Stock market task force to propose sweeping reforms to public issue rules

A task force on the country's capital market reforms is set to deliver a series of recommendations aimed at overhauling public issue rules to attract good companies to the stock market and enhance its depth.

One of the crucial proposals from the committee will be to make stock exchanges responsible for ensuring the due diligence of initial public offering (IPO) proposals. Under the new guidelines, the regulator will not approve IPO proposals if the stock exchanges deem them unfit for public listing, sources close to the task force said.

Reforming public issue rules has long been a demand from market stakeholders and operators, who say that the current book building method discourages many reputable companies, including multinational ones, from going public as it lacks proper valuation mechanism.

The task force will also recommend the restoration of direct listing on a case to case basis for large multinational and local private businesses so that a minimum 10 per cent shares can be floated.

New Valuation Approach

Under the task force's plan, issuer companies and issue manager jointly would set an indicative price based on their own valuation, allowing eligible investors (EIs) to bid above or below this benchmark.

The EIs will be allotted shares at their respective prices they bid for and the cut-off price will be the value at which the allocation for EIs would be exhausted.

The task force is also considering a provision allowing EIs to bid below the indicative price. This provision would be activated in cases where a majority of investors express a preference for acquiring shares at a lower price.

Currently, eligible investors are allowed to bid for up to 2 per cent of the bid offer. The task force will recommend reducing this allocation to 1 per cent to allow for greater participation from a wider range of investors.

There will also be a lock-in period of three months for 50 per cent shares of the EIs, so that they take a proper judgment call while quoting.

A member of the task force, who declined to be named, explained that the proposed changes would allow for better valuation of IPO shares while curbing the influence of EIs in setting abnormally high prices.

"The issuer company will have the freedom to fix an indicative price based on proper valuation," said the task force member.

Presently, general investors receive shares at a discounted rate below the cut-off price. However, the task force is against offering any discounts to general investors, which means they should purchase shares at the cut-off price set during the public offering.

In this regard, a task force member said such price is a justified one and the discount would deprive the issuer company of its due benefit.

Under the existing Dutch-auction valuation process of the book building method, a company's valuation is determined on the basis of its 'fair value'.

The fair value is derived from a company's five-year weighted average earnings per share (EPS) multiplied by 10, combined with its net asset value per share (NAVPS).

But the company's fundamentals are not reflected in such valuation process because of the regulatory practices and bad intentions of many bidders.

Considering this value as indicative price, the eligible investors are allowed to bid up to 1.2 times the fair value, and the cut-off price, at which the shares are issued, remains between the face value and the highest bid cap.

Talking to the FE, an issue manager said the existing valuation method does not work properly as maximum bidders try to fix an indicative price at the upper end.

Secondly, the valuation based on fair value does not help even a fundamentally strong company to get a proper price for shares.

For example, a non-listed multinational company earns hefty profits every year. As it distributes good cash dividends, the company's NAV does not increase significantly. As the company's NAV remains static, its IPO valuation will remain inadequate under the existing method.

Md. Moniruzzaman, managing director of Prime Bank Securities, said presently there are two major hurdles in the listing process.

"We are proposing the market-based pricing of IPOs. No valuation formula is to be given by the regulator. Valuation is rather an art, not a science," said Moniruzzaman, also a member of the focus group of the task force.

Streamlined Timelines and Flexibility

The task force also aims to accelerate the IPO process, recommending a maximum six-month window from proposal submission to debut trading -- aligning with regional norms, where timelines range from three to six months.

The task force member cited the chairman of the Colombo Stock Exchange, who recently visited the securities regulator, noting that it takes six weeks in Sri Lanka to start debut trading.

Additional flexibility is proposed for private placement shares.

Under existing rules, issuers are not allowed to issue private placement shares within two years of an IPO proposal. However, the task force is in favour of allowing such private placements, subject to a three-year lock-in period, similar to that imposed on sponsor shareholders.

Meanwhile, IPO bidders would be allowed to offload 50 per cent of their holdings on debut trading day, and the remaining 50 per cent within the next three months.

The objective of offloading 50 per cent holdings by EIs after the debut trading is to see whether the market-driven prices justify the IPO valuation.

Strengthening Market Integrity

To enhance oversight, the task force will propose eligibility criteria for underwriters, who must have liquid assets along with a credit line. The credit line means an unused credit facility within a limit offered by any bank.

Also, auditors appointed by the issuer company must meet defined 'fit and proper' criteria, with a separate panel of special auditors to be established.

Targeting Large-Cap Listings

A large number of small-cap companies having weak fundamentals is one of the major reasons behind the volatility in the equity market.

To reduce the volatility, the task force will suggest the listing of large-cap companies.

The committee will recommend setting minimum pre-IPO capital requirements: Tk 300 million under the fixed-price method and Tk 500 million under the book-building method.

Presently, the minimum pre-IPO paid-up capital is Tk 150 million under the fixed price method while the amount is Tk 300 million under the book building method.

Cost-Cutting and Investor Access

In an effort to lower the costs associated with public offerings, the task force will recommends eliminating physical IPO roadshows. Instead, these roadshows would be held online between IPO approval and price discovery.

Finally, the committee suggests reducing the private offer allocation for employees of the issuer company from 15 per cent to 5 per cent, freeing up more shares for general investors.

Strengthening the bourse

Presently, the BSEC approves the IPO proposals following fulfillment of different requirements.

Before the approval, the stock exchanges are allowed to submit observations on the IPO proposals to the securities regulator.

But the bourses, especially Dhaka Stock Exchange (DSE), many times expressed its dissatisfaction over the regulator's non-cooperation in giving their observations due importance and it ultimately resulted in standoff with the regulator.

Bypassing the DSE's observation, the securities regulator previously approved some IPO proposals, which ultimately caused harm to general investors.

For example, the DSE board members had requested the securities regulator not to approve the IPO proposal of Ring Shine Textiles whose owners eventually fled the country, leaving general investors at bay.

The recommendations of the task force would include a provision of transferring the responsibility of scrutinising IPO proposals to the stock exchanges.

"The BSEC only will approve the IPO proposals on completion of relevant works in association with the issue manager," said a task force member.

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