IPO Pricing Issues in India

One of the most important issues in floating an IPO is the pricing aspect. Different forces, often in conflict with each other, are at play here. Issuers would ideally like to maximize the proceeds from the process. Investors would want the offer to be under priced at best and to be (near) correctly valued at worst. Underwriter gets a portion of capital raised as fee, and they would want to maximize their income. But if an IPO is overpriced, there may not be sufficient demand from the market and as a result the issuer may not be able to sell all the shares it had planned. The reputation of the underwriter is also at stake here. It has been observed from empirical data that historically IPOs have been under priced. However, the trend regarding pricing of IPOs seen in India over the last one year has followed an opposite pattern. It has been observed, 70% of the 55 firms that went for IPO during the period April, 2010 to March, 2011, are trading below their offer price. Moreover, 70% of the same 55 firms traded at premium on their listing days, but price fell on subsequent trading days. This implies only very short term investors have actually benefited from these offerings. This is even more surprising when one considers IPO performance in conjunction with overall market performance. In August 2009 BSE created an IPO index that tracks the value of companies for two years after IPO starting from the third day of trading. The graph shows the movement of this BSE IPO index along with that of the SENSEX. It is noteworthy, while the two moved in tandem initially, they have diverged from each other since September, 2010. Thus while the SENSEX gained over 10% during April 2010 to March 2011, BSE IPO index fell over 15% during the same period. This implies overall market condition is not to be blamed for the poor performance of the newly listed firms. This does not augur well for the markets. Retail investors, most of whom invest with medium to long term objectives and are not very sophisticated or well informed, suffered heavy losses and may lose interest in the IPO segment. The pricing of IPOs has come under scrutiny from a number of market participants and the capital market regulator, Securities and Exchange Board of India (SEBI), has taken note of the situation. In the past SEBI had expressed its displeasure regarding overpricing of IPOs and asked the underwriting banks to be more prudent regarding IPO pricing. Recently SEBI proposed that underwriting banks must disclose to investors the performance and track records of their earlier issues in their prospectus and on website. The regulator is also concerned about hyping of public issues through misleading advertisements and media reports and could propose strict penalty if underwriters are found to be involved in such activities. Moreover, SEBI has expressed its displeasure over investment banks, vying among each other to bag deals, quoting very low fees from issuers, thereby promoting issuer interest above investor interest.

Private Equity in India: Poised for growth

The year 2010 was a good one for PE in India. India posted the highest growth rate in PE deal value among all major economies in Asia-Pacific, clocking 111% growth, ahead of China’s 56% growth. The deal activity in India doubled to about US$7.4 billion, compared to US$3.5 billion in 2009. The past decade saw enormous growth in PE investments, which increased from US$1.2 billion in 2000 to US$7.4 billion in 2010, registering a CAGR of 20% during this period. However, the credit crisis of 2008 threatened to stall the growth in deal activity, because the crisis had a clear impact on PE activity in India. Deal values dropped considerably starting Q4, 2008. The lull lasted five quarters before the deal values were restored to pre-crisis levels in Q1 2010. The total deal value in Q1 2011 has shot up to US$3.3 billion from US$1.4 billion in the previous quarter, a 142% rise. With the economy poised to grow at around 9%, and the IMF providing a close growth forecast figure of 8.3% for 2011, investors are upbeat about growth prospects. The year 2011 has clearly begun well, and the deal activity is expected to continue into the next quarters. According to industry estimates, there is US$20 billion of committed, unused capital yet to be deployed in the Indian market, which already makes supply constraint a non-obstacle. The PE landscape in India is highly dynamic, and more often than not, it systematically responds to macroeconomic cues, domestic and global, and indicators such as interest rate and inflation. It is interesting to note that in spite of its dynamic nature, there is a striking characteristic that continues to persist. The average deal size has mostly flickered around US$25 million since 2004. The quarter-on-quarter figures since Q3, 2008, as shown in the Figure, do not show much variation in average deal size. It suggests a mindset that a majority of PE deals target minority positions. Tighter regulation on buying large positions in publicly listed companies could be one factor that is keeping the average deal size low.

Infrastructure was the star sector for PE investments in 2010. The aggregate deal value in infrastructure stood at US$2.3 billion, accounting for 32% of the announced deal value. The power sector is emerging as an attractive segment within infrastructure, with PE funds looking to capitalize on the demand-supply gap. India is currently power starved; industry estimates suggest that the energy availability of 750,000 million units (MU) fell significantly short of the demand of 830,000 MU during 2010. PE firms are chasing investment opportunities as India expands its power generation capacity. Infrastructure is followed by telecommunications, where the aggregate deal value stood at US$823 million. A close third position was taken by the financial services sector, which registered an aggregate deal value of US$820 million. In terms of volumes, technology sector saw the largest number of PE deals. Q4 2010 was particularly favourable to the technology sector, with the total deal value more than trebling when compared to Q4 2009. Technology is expected to continue leading PE deal volumes in 2011 as well. There are several challenges facing the PE industry. The regulatory challenge is foremost, followed by political pressures (especially in infrastructure sector) and volatile macroeconomic factors such as high inflation. The current regulation is particularly unfavourable for picking up large equity (over 15%) in publicly listed companies. Moreover, private equity is not treated as a separate asset class, which makes its treatment under securities and tax laws complex. Lack of meaningful exits was criticized as an impediment, but 2010 has proved it wrong. PE exits in 2010 stood at US$5.3 billion, and the exit volume registered at record high of 120 exits during the year. Strategic sales emerged as an important exit mode, with 26 deals choosing this route. The strong record of exits should boost investor confidence and fuel the next round of growth in 2011. The Indian PE industry is maturing. The attitude of promoters towards PE/VCs is changing, and there is greater recognition of the value that PE/VCs bring to the business. Although obstacles such as divergence on valuation expectations between promoters and investors, a tough regulatory environment, and inflation concerns remain, the fundamentals are intact. The PE industry is set for aggressive growth in 2011.

Microfinance in India

On May 2, Reserve Bank will announce its annual credit and monetary policy which will include the changes to be implemented in the microfinance industry in the country. This is expected to enable the industry to come out of the turmoil it is facing on two fronts – sourcing of funds and questions over their own lending activities and practices. When India gained independence in 1947, most of India’s banking sector was nationalized with the focus of inclusive growth. As part of this policy, regional rural banks were set up in the 1970s to promote inclusion while the 1980s saw the emergence of the Self Help Group (SHG) – bank relationships for rural financing and empowerment. NABARD along with the priority sector lending policies enabled the growth of SHG lending. With the economic liberalization in the 1990s, a new breed of organizations emerged – Microfinance Institutions, which originated initially as non-profit but later transformed into for-profit NBFCs came into the arena through increased private sector participation. By 2010, the SHG-Bank linkage model accounted for 58% of loans outstanding. Most of the bigger MFIs are operating as NBFCs and account for 34% of the outstanding loans. These NBFCs are growing at an annual rate of 80% and reaching 27 million borrowers. The balance 8% of loans is extended by trusts and societies. The MFIs are not allowed to take deposits and hence the financing happens through the banks lending to the MFIs, buying their loan books through securitization deals or borrowing from the market. So microfinance institutions mainly rely on funds from banks to disburse microcredit to needy borrowers. While the bigger and more reputed MFIs have been able to raise a major part of their funds from the market, many others depend on institutional bank funds which are refinanced by NABARD. Banks also have to meet their priority sector lending requirements and the way they generally did that was through purchase of MFI loans. Since the MFIs are better in performing the due diligence at the ground level, many a times, the safer option for the banks is to purchase the MFI loans to meet their PSL needs. So when a crisis broke out in Andhra Pradesh leading the Reserve Bank of India to establish the Malegam Committee to study the state of MFIs in the country, most of the microfinance funding was put on hold, forcing the players to look at other options including restructuring. This has put immense pressure on the MFIs as well as for the banks. Most of the microfinance activities came under the purview of the state government and did not have the regulatory clarity of being under the control of the central banks. While NBFCs were already regulated by RBI, the NBFCs in microfinance have to be considered separately as they cater to a vulnerable section of the society and are an important tool of financial inclusion. Also, they compete with the SHG-Bank linkage model and hence the decisions made by the NBFCs have impact on the SHG-Bank model as well. Also, the interest rates charged were unjustified in many cases and there was lack of transparency in the rates charged. Other practices like multiple lending to the same borrower leading to over-borrowing, taking deposits, ghost borrowers, coercive recovery mechanisms were rampant. With the new rules, there will be a centralised regulatory rule and microfinance will come under the purview of Reserve Bank of India. This clarity will enable the future growth of the industry but in a manner protecting the end borrowers. With the recent controversy, the certainties in funding had been lost but with the committee report being put into implementation, the MFI lending will mostly retain its PSL status thereby guaranteeing funding certainty. The Committee advises for the creation of a separate category of non-banking financial companies (NBFC-MFIs) for the MFI sector. This will empower the central bank to bring in some restraint to the unwanted aspects of competition in the industry. The small loans now cannot exceed Rs. 25000 and most importantly, the interest charged should not exceed 24% for individual loans. These, along with other suggestions, will improve transparency in micro-lending and reduce issues related to over-borrowing. While there will be some constraints arising out of these regulations for the participants in the short run, these changes will align microfinance more along the lines of the financial inclusion strategy that has been envisaged for India.

Trends in Indian Mutual Funds since Abolition of Entry Load

The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets. According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened. Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds. In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Quarterly Equity Mutual Fund Sales

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The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets.

According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened.

Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds.

In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Islamic Bank in India to get Green Signal

The Kerala high court recently dismissed a petition objecting to the creation of an Islamic financial institution and said the proposed body was to work in accordance with financial laws of the country even while it complied with Shariah rules. The move could pave the way for introduction of Islamic finance products by existing lenders and also reduce regulatory objections for an Islamic Bank. The conventional Indian banks have welcomed Islamic banking and finance take roots in India with the second largest Muslim population in the world (over 150 million). This has certain set of apprehensions about whether Islamic finance has any future in this country with an avowedly secular constitution. While regulators make way for Islamic banks in India the big question is about the responsibilities associated with it for the advocacy groups to move ahead and lay a solid foundation for introduction of Islamic finance in India keeping in line with Shariah principles. The dearth for Islamic scholars should not put the task of Islamic banking into wrong hands repeating in the blunders committed elsewhere of bringing in the “corrupt and spurious” products and models of some so-called Islamic banks. It is also of at most important to focus on organic growth with out being over ambitious, resulting in dilution of Shariah laws. The point of concern is the awareness of the concept of Islamic banking even with in Muslims with in the country is very low which will result in delayed acceptance and this is where educating the customers comes into picture.

Are we witnessing times of diluted Micro-finance objectives?

Microfinance, synonymously cited for growth in emerging markets has been witnessing its share of negative publicity of late. The spotlight is currently on how the sector is rapidly becoming an area of exploitation for individual benefit. The recent crisis in Andhra Pradesh (India) has drawn the attention of microfinance practitioners worldwide towards regulations & compliance within the MF operation space. India’s sporadically growing unregulated MFIS have created havoc and have resulted in suicide of many borrowers for over –indebtedness, specifically in the state of Andhra Pradesh. The alarming debt to equity ratio, which is high in India as compared to other similar economies, finally resulted in the regulators intervention. The drilled down motive behind investors funding MFIs was more for an individual profit than that of social objective. This translated into high pressure on the MFIs for repayments. The Reserve Bank of India set up Y H Malegam committee to probe into MFI issues to bar MFIs from stock markets and private equity (PE) saying that such moves are profit-driven, thus defeating the very purpose of financial inclusion. Apart from the clear need for a separate regulator for MFIs, there are several points of concerns at the individual MFI level like lack of transparency, conflicts of interests in ownership, accounting standards, lack of clearly defined roles etc. To conclude, micro-finance, which started as an informal lending sector at local levels has now transformed into a full fledged industry with significant capital market participation and global integration. This is also accompanied with some of the pain points discussed earlier; therefore any further development in this space will clearly call for fair rules and regulations together with compliance and supervision on the part of various stakeholders.

Increasing banking penetration in India

The RBI recently brought out a discussion paper on giving out new banking licences to business houses and non-banking financial companies (NBFCs) to increase competition in the sector, and also expand the reach of banking services across the country. The estimated banking penetration in India is about 45% among middle and high income groups and less than 5% among low income segment. Expanding the reach of banking services is crucial to tap the country’s savings and investments. Microfinance institutions have been partly effective in tapping rural savings, 41% of which are held as cash according to NCAER estimates. The RBI therefore has a clear mandate in awarding new banking licences, however, more deliberation is required on a few issues before the RBI actually implements it. The issues that are being debated widely in this context are – minimum capital requirement, shareholding of promoters and foreigners, permitting industrial and business houses, and NBFCs to start banking arms. RBI’s stance on disfavoring groups with real estate interests was a bold assertion. It highlighted the view that linkages with the real-estate sector, given its sensitivity and any subversion of the Chinese walls between the bank and real-estate business would have implications for the financial stability of the bank. On minimum capital requirements, we hold the view that the RBI should set it in the range of 300 to 700 crores and gradually increase it to 1000 to 1500 crores over a period of five years, in order to encourage only serious players to apply for licences. We recount here that the RBI, in 2001, had set a minimum capital requirement for banks at Rs 200 crore, which was to be increased to Rs 300 crore in 2004. We also expect the minimum capital requirement for other banks to go up once the announcement for the new banks is made. In addition to technical details, we hope that the debate also includes innovation in banking models and leveraging technology for better penetration of banking services, especially transaction banking at a time when mobile phones have seen high penetration in rural areas. If the business is able to generate wider employment opportunities and is also able to gain access to a wider customer base, then it’s a win-win situation for both the business and the people.

New Wealth Managers in India- the Chartered Accountants !!

In an upcoming report titled – Trends in Indian Wealth Management Market, Celent analyzes the key emerging trends in the wealth management domain in the Indian market. The report captures all that is shaping the contours of this very interesting market place. One of the key discoveries is the growing trend of chartered accountants doubling up as wealth management consultants. This is a new phenomenon, where in small accountancy outfits are also doubling as point of sales of tax planning and savings instruments for clients. These products range in breadth from insurance to mutual funds. In larger cities accountants are also helping clients route investments into private equity and venture capital transactions. Manned by professional accountants with long standing relationships with their clients, smaller accountancy firms are only recently beginning to leverage their intimate understanding of their clients’ financials to advise them on suitability of different product classes for investments. This class has become active in advisory services in the wealth management domain recently. The wealth management offerings are positioned more in way of the traditional financial advisers. Accountants have emerged as an important intermediary in the wealth management business lately, charging commission income for products proffered and fee income for advisory services as their overall annual fee. Interesting how new channels are adding to the dynamism of the market place !!!

Putting the best foot forward, by choice

The recent City Day organized by SunGard in Mumbai provided interesting insights into India’s equity trading industry. Mr. Damodaran, ex-head of SEBI, the capital market regulator put India’s liberalization and globalization into perspective by pointing out that often in its recent history India has been forced to take actions that are seen to be desirable in hindsight. In 1990-91, it was the precarious forex reserves situation that forced India to open up its economy. Moving on two decades down the line, one hopes that electronic trading in the form of Direct Market Access (DMA), Smart Order Routing (SOR) and algorithmic trading would be something that our capital markets adopt out of choice and because they see the merit in doing so, as opposed to either being forced to do it, or even worse, not doing it at all and facing the possibility of extinction once the global broker-dealers enter the market in a big way. A trend that usually follows the widespread adoption of electronic trading is the concentration of trading, especially in one financial center across a region. In Europe, London happened to be the center that benefited most from the introduction of these technologies. Similarly, markets such as Japan, Korea, Taiwan, Singapore and Hong Kong are adopting high frequency trading in a big way. India cannot afford to be left behind in this context. The same goes for the leading brokerages in the Indian markets. It takes a trading desk between six months to a year to fine-tune its electronic trading capabilities. The longer the delay in getting the buy-in to do so, the lower the chance of success and indeed survival. The buy-side also has to be decisive and quick in its approach. Moving on to some of the other presentations in the event, there were useful inputs given into the issues that are cropping up in terms of the infrastructure for electronic trading. While NSE has a fast matching engine, the rest of the infrastructure has a long way to go. As pointed out, in Indian centers outside Mumbai the contrast between Indian and international capabilities is even more stark and communication networks have been found lacking. Data quality is also something that brokers, especially the smaller ones are struggling with. In this scenario, it is important that India opens up its markets to globally renowned vendors, while at the same time encouraging its local IT firms to also compete in the market. The Indian market is large enough for a number of firms to participate and be able to meet the various requirements for electronic trading.

Bancassurance, Next Only to Agent Distribution Channel in Asian Insurance Market

While my earlier article discussed in general on how Bancassurance channel is shaping up in various regions in Asia Pacific. This write-up sheds some light in terms of market share and growth of Bancassurance in various regions in A Pac. It is evident that this channel is picking up in most of Asia Pacific region. However the channel is still next only to the dominent Agent channel. In Mainland China, Bancassurance accounted for 27 percent market share of total insurance sales, agent channel dominated the market (37 percent market share) in 2009. Insurance market in China is undergoing structural changes with in the market and this is expected to boost the premium income of insurers via banking channel. In Hong Kong, Banks have become an important distribution channel for life, health and mandatory provident funds, supplying up to 40 percent of the market’s new business. HSBC and Hang Seng Bank together held 40 percent of the Mandatory Provident Fund (MPF) market. In Taiwan, the concept of “One Stop Shop” has become a common philosophy for banks. Premium income for individual life insurance new business from bancassurance accounted for 68 percent in 2009. Banks contributed 88 percent to new individual annuities, 66 percent to new investment-linked businesses, and 51 percent to new life insurance businesses. While P&C market is dominated by agents and brokers (67 percent of the market share). Personal accident/ health Insurance is mostly under taken by Insurance companies themselves, thus accounting for 91 percent of this line of business. In Singapore, insurance agents make up the main sales channel for life insurance. The market share however has declined from 66 percent from 2004 to 61 percent in 2009. Bancassurance accounted for 22 percent of the total weighted new business premium income Bancassurance market share in Malaysia has grown from 45 percent in 2005 to 51 percent in 2008. The agency network had traditionally been the main distribution method but has gradually lost some ground to bancassurance. Agency network accounted for 47 percent market share in 2004 which has come down to 44 percent in 2008. Domestic insurers account for over 80 percent of Bancassurance market. In South Korea, solicitors and internal employees make up the main sales channel for the life insurance industry. In 2008, the bank channel grew to 37 percent next only to solicitors and internal employees of the insurance companies with 54 percent. Indian life insurance market is dominated by tied agents, more so with the state owned Life Insurance Corporation of India (LIC). Over 75 percent of new business premium is generated by individual agents. However, individual agents in private companies account for less than 50 percent of total sales, while more than 40 percent is attributed to the bank and direct selling channel. Banks and brokerage firms have 30 percent and 20 percent respectively of the P&C insurance market. Markets such as Thailand, Malaysia and China have better acceptance of bancassurance channel as opposed to India and Singapore as brokers and agents are still major insurance carriers in these region. It is also noteworthy that all developing and accelerating markets are evidencing high potential for growth in Bancassurance.