Capital market regulator Securities and Exchange Board of India (SEBI) may propose major changes in the IPO process for small and medium enterprises (SMEs). The regulator will issue a consultation paper soon. Recently, at the Morningstar Investment Conference in Mumbai, SEBI Whole-time Member Ashwani Bhatia emphasised the importance of the SME sector in the economy but also raised concerns about the SME IPO frenzy.

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“What we have seen is pretty disturbing. The way retail participation is happening, the number of times IPO issues are oversubscribed, the way market making happens, the way underwriting happens... And obviously, we do not feel very comfortable about what is going on," said Bhatia.  

SEBI’s recent orders also indicate how the SME companies are being used as a conduit for stock manipulation and siphoning of funds. This is why SEBI is considering overhauling the SME IPO regulations.

According to a merchant banking source aware of the development, “The consultation paper is likely to focus on tighter entry criteria, application size, monitoring of funds and disclosures made by companies."

The regulator is reviewing the whole SME IPO process due to the high exuberance created for such offers and the possible misuse of the route. 

Who can come for IPO?

“SEBI’s proposal on entry criteria may focus on who can come up with SME IPO, it may set tighter norms like companies who are genuinely running a business having a verifiable track record, partnership firms/LLPs and others who convert into companies just before IPO plan, may find it difficult to get approval," according to one source. 

Because partnership firms don’t have a track record like companies, there could be a cooling off period for filing of IPOs. Merchant bankers may have to do more on-ground and background checks. Net worth-based fundraising can also be a consideration, as in the past, companies with negative net worths have raised money and listed on huge premiums on the SME platform. Underwriting practices may also get overhauled. Also, there is a thinking that SME issues of Rs 100 crore and above should be mandatorily listed on the main board, instead of SME platforms.

Unified regulation across exchanges

The regulator may propose unified regulations across exchanges. Currently, all exchanges have their own criteria to allow companies to list on their platforms. The only common eligibility criteria is post paid-up capital should not be above Rs 25 crore. The rest of the criteria is decided by BSE and NSE platforms on their own. Many times, SME companies find regulatory arbitrage opportunities. However, unified regulation may lead to a lack of differentiation in offerings on exchange platforms. Unlike main board companies, SME IPOs are cleared by exchanges and not by SEBI.

Higher application size

To deter the retail frenzy, it is likely that SEBI may hike the minimum application size of Rs 1,00,000 so retail investors can be discouraged. The application size of Rs 1,00,000 was fixed in 2012 and has not been reviewed since then. The capital market scenario has changed so much since then and more so in the last five years. Seeing the huge oversubscription, SEBI may consider reviewing it. There were SME issues where the retail quota was subscribed more than 1,000 times. This year, the issue of HOAC Foods India Ltd was oversubscribed by 2013 times. Similarly, Kay Cee Energy & infra's issue was subscribed 1,052 times. Oversubscription numbers just show the level of interest of investors, it does not mean that the company has actually received the money from investors.

Tighter monitoring of issue proceeds

Tighter monitoring of issue proceeds is one more area, that SEBI can look into for all SME issues. Currently, only issues above Rs 100 Cr are required to have a monitoring agency for the main board but not for SMEs. So, monitoring agency and fund utilization certificates may also find a place in consideration. Misuse of issue proceed is a big concern for the regulator. So, there are suggestions that SEBI should look into it. Recent SEBI orders also suggest how funds are misused and many times siphoned from listed SME companies. 
 
Checks on corporate action

The regulator may also come up with some kind of check on corporate actions like stock spilt, issuance of bonus shares, and rights shares. The regulator may propose certain financial performance parameters for the companies. To ensure that, corporate actions are not only to pump the share prices but genuinely reward the shareholders. SEBI’s orders on SME companies have shown a trend where promoters used corporate action to fuel the price and dump their holdings. There is a new trend in SME companies, promoters come up with offers for sale (OFS), which was unusual for SME companies earlier. Exchanges are keeping a close watch on such issues.

Tighter disclosure norms

SEBI may also propose main board-like disclosure norms for SME IPOs. Currently, SME companies are required to file half-yearly financial numbers while mainboard companies have to file quarterly results. However, SME companies may oppose it, citing an increase in compliance costs. SEBI is also concerned with SME companies auditors, as many times they don’t do their job properly and don’t flag the issues.

Review of the market-making mechanism

The market maker mechanism may also get overhauled, according to one merchant banking source, “Market makers are actually becoming trouble makers as they create demand-supply imbalance, by keeping a tight hold on the supply of shares, to create a mismatch." However, any review of this proposal will require data. But, the job of merchant bankers is likely to become tough, as scrutiny will go up. 

Demand for an overhaul of allotment 

There is also a growing demand that the quota for qualified institutional investors and anchor investors in SME IPOs should be removed. The regulator may look into this issue as well. To ensure that allotment is fair, exchange or SEBI-approved auditors certification may also be a condition.

A delicate balancing

The issue of SME funding is sensitive as it may create a narrative that the regulator is against the sector, so a delicate balancing may be required. SME associations have been complaining that institutional funding for them is a big issue and if exchanges also tighten the norms then the sector may be impacted. Besides reviewing the regulations SEBI will also focus on increasing investor awareness. So, that investors make an informed decision before investing.