I had something to do with the creation of SEBI when I was in the finance ministry; my idea was to transfer capital market regulation from the ministry to a professional regulator. But if I had had an inkling of what it would become, I would never have let it be born. With its fondness for the oligopoly of qualified institutional investors and risk aversion, it has killed the risk capital market and curbed market competition. It is one of the prime causes for India's poor industrial growth.
The public issue of Tata consultancy Services attracted half a million applications from “retail” investors. The Oil and Natural Gas Corporation issue attracted 567,000. The NTPC issue attracted 14.1 million. Seeing their response, the Securities and Exchange Board of India (SEBI) has increased their quota in public issues from 25 to 35 per cent. It also redefined retail investors as those whose application was under Rs 100,000 instead Rs 50,000.
These investors are an ancient tribe; once they used to be known as small investors. They used to swarm in thousands around such speculative issues as those of Reliance in the 1980s. There was a special reason for this. The Controller of Capital Issues used to fix prices of public issues; he based the prices on past profits of companies, and thus underpriced shares of companies expected to better in the future. So investors could confidently expect that the market price of the shares, once they were listed, would be far above the issue price; in other words, an investor could multiply money within a few weeks if he got an allotment. Naturally, investors applied for more shares than were to be issued. So the government imposed rationing: no one could get more than a certain number of shares. To increase their allotment, investors made multiple small applications. These makers of multiple applications were christened small investors. They were in a lucrative business; vested interests grew up around it. Politicians would bat for them and protect their interest. That is how they came to be deified.
This business of easy money should have died when, in 1992, the government abolished the controller of capital issues and abolished issue price fixation. But in the great stock market boom of the early 1990s, too much money was chasing too few issues. The market price of some shares climbed immediately after public issue. That kept “small” investors applying; and ever sensitive to political advantage, SEBI created a quota for them.
Now that the stock market is booming, small investors are again being attracted to it. SEBI has made it so difficult to make a public issue that only rock-solid companies are able to make one. Because there are so few, they are being oversubscribed. And – most important – listing at a premium has returned. That means automatic profit for an allottee, and the return of multiple applications. SEBI encourages them by keeping a part of the allotment for “retail” investors.
The strike price of issues is fixed by book-building, which is a kind of auction; if the auction were perfect, the issue would not go into a premium on listing. Here, SEBI introduces systematic imperfection. The quotas for different investors mean that their chance of getting an allotment depends on the caste they belong to; the highest bidder cannot be sure of getting an allotment, so highest bidders do not bid. When the finance ministry abolished control of issue prices, it meant to abolish profits arising from underpricing. SEBI has brought them back through the back door.
Today’s paperless trading ensures that in theory, a subscriber could apply for even one share at a price of his choice. The strike price is decided in such a way that anyone who bid more than it would get an allotment even if he applied for only one share. So small investors could get allotment today without any special arrangements for them. The rationing system set up by SEBI only panders to a political lobby, and brings profits to multiple applicants at the expense of the issuing company. As it is, there are too few public issues; the underpricing SEBI imposes on them raises the cost of capital to companies and reduces public issues even further.
Instead of pandering to the mythical small investor, SEBI should allow experiments in the auctioning of public issues. Auction theory is a live area in economics, and many experiments are being tried out round the world; the Google public issue was the latest amongst them. Let India too be a laboratory.
Instead of creating an oligopoly of so-called qualified institutional investors, SEBI should define such qualifications for public issue applicants that the smallest individual investor can easily and confidently take part in an issue auction. It has already given every investor a code. Now it needs to create a mechanism by which investors can apply for an issue without locking up their investment: it would involve an automatic debit to their bank accounts at the same time as they are allotted shares. For all its perfection, the Indian stock market raises little money for companies, and none for new and small companies. It is this failure to which SEBI should apply its attention.