largely deals with the securitiessuch 3.s equi ty shares , pleference shares , bonds andd e b e n t u r e s i s s u e d by corpora t es , s emi -Governmen torganizations and Governments.8-52 PRIMARY MARKET AND SECONDARY

K r nThe Securities Market is divided into two segments--thePrimary Market and the Secondary Market. The maindifference between these two lies in the fact that while thefc~rrner eals with the securities, which the issuer issues forthe first time, the latter deals in the existing securities.Tllas, the primary market facilitates the transfer of investiblefu nd s of the savers to the corporates, which need them forproductive purposes. In the Secondary Market, no newsecurities come into existence, rather the existing securitieschange hands-one se t of persons invest in them, while theottxer group disinvests. ' The Primary Market, also called theNen7 Isse?es Market, i s of vital importance in the economv ofa country, a s it leads to better utilisation of otherwise inactiveu s dormant monetary resources in the economy,Tlnese two markets are not isolated from each other, ratherthey are very much inter-dependent. Activities in the newissues market and the response r ~ f he investors to the nearissues of securities depend upon th e prevailing conditionsin the Secondary Market. If the secondary market is vibrantan d booming, is sues of new securities in the Primary Marketwill be easily able to rnobilise support of a large number ofinvestors and vice-versa. We shall study in this Unit theexisting practices for floating new issues in the SecuritiesMarket.8.3 METHODS OF FLOATATION OF NEW

There are three ways in which a company may raise capitalin the prjixlaty market.i) P~a,h!ic ssue


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ii: i3ights Issueiii)Private Placement8.3.1 Public Issue

C a p i t a l M a r k e t (I ) :New Issues M a r k e t

The most important mode of issuing securities is by issuingprospectus to the public. If the is sue ha s been made for thefirst time, by a corporate body, it is known a s Initial PublicOffer (IPO)The procedure followed in cases of public issue is as follows:Invitation to subscribe the share is made through a documentcalled 'prospectus'. The applications on the prescribed form,along with application money, are invited by the company.Thc subscription list is open for a period of 3 to 7 days.No allotment can be made unless, the amoun t stated in theprospectus as the min imum subsc r ip t ion has beensubscribed, and the company has received sum payable onapplication. Minimum subscription refers to the num ber ofshares, which should be subscribed. A s per the SEBIguidelines, minimum subscription has been fixed at 90% ofentire public issue.Generally, the amount is mobilized in two instalments-application money and allotment money. If the full amountis not asked for a t the time of allotment itself, the balanceis called u p in one or two calls thereafter knourn a s callmoney. The letter of allotment sent by the company isexchangeable far share certificates. If the allottee fails topay the calls, his shares are liable to be forfeited. In thatcase, allottee is not eligible for any refund.The public issue may also be underwritten by an underwriter.Underwriting is nut mandatory now. BE underwriter givesan undertaking, to the issuing company to take theunsubscribed sha res . This is called devalvement of sha reson. the underwriter:;;, for which they ar e paid a commission.In India unde, writing agencies can be classified into followingcategories: 'sole underwriting', 'syndicate underwriting', a'sub-underwriting under sola: underwriting'. An underwriterenters into an agreement for underwriting with the issuingcompany all alone. Syndicate underwriting is used whenthe investment banke:rs form a syndicate to purchase thesecurities of cornpal-~ybecause money needed for suchventure may be larger than any axle banker megr like toinvest. The third underwriting method i.e, sub-underwriting,involves appointment of a sub undenvriter to quicken thesale of securities a nd diversify the risk i~zvolved.Two typesof agreem ents are involved in un~der~lrit ir~g,.g.


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Capital Marketin India 8 Agreement between issuing company and the underwriters

8 Agreement between the underwriter0 and sub-under-wrlter(s)8.3.2 Rights IssueA rights issue involves selling securities in the primarymarket by issuing rights to the existing shareholders. Inthis method the company gives the privilege to its existingshareholders for the subscription of the new sh are s on prordte basis. A company making a rights issue sends a letterof offer along with a composite application form consistingof four parts A, B, C, and D. Part A is meant for acceptanceof the offer. Part B is used if the shareholder wants torenounce his rights in favour of someone else. Part C isfilled by the person in whose favour the renunciation hasbeen made. Part D is used to request the split of the shares .The composite application form must be mailed to thecompany within a stipulated period, which is usually 30days. The shares that remain unsubscribed will be offeredto the public for subscription. Sometimes an existingcompany, can come ou t with a simultaneous 'Right cumPublic Issue'.The important characteristics of rights issue are:1) The number of shares offered on rights basis to each existingshareholder is determined >by he issuing company. The

, entitlement of the existing shareholder is determined onthe basis of existing shareholding. For example one Rightsshare may be offered for every 2 or 3 shares held by theshareholder.2) The issue price per Rights share is left to the discretion ofthe company.3) Rights are negotiable. The holder of rights can transfer theserights shares to any other person, i.e. he can renounce hisright to subscribe to these shares in favour of any other

' person, who can apply to the company for the allotment ofthese shares in his name.4) Rights can be exercised during a fixed period, which isusually 30 days. If it is not exercised within this period, it

auto~iiatically apses.8.3.3 Private PlacementA Publia Issue is a costly affair involving Press advertisements,brokers, fees and Press conference, etc. Therefore, some ofthe companies find it easy and cheaper to raise fundsthrough private placement of bonds arrd shares.


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In this method, the securities are issued to some selectedinvestors like banks or financial institutions. The privateplacement agreement is undertaken when the issue size isnot very big and the issuer does not want to spend much,on floating the issue. Private placement market h as grownphenomenally. During the last few years in India, the rateof growth of private placements has been higher than publicissues as well a s right issues because. of following advantages:

Capital MarketNew lssues Ma

i) Accessibility: Whether it is a public limited company, or aprivate limited company, or whether it is listed company oran unlisted one, it can easily access the private placementmarket. It can accommodate issues of smaller size, whereaspublic issue does not permit issue below a certain minimumsize.

ii) Flexibility: There is a greater flexibility in working out theterms of issue. A private placement results in the sale ofsecurities by a company to one or few investors. In case ofprivate placement, there is no need for a formal prospectusa s well a s under-writing arrangements. Generally, the termspf the issue are negotiated between the company (issuingsecurities) and the investors.

When a nun-convertible debenture issue is privately placed,a discount may be given to institutional investor to makethe issue attractive.iii) Speed: The time required, for completing a public issue isgenerally 6 months or More because of several formalitiesthat have to be gone through. On the other hand, a private

placement requires lesser time.iv) Lower Issue Cost: A public issue entails several statutoryand non-statutory expenses associated with underwriting,brokerages etc. The sum of these costs used to work outeven upto 10 percent of issue. For a company going for aprivate placement it is substantially less.Check Your Progress 11) What are the different ways in which a company can raise

its capital?

...........................................................................................2) What is private placement? What are its advantages?


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Capital Marketin India

3) which dclcument does provide the details of the proposedpublic issue?

4) What is underwriting of an issue? f

........................................................................................... ,8.4 E N T R Y N O R M S F O R 'N EW I S S U E SThe experience of free pricing of new issues , introduced in1992, did not prove useful, as there was great influx ofcompanies in the new issues market, a t high premium. TheSecurities and Exchange Board of India imposed strict normsfor the en try of companies in the new issues market in April1995. It requires that only those companies will be allowedentry into the share market, which have track record ofdividend payments in the last 3 years. This requirementwas changed in 1999 to ability to pay dividend in each ofthe 3 years. Alternatively, in ca se of man ufac turingcompanies, its project must have been appraised by ascheduled bank/ financial institution, which is also providingloan/equity to the extent of 10% of the project cost. Thus,only profit earning and dividend-paying existing companiesand new companies, with their projects appraised by banks/financial institutions, are permitted to enter into the newissues market. This step ha s been taken to improve thequality af shares being issued in the primary market. Youwill study the full details of the SEBI guidelines in Unit-10.8.5 F IX A TI ON O F P R EM I UMCompanies are allowed to issue their securities at par, at apremium or a t a discount. When the issue price is equalto the face value of the security, it is issued at par, if theformer exceeds the latter, it is issued at a premium, and inthe reverse condition a t a discount. The amount chargedfrom the investors above the face value is called 'Premiump.For example, if the share of the face value of R s . 10, isissued for Rs. 15, the extra amount of Rs . 5 / - is calledPremium.Till May 199 2, com pani es were required to see k thepermission of the Controller of Capital Issues, under the


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Control on Capital Issues Act, to issue capital above thepermitted amo un t. The am ou nt of premium was alsodetermined by the Controller of Capital Issues, taking intoaccount various facts relating to the Company's functioning.In May 1992, the above Act was repealed and instead theSecurit ie s an d Exchange Board of Ind ia (SEBI) wa sempowered to exercise control over the new issues marketas well. The SEBI subsequently permitted the companiesto determine the premium themselves. However, SEBI issuedguidelines in this regard, which divided the companies intothree categories, and within each category, companies whichfulfilled conditions of consistent profit for specific numberof years ar e permitted to charge premium. Rest of them ispermitted to issue the shares at par only. This led to greatrush in the new issues market and companies chargedheavy premium for their issues. You will study the detailsof these guidelines in Unit-10 dealing with Regulatoryframework f ~ rapital Market.

Capital Market (I) :New Issues Market

8.5.1 Book Building ProcessA new system to determine the amount of premium to becharged by a company on its new issues was introduced inOctober 1995, when SEBI permitted the system known as'Book Building'. It is a pricing mechanism wherein newissues are priced on the basis of demand feedback. Underthis system, the price of the new issue is based on real timefeedback from the investors.The mechanism adopted under the Book Building is asfollows:a A draft prospectus containing all information, except theprice and the number of securities, is filed by Lhe Company

with SEBI.A lead merchant banker to the issue i s appointed as BookRunner.

a The Book Runner will circulate copies of the prospectusamongst the institutional investors and underwritersinviting ~f f e r sor subscription to the security.

a The Book Runner maintains a record of the offers receivedf rom the ins t i tu t iona l inves tors and underwr i te r smentioning the price they are ready to pay and the numberof securities they intend to buy.

a On the basis of these offers, the Company and the 5onhrunner will determine the price of the security. TEie price.so determined, will be the same for both placement positioiland the public issue.


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Capital Marketin India Thereafter, the Underwriting Agreement is entered into andprospectus is filed with the Registrar of Companies.One-day prior to the public issue, institutional investorsare required to submit application forms along with moneyto the extent the securities are proposed to be allotted tothem.

Initially, the book-building process was optional to thecompanies, but gradually, an element of compulsion hasbeen introduced.During the fiscal year 2000-0 1, the book-building route wasmade compulsory for companies, which do not have thetrack record of profitability and networth as specified inEntry norms prescribed by SEBI.Moreover, 60% of the offer made by them is to be allottedto 'Qualified Institutional Buyers', comprising financialinstitutions, banks, mutual funds, Foreign InstitutionalInvestors (FIIs) and ventu re Capital Fun ds registered withSEBI. Inability to meet this condition is regarded as failureof the issue.The book-building route has also been made compulsory forIPOs with issue size more than 5 times the pre-issue networthand for public issues by listed companies worth more thaq5 times the pre-issue net worth. In these cas es also, 60%of the 'offer should be allotted to QIBs.Check Your Progress 2I ) , What do you mean by the premium? Who can chargepremium?

2 ) What do you understand by entry norms for new issues?Discuss briefly.

3) What is book-building process?


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8.6 REFORMS IN PRIMARY CAPITALMARKET

SEBI has brought about several reforms in the new issuesmarket during recent years. Important reforms are as detailedbelow:i) Minimum offer to public: SEBI (Disclosure an d Investor

Protection) Guidelines' required a minimum offering of 25%of post-issue capital to the public. This requirement wasgradually relaxed to 10% for companies in all sectors. Forthis purpose, SEBI also kept the minimum offering size a tRs. 100 crore and retained the existing limit of minimumpublic offering of 20 lakh shares . The Companies whichare unable to meet these conditions are required to make aminimum public offering of 25%.ii) Lock-in-period:The provisions for lock-in applicable to IPOshave been rationalized. ~oc k-in -per iod o r minimum

promotersJ contribution of 20 per cent Continues to be 3years, the balance of the entire pre IPO Capital held bypromoters and others shall have-lock-in period of 1 ye&from the date of allotment of the IPO.The shares issued on preferential basis by a listed companyto any person shall have a lock-in period of one year termfrom the date of their allotment.

iii) Allotment of Shares: The time for finalizing the allotmentof share has been reduced from 30 days to 15 days, incase, issues are made on book-building basis.

iv) Merch ant ban ke rs have been brought under SEBIregulatory framework and a code of conduct is issued for them.v) Companies are required to disclose all material facts andspecific risks factors associated with their projects while

making public issues through the prospectus.vi) Pro)t:bition L ~ ceen imposed on payment of any direct orindirect discounts or commission to person receiving anyfirm allotment of shares .vii) The requirement of 90% minimum subscription in case ofoffer for sale is no longer applicable.viii) Underwriting of the is sue made optional subject to thecondition th at if an issue was not underwritten and was

not able to collect a t least 90% of amo unt offered to publicas subscription, the entire amount will be refundable toinvestors.

ix) SEBI introduced a code of advertisement for public issuesfor ensuring fair and truthfu l disclosures

Capital Market (I) :New Issues Market


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Capital Marketin India 83' RECENT TRENDS IN NEW ISSUESMARKET IN INDIA

The new issues market in Indiq has passed ihrough boththe phases of boom and depression during the las t decade.The nurnber of new public issues shoot u p from 528 in1992-93 (Amount Rs. 6060.83 crores) .t o 770 in 1993-94(Rs. 12544 crores) and thereafter to 1343 and 1428 during1994-9.5 and 1995-96 amounting to Rs. 1331 1 OO and Rs.10981.72 crores respectively. This was largely du e toopt.imistic outlook following free pricing of sh ares allowed bySEBI.Table-8.1 shows the mobilization of resources from theprimary market during the last few years. The followingtrend emerges froin the table:i) Though, tl-ne numbers of issues and their amounts haveincreased during recent past from 367 (Rs. 59044 crores)

in 2997-98 tsj 737 (Rs . 7392 1 crores) in 2000-01, the majorportion was raised through private placement route. Withinthis categoly, public sector dominated and accounted for abigger portion. IDBI, IFCI, ICICI, IIBI were the largestmobilizers of funds in this category, followed by state levelund ertaking s. Thus , we may conclude th at privateplacement of shares/debentures, bonds, eitc. have becornepopular because of adverse sentiments towards equities andlower cost ~ 4 f lacement route. The willirigness of banksand other financial institutions to sutjscribe to debtinstruments through private placemerit has also been acontributing factor.

ii ) The number of new issues through prospectus and rights,which fell to 51 in 1998-99, rose to 83 i r ~ 999-2000 andfurther to 150 in 2000-01. Rut their amo unts c~n tin uo us ideclined from Rs. 9365 crores to Rs. 6421 crores. Thesefigures incIu.de both of the public issues 'chrough prospectusand the rights issues.

iii) Public Sector undertakings an d Gove rnment companiesrcniained absent from the public issue:; market during thelast three years , Resource mobi1izal:ion by ba nk s an dfinax~cial nsritu tions in the public sectcrr declined sharply.

iv) Out of 145 issues made by Non-Government public limitedcompanies, 134 issues were of equity shares, the remainingbeing debt issuets. But in te rns of resource mobilization, tileshares of e q u i ~rlstruments was only 53.9%. Most of theissues durjug IE080-01 were of Rs. L 0 croxs arid less, whiit: i nthe previous vezr most of the issul:s were of Rs. 10 crore andabove. A s a result, the average sm: of issues b1 private sectorcomp.anies sh~.:nplgreclined to Rs. I 4 crores from Rs. 65 crores;.ti 1939-20GOm.4 As. 164 crore im i998-99.


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v) The above figures of total amount mobilized by equity issu esinclude the amount of premium also. The share of premiumin the total amount mobilized by equity shares declinedsharply to 47.5% in 2000-01 from 78.8% n the 1999-2000,while it was 51.7% in 1998-99. This rise in premium wasdue to successful initial public offering of companies inInformation Technology Sector.In brief, it can be stated that the public issues market inIndia at present is not very attractive to the retail investorsbecause of the economic slow down and the depressed shareprices in the Secondary Market. Corporates have, therefore,preferred the route of private placement of debt instruments.Resource mobilization through IPOs accounted for only 5.5%of the total resource mobilization during April-December200 1, compared with 56.7% in the corresponding period oflast year. Banks and financial institutions raised about70% of this amount. Amount raised by IT Companies wasless th an 1%. In March 200 2, Pun jab National Bank ,however, made its successful IPO, which was over-subscribedby over 4.5 times and that too at a premium of Rs. 21 per 'share of Rs. 10 each. It shows revival of the small investorsinterest in the IPOs, especially those of banks and financialinstitutions.

Table 8.1Mobilisation of Resources from the Primary Market in India(Amount in crore rupees)

Security &Type of Issue

1 1!397-98 1 .1998-99No. Amount No. Amount

A: Prospectus& Rlghts

(1)Non-GovtPublic Ltd.Companies

(a) EquityShares

(b) Preference 1 4.3 3 59.7Shares

(c) Debentures 12 1,971.6 1 12 2,390.7I(2) anks andFinancialB: Private Placement

1999-2000 2000-2001No. Amount No. Amount

(1) Private Sector 1 180 16,997.7 367 19,403.5 387 24,390.8I I(2) ublic Sector 1 136 32,681.3 211 41,855.5 200 43,101.2- --Total (A+B) 367 59,044 66168,963.3 737 73,921.3

Source: Annual Report 0: ' Reserve Bank of India (2000-2001

Capital Market (I )New Issutr Marke


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Capital Marketin India Check Your Progress 3Match the following:

A Bi) Lock in Period for minimum promoters'distribution of 20% continues to be (a) 90ii) SEBI's guidelines require a minimum (b) 3offering of post issu e of capital to

the public to the percentageiii) The minimum percentage subscription in (c) 25case of offer for sale is no longer8.8 LET US SUM UPFinancial Market is broadly categorised into Money Marketand Capital Market. Capital Market deals with the long-term fund s such as equity shares, preference sh ares, bondsand debentures issued by the corporate sector, semi-government organizations and other financial institutions.The security market is divided into two segments-PrimaryMarket and Secondary Market. The former dea ls with thesecurities, which the issuer issues for the first time, whilethe latter deals in the existing securities. Any company canraise the capital in the primary market by three ways,namely-Public Issue, Rights Issue and Private Placement.Companies are allowed to issue their securities either atpar, or at a premium, or at a discount.The Securities an d Exchange Board of India (SEBI) hasimposed strict norms for entry of companies in the newissues market with effect from April, 1996. A new systemnamely 'Book Building' has been adopted by SEBI todetermine the amount of premium to tje charged by acompany. SEBI has brought several reforms in the newissues market during recent years. These :include minimumoffer to public, lock-in-period for mini~numpromoters'contr-ibution of 20% and reduction of time. from 30 days to15 days for finalising the allotment of sh ares .Recent trends in new issues market in India indicate revivalof the small investors' interest in the primary i ssues speciallythose of banks and financial institutions.8.9 KEY WORDSBands : Bond refers to a security issued by

a company, finar lcial in stitution , orGovernment, wllich offers regularor fixed paymc:nt of interest inreturn.


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Boom : A condition of the market denotingincreased activity with rising pricesand higher volume of the businessresulting from greater demand tosecurities.Buvback : The arrangement agreed to between

1 the comDanv and its investors tobuy back the securities at a laterdate for a specific price.

I Coupon Rate : It is the rate of interest, which theissuer pays in the principal/paidu p value of the bond. It is fixed atthe time of issuance of the bond.Deen Discount Bonds : This bond is issued at a discount- on the face value. The face value is

Gilts

paid at the maturity. These bondsare also known as Zero CouponBonds.: Fixed interest securities by thegovernment to raise money forpublic expenditure in India byauction across.

Securities & Exchange : Set u p in April 1988 by the Govern-I Board of India ISEBI) ment of India with the obiective ofpromoting healthy and orderlydevelopment of the securi t iesmarket and ensuring investorsprotection.

I Split : S u b division of s ha re of largedenomination into share of smallerdenomination. Also means sub

b division of holding.I Stagfii

: An application for a new issue ofshare s that hopes to sell the shareson al lotment at a prof i t once,trading commences in the secon-dary market. A speculator i s onewho buys and sells stocks rapidlyfor fast profits.

Underwriting : An individual or institution mar-anteeing subscription in part or infull of a security issue a t a laterdate for a specified price.

Volatility : A measure of the mice moment of

Capital MarlreNew Issues M

a security during a specific period.


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Capital Market of India