New issue market and Stock exchange

MEANING:

The industrial securities market in India consists of new issue market and stock exchange. The new issue market deals with the new securities which were not previously available to the investing public, i.e., the securities that are offered to the investing public for the first time. The market, therefore, makes available a new block of securities for public subscription. In other words, new issue market deals with raising of fresh capital by companies either for cash or for consideration other than cash.

The new issue market encompasses all institutions dealing in fresh claim. These claims may be in the form of equity shares, preference shares, debentures, right issues, deposits etc. All financial institutions which contribute, underwrite and directly subscribe to the securities are part of new issue market.

STOCK EXCHANGE:

The stock exchange is a market for old securities, i.e., those which have been already issued and listed on a stock exchange. These securities are purchased and sold continuously among investors without the involvement of the companies. Stock exchange provides not only free transferability of shares but also makes continuous evaluation of securities traded in the market.

RELATIONSHIP BETWEEN NEW ISSUE MARKET AND STOCK EXCHANGE:

Despite the above mentioned differences, the new issue market and stock exchange are inseparably connected and work in conjunction with each other.

The new issues first placed in the new issue market can be disposed off subsequently in the stock exchange. The stock exchange provides the mechanism for regular and continuous purchase and sale of securities. This facility is of immense utility to potential investors who are assured that they will be able to dispose off the allotment of shares at any time. Thus the two markets are complementary in nature.

Both the markets are connected to each other even at the time of new issue. The companies which make new issue apply for listing of shares on a recognised stock exchange. Listing of shares adds prestige to the firm and widens the market for investors. The companies which want stock exchange listing have to comply with statutory rules and regulations of the stock exchange to ensure fair dealing in them. The stock exchanges, thus, exercise considerable control over the organisation of new issues.

The new issue market and the stock market are economically an integral part of a single market, i.e., industrial securities market. Both are susceptible to the common influence of the environmental conditions such as political stability, economic conditions, monetary policy of the central bank and the fiscal policy of the government. The two markets act and react upon each other in the same direction. When the stock prices go up in the market, the new issues increase and when the stock prices show a downward trend the new issues decline. The new issue market also depends on the stock exchange to find out price movements and general economic outlook and to forecast the climate for the success of new issues.

FEATURES OF PRIMARY MARKET:

1. This is the market for new long term capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called New Issue Market (NIM).

2. In a primary issue, the securities are issued by the company directly to investors.

3. The company receives the money and issue new security certificates to the investors.

4. Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.

5. The primary market performs the crucial function of facilitating capital formation in the economy

6. The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as ‘going public’.

FUNCTIONS:

The main function of a new issue market is to facilitate transfer of resources from savers to the users. The savers are individuals, commercial banks, insurance companies etc. The users are public limited companies and the government. The new issue market plays an important role of mobilizing the funds from the savers and transfers them to borrowers for production purposes, an important requisite of economic growth. It is not only a platform for raising finance to establish new enterprises but also for expansion/diversification/modernizations of existing units. In this basis the new issue market can be classified as follows:

1. Market where firms go to the public for the first time through Initial Public Offering (IPO).

2. Markets where firms which are already trading raise additional capital through Seasoned Equity Offering (SEO).

The main function of a new issue market can be divided into a triple services function:

1. Origination

2. Underwriting

3. Distribution

Origination

It refers to the work of investigation, analysis and processing of new project proposals. Origination starts before an issue is actually floated in the market. There are two aspects in this function:

1. A careful study of the technical, economical and financial viability to ensure soundness of the project. This is a preliminary investigation undertaken by the sponsors of the issue.

2. Advisory services which improve the quality of capital issues and ensure its success.

The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms. The success of the issue depends, to a large extent, on the efficiency of the market. The origination itself does not guarantee the success of the issue. Underwriting, the special service is required in this regard.

Underwriting

It is an agreement whereby the underwriter promises to subscribe to a specified number of shares or debentures or a specified amount of stock in the event of public not subscribing to the issue. If the issue is fully subscribed, then there is no liability for the underwriter. If a part of the share issues remain unsold, the underwriter will buy the shares. Thus, underwriting is a guarantee for the marketability of shares.

Method of underwriting

An underwriting agreement may take any of the following three forms:

i. Standing behind the issue: Under this method, the underwriter guarantees the sale of a specified number of shares within a specified period. If the public do not subscribe to the specified amount of issue, the underwriter buys the balance in the issue.

ii. Outright Purchase: The underwriter, in this method, makes outright purchase of shares and resells them to the investors.

iii. Consortium Method: Underwriting is jointly done by a group of underwriters in this method. The underwriters form a syndicate for this purpose. This method is adopted for large issues.

Distribution

It is the function of sale of securities to ultimate investors. This service is performed by brokers and agents who maintain a regular and direct control with ultimate investors.

INSTRUMENTS OF ISSUES

Traditionally, equity shares preference share are issued by companies as ownership capital and debentures and bonds as debt capital. Recently, new instruments to meet the varied needs of investors in terms of security, rate of return, marketability and appreciation in value are being issued by the companies.

The important new instruments and their characteristic are explained below

i. Secured premium notes with detachable warrants (SPN)

Secured premium notes are issued along with detachable warrant. The warrants attached to it ensure the holder the right to apply and get equity shares after a notified the SPN is fully paid up.The SPN is issued at nominal value and does not carry any interest.

The SPN is redeemed by repayment in several installments at a premium amount is distributed equally over the period of maturity of the instrument. There is a lock in period for SPN during which no interest will be paid for the invested amount. The instrument is secured by mortgage of all immovable properties of the company.The investor can disclose off the SPN on allotment at a premium if the shares of the issuing company commands a high premium in the market.

The conversion of detachable warrant into equity shares will have to be done within the time limits given by the company

ii. Equity Shares with Detachable Warrants

In this instrument along with fully paid up equity shares, detachable warrants are issued which entitle the warrant holder to apply for a specified number of shares at a determined price. Detachable warrants are registered separately with the stock exchange and traded separately.

iii. Preference Shares with Warrants

This instrument shall carry certain number of warrants entitling the holder to apply for equity shares “at premium” at any time in one or more stages between the third and fifth year from date of allotment. From the date of allotment, the preference shares with warrant should be transferred or sold for a period of three years.

iv. Non Convertible Debentures with Detachable Equity Warrants

The holder of instrument is given an option to buy a specified number of shares from the company at a pre determined price with a definite time frame. There is a specific lock in period after which the holder can exercise his option to apply for equity shares.

v. Fully Convertible Cumulative Preference Shares

This instrument has two parts A and B. part A is convertible into equity shares on the date of allotment without application by the allottee. Part B will be redeemed at par /converted space into equity after lock in period, at the option of investors.

vi. Zero Interest Fully Convertible Debentures(FCDs)

No interest will be paid to the holders of this instrument till the lock in period. After a notified period this debenture will be automatically and compulsorily converted into shares. Before the conversion of FCDs into equity, if the company issues rights, it would be available to the holders in the proportion decided by the company.

7. FULLY CONVERTIBLE DEBENTURES (FCDs) WITH INTEREST

This instrument carries no interest for a specified period. After this period, option is given to apply for equities at premium for which no additional amount is payable. However, interest in FCDs is payable at a determined rate from the date of first conversion to second / final conversion and equity will be issued in lieu of it interest amount.

8. ZERO INTEREST PARTLY CONVERTIBLE DEBENTURES (PCDs) WITH DETACHABLE AND SEPARATLY TRADABLE WARRANTS

This partly convertible debenture has two parts- A and B. part A is convertible into equity shares at a fixed amount on the date of allotment. Part B is non convertible and redeemed at par at the end of a specific period. Part B will also carry a detachable and separately tradable warrant. It also gives an option to the holder to receive equity share for every warrant.

9. ZERO INTEREST BONDS

Zero interest bonds are sold at a discount from their eventual maturity value and bear no interest. In India, zero interest convertible is bonds are issued by companies. These bonds do not carry any interest till the date of conversion and are converted into equity shares at par or premium on the expiry of a fixed period.

10. DEEP DISCOUNT BONDS

These bonds are sold at a large discount to their nominal value. There are no interest payments on these bonds and the investors get return as accretion to the par value of the instrument over its life.

The Industrial Development Bank of India issued in February 1996 deep discount bonds. Each bond having a face value of Rs. 200000 was issued at a discounted price of Rs. 53000 with a maturity period of 25 years. The Industrial Finance of India issued Deep Discount Bonds of Rs. 2500 and promised Rs. 100000 after 25 years. The Small Industrial Bank of India also issued similar type of bonds.

11. OPTION BONDS

Option Bonds may be cumulative or non-cumulative as per the option of the holder of the bonds. In case of cumulative bonds, interest is accumulated and is payable on maturity only. In case of non-cumulative bonds, the interest is paid periodically. The option is to be exercised by the investor at the time of investment. The Industrial Development Bank of India issued option bonds in January 1992.

12. BONDS WITH WARRANTS

A warrant allows the holder to buy a number of equity shares at a pre-specified price in future. The warrants are usually attached to debentures or preference shares issued by companies as sweetners to make issues more attractive. Essar Gujarat, Ranbaxy and Reliance have issues bonds with equity warrants.

Besides the above, the Abid Hussain Committee has recommended the issue of the following instruments:

a) Floating Rate Notes

b) Clip and Strip Bonds

c) Dual Convertible Bonds

d) Index Rate Notes

e) Stepped Coupon Bonds

f) Dual Option Warrants

g) Extendable Notes

h) Level Pay Floating Rate Notes

i) Commodity Bonds

j) Industrial Revenue Bonds.

The Pherwani Study Group has recommended the following new instruments:

1. Participating Preference Share

2. Participating Debenture

3. Convertible Debenture with Options

4. Third Party Convertible Debenture

5. Convertible Debentures Redeemable at Premium

6. Debt for Equity Swap.

PLAYERS/INTERMEDIARIES IN THE NEW ISSUE MARKET

There are many players in the new issue market. The important of them are the following:

1. Merchant bankers:

They are the issue managers, lead managers, co-managers and are responsible to the company and SEBI. Their functions and working are described in a separate chapter.

2. Registrars to the issue:

Registrars are an important category of intermediaries who undertake all activities connected new issue management. They are appointed by the company in consultation with the merchant bankers to the issue. Registrars have a major role, next to merchant bankers, in respect of servicing of investors.

The roles of registrar in the pre-issue, during the currency of issue, pre-allotment and post- allotment are described below:

Role of registrar in pre-issue

1. Suggest draft application form to the merchant bankers.

2. Help in identifying the collection centres. The choice of collection centre and of collecting banker is critical to the issue.

3. Assist in opening collection accounts with banks and lay down procedure for operation of these accounts.

4. Send instructions to collecting branches, for collection of application along with cheques, drafts, stock invest separately and remittance of funds.

5. Workout modalities to receive the collection figures on a regular basis until the subscription list are closed.

During the currency of issue

1. Receive the collection figures every day.

2. Tabulate and classify the collection data on the basis of the standard proforma of slabs of shares applied for.

3. Keep the merchant bankers and the company informed of the progress of total subscriptions.

4. Inform the stock exchange about the closure of issue.

Pre- allotment work

1. Get all application forms from the collecting bankers and sort out valid and invalid application forms.

2. The valid applications are to be categorized and grouped as cash, draft and stock invest applications.

3. Reclassify the valid applications eligible for allotment.

4. Prepare the list with inverted numbers and then approach the regional stock exchange for finalizing the basis of allotment, in the event of over subscription.

5. Finalize the allotments as per the basis approved by the stock exchange.

6. Tally the final list approved for allotment and rejections with the inhouse control numbers and correct mistakes, if any.

Allotment work

The most important work of a registrar is allotment of shares. The system of proportional allotment was adopted for new issues in 1993. A new quota system was approved by SEBI in April, 1995. According to the new system 50% of quota is for small investors and another 50% for other categories. The small investors include all applicants upto 1,000 shares. It has also been revised recently.

Post allotment work

1. Get the letters of allotment and refund orders printed ready for dispatch. They have to be mailed on or before 70 days from the closing date of subscription. For any delay, get the permission of the Registrar of Companies and the relevant stock exchange.

2. Submit all statements to the company for their final approval.

3. Arrange to pay the brokerage and underwriting commission and submit their relevant statements.

4. Assist the company in getting the allotted shares listed on the stock exchange.

Qualifications for Registrars to the issue

To be appointed as Registrar to the issue, registration with SEBI is essential. The criteria adopted by SEBI for registration are the competency and expertise, quality of manpower, their track record, adequacy of infrastructure such as computers, storage space etc. and capital adequacy. A net worth of Rs.6 lakhs is essential for Registrars. SEBI has laid down a code of conduct for their observance. They have to maintain proper books of accounts and registers for a period of three years.

3. Collecting and co-ordinating bankers:

Collecting bankers collect the subscriptions in cash, cheques, stock invest etc.

Co-ordinating bankers collect information on subscriptions and co-ordinate the collection work. They monitor the work and inform it to the registrars and merchant bankers.

Collecting banker and co-ordinating banker may be the same bank or different banks.

4. Underwriters and brokers:

Underwriting is an agreement whereby the underwriter promises to subscribe to a specified number of shares or debentures or a specified amount of stock in the event of public not subscribing to the issue.

Brokers along with the network of sub brokers market the new issues. They send their own circulars and applications to the clients and do follow up work to market the securities.