Friday December 5, 02:54 AM
Sebi needs to take a look at mandatory
IPO grading
By Sunny Verma
The Securities and Exchange Board of India (Sebi) announced steps to revive the flailing primary market
in the country on Thursday such as extending the validity period of the nod from the regulator to raise
funds from three months to a year. But Sebi will need to take a hard look at another aspect of its IPO
(initial public offering) rules the much-hyped mandatory IPO grading launched last year.
Sebi made grading mandatory for initial public offers or IPOs starting May 1, 2007. The downturn in Dalal
Street has meant that share prices of all the companies who issued shares since May 2007, have fallen in
the range of 50-80% irrespective of what ratings were assigned to them by the grading agencies.
Even the nine companies that got 'above average' ratings (a notch below the highest grade) for public
issues have seen their prices erode by as much as 69% since their listing. Stock prices of companies
listed in 2007 and 2008 including Edelweiss Capital Limited, Central Bank of India, Gammon
Infrastructure Project Ltd and Reliance Power Ltd have fallen by 74.84%, 73%, 79.22% and 68.64%,
respectively, data compiled by Nexgen Capitals Ltd show. The comparison is based on the issue price
and the market price on Tuesday.
It must be noted here that the failure of international credit rating agencies to do due diligence on the risks
inherent in exotic mortgage-backed securities was one of the key catalysts for the sub-prime crisis that
has now become a full-blown global crisis of confidence. IPOs in India are graded in the range of 1 to 5
by rating agencies ICRA, CARE, Crisil and Fitch. Grade 5 reflects the top ranking or strong fundamentals
whereas Grade 1 is the lowest ranking or poor fundamentals. Agencies rate the issuing companies and
the not the instrument or the IPO, per se.
Barring Religare Enterprises Ltd and Vishal Enterprises Ltd, which secured Grade 3 or average
fundamentals, and Alakali Metals Ltd and Anu's Laboratories Ltd, which secured Grade 2 or below
average fundamentals, all other 55 companies that listed after the grading was mandated have seen

substantial value erosion. Last year, the Indian equities market saw public issues to the tune $8.3 billion,
of which $5 billion were rated, says Jagannadham Thunuguntla, equity head at Nexgen Capital.
While a major part of the reason for value erosion in these rated companies is the ongoing rout in the
local and global stock markets, the fact that erosion has been higher for companies with above average
grading (Grade 4) than with average (Grade 3) and below average (Grade 2) fundamentals reflects that
grade rankings may be a poor indicator of value protection for investors.
This brings back the old debate on the relevance of the entire IPO grading process. While sections feel
that IPO grading misleads retail investors without bringing in any tangible benefits, those in its favour say
it is neither very costly nor time consuming and hence should continue as supplementary information for
the investors.
The fee charged by rating agencies for grading an issue is usually in the range of Rs 10-20 lakh, or 10
basis points for a large issue. The fee is capped at Rs 75 lakh per issue. To be sure, no other country has
mandated grading of IPOs and it is so far specific to India. Sebi introduced the grading process as it was
expected to help retail investors in taking informed decisions whiling subscribing for shares.
However, it has since received criticism from various quarters. \"The grading is actually misinforming the
retail investor as market performance is not being protected through different grades of ratings,\"
Thunuguntla says, suggesting that the regulator should take a re-look at IPO grading process. There are
also concerns that IPO grading does not take into account the issue price, corporate governance norms
and profitability. The primary markets advisory committee of Sebi has reviewed the IPO grading process
in the last 2-3 months, but has not come out with any changes so far. A member of this committee who
participated in these deliberations told FE that many members were in favour of scrapping the IPO
grading process. \"My sense is that it would be eventually done away with,\" the member said, wishing not
to be quoted.
There has also been a suggestion that since agencies rate the issuer and not the instrument, ratings can
be released separately. A securities market analyst, who has been consulted by the government for the
IPO review process, says it is not clear to what extent ratings influence retail investors. \"The purpose of
grading is to give some investor protection. It is materially not that important, but it is just an assurance,\"
he says.