Book Building Process
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Book Building Process
Mukesh Kr. Singh
Introduction To keep pace with the globalization and liberalization process, the government of India was very keen to bring the capital market in line with international practices through gradual deregulation of the economy. It led to liberalization of capital market in the country with more expectations from primary market to meet the growing needs for funds for investment in trade and industry. Therefore, there was a vital need to strengthen the capital market which, it felt, could only be achieved through structural modifications, introducing new mechanism and instruments, and by taking steps for safeguarding the interest of the investors through more disclosures and transparency. As such, an important mechanism named as Book building in the system of initial public offerings (IPOs) was recognized by SEBI in India after having the recommendations of the committee under the chairmanship of Y. H. Malegam in October, 1995. SEBI guidelines recognized book building as an alternative mechanism of pricing. Under this approach, a portion of the issue is reserved for institutional and corporate investors. SEBI guidelines, 1995 defines book building as “a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.” Book building process is a common practice used in most developed countries for marketing a public offer of equity shares of a company. However, book building is a transparent and flexible price discovery method of initial public offerings (IPOs) in which price of securities is fixed by the issuer company along with the Book Running Lead Manager (BRLM) on the basis of feedback received from investors as well as market intermediaries during a certain period.
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Need of Book Building The abolition of the Capital Issue Control Act, 1947 has brought a new era in the primary capital markets in India. Controls over the pricing of the issues, designing and tenure of the capital issues were abolished. The issuers, at present, are free to make the price of the issues. Before establishment of SEBI in 1992, the quality of disclosures in the offer documents was very poor. SEBI has also formulated and prescribed stringent disclosure norms in conformity to global standards. The main drawback of free pricing was the process of pricing of issues. The issue price was determined around 60-70 days before the opening of the issue and the issuer had no clear idea about the market perception of the price determined. The traditional fixed price method of tapping individual investors suffered from two defects: (a) delays in the IPO process and (b) under-pricing of issue. In fixed price method, public offers do not have any flexibility in terms of price as well as number of issues. From experience it can be stated that a majority of the public issues coming through the fixed price method are either under-priced or over-priced. Individual investors (i.e. retail investors), as such, are unable to distinguish good issues from bad one. This is because the issuer Company and the merchant banker as lead manager do not have the exact idea on the fixed pricing of public issues. Thus it is required to find out a new mechanism for fair price discovery and to help the least informed investors. That’s why, Book Building mechanism, a new process of price discovery, has been introduced to overcome this limitation and determine issue price effectively. Public offers in fixed price method involve a pre issue cost of 2-3% and carry the risk of failure if it does not receive 90% of the total subscription. In Book Building such cost and risks can be avoided because the issuer company can withdraw from the market if demand for the security does not exist.
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Malegam Panel’s Recommendations: The introduction of book-building in India in 1995 was on account of the recommendations of an expert committee appointed by SEBI under Chairmanship of YH Malegam “to review the (then) existing disclosure requirements in offer documents.” Two of the terms of reference being “the basis of pricing the issue” and “whether substantial reduction was possible in the time taken for processing applications by SEBI.” The committee has submitted its report with several recommendations and the SEBI accepted the same in November 1995. The book-building route should be open to issuer companies, subject to certain terms and conditions. Some of them are presented below: 1. The option should be available only to issues exceeding Rs. 100 crore; 2. The book-building issuer companies could either reserve the securities for firm allotment or avail themselves of the book-building process; 3. Draft prospectus to be submitted to SEBI could exclude information about the offer price; 4. A book runner to be nominated from among the lead merchant bankers, charged with specific responsibilities and the name is to be submitted to the SEBI’s approval 5. The requirement of 25 percent of the securities to be offered to the public will be continued. There have been several amendments/revisions to the above guidelines; the first one in December 1996 made available the option of book-building to all corporate bodies which were otherwise eligible to make an issue of capital to the public, and in case of under subscription, the spill-over from the public portion could be permitted to the placement area and vice-versa. In 1997, the restriction of the facility to 75 % of the issue was thought to severely constrain the benefits arising out of price and demand discovery, and the facility was extended to 100 percent of the issue, available only if the issue amount was Rs. 100 crore and above, compulsorily offering an additional 10 percent of the issue to the public through prospectus, and reserving at least 15 percent of the issue size to individual investors applying up to ten tradable lots. Further, audited financial ratios had to be disclosed, namely, EPS, P/E, average return on net worth for the last three years and net
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asset value based on last year’s balance sheet. However, there were no takers for the 100 percent book-building facility. Based on suggestions made by leading merchant bankers, the following amendments were made to the guidelines in 1999: 1. The issuer may be allowed to disclose either the issue size or the number of securities to be offered to the public; 2. Allotment should be in demat mode only; and 3. Reservation of 15 percent of issue amount for individual investors need to the public at a fixed price. Some of the earliest mega issues through the book-building route were those of Larsen & Toubro, ICICI, TISCO and others.
Book Building and Fixed Price Option in the IPOs A company may raise capital in the primary capital market through initial public offers (IPOs), rights issues and private placement. IPOs, the largest sources of funds in the primary capital market, to the company are basically an invitation by a company to the public to subscribe to its securities offered through prospectus. In fixed price process in IPOs, allotments of shares to all investors are made on proportionate basis. Institutional investors normally are not interested to participate in fixed price public issues due to uncertainty of allotment and lack of opportunity cost. On the other, they like to participate largely in book built transactions as in this process the costs of public issue and the time taken for the completion of the entire process are much lesser than the fixed price issues. In Book Building the price is determined on the basis of demand received or at price above or equal to the floor price whereas in fixed price option the price of issues is fixed first and then the securities are offered to the investors. In case of Book Building process book is built by Book Runner Lead Manager (BRLM) to know the everyday demand whereas in case of fixed price of public issues, the demand is known at the close of the issue.
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How is Book Built in India? The main parties who are directly associated with book building process are the issuer company, the Book Runner Lead Manager (BRLM) and the syndicate members. The Book Runner Lead Manager (i.e. merchant banker) and the syndicate members who are the intermediaries are both eligible to act as underwriters. The steps which are usually followed in the book building process can be summarized below: 1. The issuer company proposing an IPO appoints a lead merchant banker as a BRLM. 2. Initially, the issuer company consults with the BRLM in drawing up a draft prospectus (i.e. offer document) which does not mention the price of the issues, but includes other details about the size of the issue, past history of the company, and a price band. The securities available to the public are separately identified as “net offer to the public”. 3. The draft prospectus is filed with SEBI which gives it a legal standing. 4. A definite period is fixed as the bid period and BRLM conducts awareness campaigns like advertisement, road shows etc. 5. The BRLM appoints a syndicate member, a SEBI registered intermediary to underwrite the issues to the extent of “net offer to the public”. 6. The BRLM is entitled to remuneration for conducting the Book Building process. 7. The copy of the draft prospectus may be circulated by the BRLM to the institutional investors as well as to the syndicate members. 8. The syndicate members create demand and ask each investor for the number of shares and the offer price. 9. The BRLM receives the feedback about the investor’s bids through syndicate members. 10. The prospective investors may revise their bids at any time during the bid period. 11. The BRLM on receipts of the feedback from the syndicate members about the bid price and the quantity of shares applied has to build up an order book showing the demand for the shares of the company at various prices. The syndicate members must also maintain a record book for orders received from institutional investors for subscribing to the issue out of the placement portion.
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12. On receipts of the above information, the BRLM and the issuer company determine the issue price. This is known as the market-clearing price. 13. The BRLM then closes the book in consultation with the issuer company and determine the issue size of (a) placement portion and (b) public offer portion. 14. Once the final price is determined, the allocation of securities should be made by the BRLM based on prior commitment, investor’s quality, price aggression, earliness of bids etc. The bid of an institutional bidder, even if he has paid full amount may be rejected without being assigned any reason as the Book Building portion of institutional investors is left entirely at the discretion of the issuer company and the BRLM. 15. The Final prospectus is filed with the registrar of companies within 2 days of determination of issue price and receipts of acknowledgement card from SEBI. 16. Two different accounts for collection of application money, one for the private placement portion and the other for the public subscription should be opened by the issuer company. 17. The placement portion is closed a day before the opening of the public issue through fixed price method. The BRLM is required to have the application forms along with the application money from the institutional buyers and the underwriters to the private placement portion. 18. The allotment for the private placement portion shall be made on the 2nd day from the closure of the issue and the private placement portion is ready to be listed. 19. The allotment and listing of issues under the public portion (i.e. fixed price portion) must be as per the existing statutory requirements. 20. Finally, the SEBI has the right to inspect such records and books which are maintained by the BRLM and other intermediaries involved in the Book Building process
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Book Building Process
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Steps involved in Book Building Process: Nominate Book Runner
Form Syndicate of Brokers, Arrangers,Underwriters, Financial Institutions, etc.
Submit Draft Offer Document to SEBI without mentioning Coupon Rate or Price
Circulate offer Document among the Syndicate Members
Ask for Bids on Price and Quality of Securities
Aggregate and forward all offers to Book Runner
Run the Book to maintain a record of Subscribers and their Orders
Consult with Issuer and Determine the issue Price as Weighted Average of the Offers Received
Firm up Underwriting Commitments
Allot Securities Among Syndicate Members
Securities Issued and Listed
Trading Commences on Exchanges
Regulatory Framework The Book Building guidelines were first introduced by SEBI in 1995 (clarification XIII, dated 12.10.95) for optimum price discovery of corporate securities. The SEBI, from time to time modifies the guidelines in order to upgrading the existing mechanism. The SEBI in its press release dated 7th September, 1998 prescribed the fresh guidelines for book building mechanism after thorough modification and it was again modified in 2001(Circular No.2, dated 6.12.2001) and 2003(Circular No. 11, dated 14.08.2003).
Some of the guidelines of SEBI are: 1. In January 2000, SEBI has issued a compendium of guidelines, circulars and instructions to merchant bankers relating to issue of capital, including those on the book-building mechanism. The compendium includes a model time frame for book-building: “After the price has been determined on the basis of bidding, statutory public advertisements for a continuous three days containing, inter alia, the price as well as a table showing the number of securities and the amount payable by an investor, based on the price determined, shall be issued and the interval between the advertisement and issue opening date should be a minimum of five days.” 2. The draft prospectus to be circulated has to indicate the price band within which the securities are being offered for subscription. The bids have to be within the price bands. Bidding is permissible only if an electronically- linked transparent facility is used. An issuing company can also fix a minimum bid size. An initial bid can be changed before the final rate is determined. 3. The Prospective bidders were advised to read the “Red herring prospectus” carefully. According to the Act, a “Red herring prospectus” means a prospectus that does not have complete particulars on the price and the quantum of securities offered. 4. The year 2000, Amendment to the Act gave legal cloak to the book-building route by allowing circulation of the information memorandum and the red herring prospectus. According to the Act, a process is to be undertaken prior to the filing of a prospectus by which a demand for the securities proposed to be issued by a company is elicited, the price and the terms of the issue of such securities are assessed by means of a notice, circular, advertisement or document. Incidentally, the working group on the Comprehensive Companies Bill, 1997 (since lapsed) had advocated introduction of book-building. It defined the term as “an international practice that refers to collecting orders from investment bankers and large investors based on an indicative price range. In capital markets, with sufficient width and depth, such a pre-issue exercise often allows the issue to get a better idea of the demand and the final offer price of an intended public offer.”
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5. SEBI (Disclosure and Investor Protection) Guidelines, 2000 contains provisions for book building under chapter XI that includes guidelines for 75 per cent bookbuilding process, 100 per cent book-building process, disclosure requirements, allocation/allotment procedure and maintenance of books and records. According to the SEBI, a public issue through Book Building route should consist of two portions: (a) The Book Building portion and (b) The fixed price portion. The fixed price portion is conducted like normal public issues (conventionally followed earlier) after the book built portion during which the issue price is fixed after the bid closing date. Basically, an issuer company proposing to issue capital through book building shall comply with the guidelines prescribed by SEBI. However, the main theme of SEBI guidelines regarding book building can be presented at a glance in the following manner:
1. 75% Book Building process: Under this process 25% of the issue is to be sold at a fixed price and the balance 75% through the Book Building process.
TOTAL PUBLIC ISSUE (i.e.net offer to the public)
BOOKBUILDING METHOD
75% of the public issue can be offered to institutional investors who had participated in the bidding process.
FIXED PRICE METHOD
25% of the public issue can be offered to the public through prospectus and shall be reserved for allocation to individual investors who had not participated in the bidding process.
75% Book Building Process
2. Offer to public through Book building process: The process specifies that an issuer company may make an issue of securities to the public through prospectus in the following manner: a. 100% of the net offer to the public through book-building process, or b. 75% of the net offer to the public through book-building process and 25% of the net offer to the public at the price determined through book building process.
100% of the net offer to the public through 100% Book Building process
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75% of the net offer to the public through Book Building process
The net offer to the public, under this process shall be fully underwritten by the syndicate members/book running lead managers. The syndicate members are to enter into an underwritten agreement with the BRLMs indicating the number of securities which they would like to subscribe at the pre-determined price and BRLMs shall in turn enter into an underwritten agreement with the issuer company. If the syndicate members are not able to fulfill their underwritten obligations, the BRLMs shall be responsible for bringing in the amount involved. The bid remains open for at least five days. The date of opening as well as closing of the bidding, the names and addresses of BRLMs, syndicate members, bidding terminals for accepting the bids must be mentioned in the advertisement.
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Recent Changes in Book- Building Mechanism: The Securities and Exchange Board of India on March 29, 2005 announced sweeping changes in the IPO norms. They are as follows: 1. Increased allocation for retail investors in book-built issue from 25 per cent to 35 per cent and has also changed the definition of the retail category. 2. The market regulator has now permitted retail investors to apply for Rs. 1 lakh worth of shares in a book-built issue against Rs. 50,000 earlier. For this purpose, SEBI has redefined the retail individual investor as one who applies or bids for securities of or for a value not exceeding Rs. 1 lakh. 3. It has reduced the non institutional category, popularly known as high net worth individuals (HNI), allocation from 25 per cent to 15 per cent. 4. Institutional investors include foreign financial institutions (FII) banks, mutual funds and Indian financial institutions like LIC or IDBI. 5. The changes have been made in the SEBI (DIP) Guidelines, 2000 on the basis of recommendations made by SEBI’s primary market advisory committee. 6. The new norms will be applicable to all public issues whose draft offers documents are filed with SEBI on or after April 4, 2005. 7. SEBI has decided to reduce the bidding period from the current 5 to 10 days (including holidays) to 3 to 7 working days. 8. It has also provided more flexibility for listed companies to disclose price band/floor price for public issues one day before bid opening. 9. SEBI has decided to give an option to listed issuers to either disclose price band in RHP/application form/abridged prospectus (current practice) or to disclose the price band/ floor price at least one day before bid opening. 10. It is proposed to amend the guidelines to improve contents and ensure uniformity in data display on the
websites of the stock exchanges. The date will be made
available for a further period of three days after the closure of the bids/issue.
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Limitations of Book Building Mechanism Retail investors are not free from certain disadvantages compared to institutional investors in Book Building, which does not provide an appropriate price discovery mechanism. It is the main reason why small investors have stayed away from the market. It needs changes to make it more suitable to the Indian context and the conditions prevailing in the Indian capital market. In the IPOs through the Book-Building route, it would be difficult to find dubious issues of the kind that put off investors. The book-building system has various limitations. Some of them are as are as follows: 1. Book-building is appropriate for mega issues only. In the case of the potential investors, the companies can adjust the attributes of the offer according to the preferences of the potential investors. It may not be possible in big issues since the risk-return preference of the investors cannot be estimated easily; 2. The issuer company should be fundamentally strong and well known to the investors; 3. The book-building system works very efficiently in matured market conditions. In such circumstances, 4. The investors are aware of the various parameters affecting the market price of the securities. But, such conditions are not commonly found in practice; 5. There is a possibility of price rigging on listing as promoters may try to bail out syndicate members.
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Green Shoe Option In most of the cases, it is experienced that IPO through Book Building method in India turns out to be overpriced or underpriced after their listing of them and ultimately the small investors become a net looser. If the IPO is overpriced it creates a bad feeling in investor’s mind as initial returns to them may be negative at that point of time. On the other side, if the prices in the open market fall below the issue price, small investors may start selling their securities to minimize losses. Therefore, there was a vital need of a market stabilizer to smoothen the swings in the open market price of a newly listed share, after an initial public offering. Market stabilization is the mechanism by which stabilizing agent acts on behalf of the issuer company, buys a newly issued security for the limited purpose of preventing a declining in the new security’s open market price in order to facilitate its distribution to the public. It can prevent the IPO from huge price fluctuations and save investors from potential loss. Such mechanism is known as Green Shoe Option (GSO) which is an internationally recognized for market stabilization. So, GSO can rectify the demand and supply imbalances and can stabilize the price of the stock. It owes its origin to the Green Shoe Company which used this option for the first time throughout the World. ICICI Bank has, used Green Shoe Option in first time in case of its public issue through the book building mechanism in India. As such, such important mechanism i.e. GSO in the system of initial public offerings (IPOs) using book building method was recognized by
SEBI
in
India
through
its
new
guidelines
on
14.08.2003
(vide
SEBI/CFD/DIL/DIP/Circular No.11). In case an initial public offer of equity shares is made by an issuer company through the book building mechanism, the Green Shoe option (GSO) can be used by such company for stabilizing the post listing price of its shares, subject to the guidelines prescribed by SEBI. According to SEBI guidelines, “a company desirous of availing the GSO shall in the resolution of the general meeting authorizing the public issue, seek authorization also for the possibility of allotment of further shares to the ‘stabilizing agent’ (SA). The company shall appoint one of the lead book runners, amongst the issue management team, as the “stabilizing agent” (SA), who will be responsible for the price stabilization process, if required. The SA shall enter into an agreement with the issuer company, prior to filing of
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offer document with SEBI, clearly stating all the terms and conditions relating to this option including fees charged / expenses to be incurred by SA for this purpose. The SA shall also enter into an agreement with the promoter(s) who will lend their shares, specifying the maximum number of shares that may be borrowed from the promoters, which shall not be in excess of 15% of the total issue size. The stabilization mechanism shall be available for the period disclosed by the company in the prospectus, which shall not exceed 30 days from the date when trading permission was given by the exchange(s)”.
Conclusion Book Building process aims at fair pricing of the issue which is supposed to emerge out of offers made by various investors. One question may arise whether book b uilding is the right mechanism for fair pricing discovery in IPOs? The answer may be in the negative because a floor price is fixed for the Book Building below which no bid can be accepted. Since investors participate through Book Building process in making fair pricing of IPOs where there is no ceiling price, there should not be any floor price. In addition to this, unlike international market, India has not reached the stage of development of the institutional framework to experiment with the book building process because retail investors (i.e. individual investors) are still now an integral part of Indian capital market. If the interests of the small investors are not safeguarded appropriately, this may be very dangerous to the primary capital market. Although only two book built issues — Hughes software and HCL Technologies have given proper returns to the shareholders in 1999 and Maruti Udyog in 2003 but the other four book built issues of Shree Rama Multitech, Cadila, Cinevista and Mascot system were trading at huge discounts to their issue price ranging between 35-50%.
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Mukesh Kr. Singh
Introduction To keep pace with the globalization and liberalization process, the government of India was very keen to bring the capital market in line with international practices through gradual deregulation of the economy. It led to liberalization of capital market in the country with more expectations from primary market to meet the growing needs for funds for investment in trade and industry. Therefore, there was a vital need to strengthen the capital market which, it felt, could only be achieved through structural modifications, introducing new mechanism and instruments, and by taking steps for safeguarding the interest of the investors through more disclosures and transparency. As such, an important mechanism named as Book building in the system of initial public offerings (IPOs) was recognized by SEBI in India after having the recommendations of the committee under the chairmanship of Y. H. Malegam in October, 1995. SEBI guidelines recognized book building as an alternative mechanism of pricing. Under this approach, a portion of the issue is reserved for institutional and corporate investors. SEBI guidelines, 1995 defines book building as “a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document.” Book building process is a common practice used in most developed countries for marketing a public offer of equity shares of a company. However, book building is a transparent and flexible price discovery method of initial public offerings (IPOs) in which price of securities is fixed by the issuer company along with the Book Running Lead Manager (BRLM) on the basis of feedback received from investors as well as market intermediaries during a certain period.
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Need of Book Building The abolition of the Capital Issue Control Act, 1947 has brought a new era in the primary capital markets in India. Controls over the pricing of the issues, designing and tenure of the capital issues were abolished. The issuers, at present, are free to make the price of the issues. Before establishment of SEBI in 1992, the quality of disclosures in the offer documents was very poor. SEBI has also formulated and prescribed stringent disclosure norms in conformity to global standards. The main drawback of free pricing was the process of pricing of issues. The issue price was determined around 60-70 days before the opening of the issue and the issuer had no clear idea about the market perception of the price determined. The traditional fixed price method of tapping individual investors suffered from two defects: (a) delays in the IPO process and (b) under-pricing of issue. In fixed price method, public offers do not have any flexibility in terms of price as well as number of issues. From experience it can be stated that a majority of the public issues coming through the fixed price method are either under-priced or over-priced. Individual investors (i.e. retail investors), as such, are unable to distinguish good issues from bad one. This is because the issuer Company and the merchant banker as lead manager do not have the exact idea on the fixed pricing of public issues. Thus it is required to find out a new mechanism for fair price discovery and to help the least informed investors. That’s why, Book Building mechanism, a new process of price discovery, has been introduced to overcome this limitation and determine issue price effectively. Public offers in fixed price method involve a pre issue cost of 2-3% and carry the risk of failure if it does not receive 90% of the total subscription. In Book Building such cost and risks can be avoided because the issuer company can withdraw from the market if demand for the security does not exist.
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Malegam Panel’s Recommendations: The introduction of book-building in India in 1995 was on account of the recommendations of an expert committee appointed by SEBI under Chairmanship of YH Malegam “to review the (then) existing disclosure requirements in offer documents.” Two of the terms of reference being “the basis of pricing the issue” and “whether substantial reduction was possible in the time taken for processing applications by SEBI.” The committee has submitted its report with several recommendations and the SEBI accepted the same in November 1995. The book-building route should be open to issuer companies, subject to certain terms and conditions. Some of them are presented below: 1. The option should be available only to issues exceeding Rs. 100 crore; 2. The book-building issuer companies could either reserve the securities for firm allotment or avail themselves of the book-building process; 3. Draft prospectus to be submitted to SEBI could exclude information about the offer price; 4. A book runner to be nominated from among the lead merchant bankers, charged with specific responsibilities and the name is to be submitted to the SEBI’s approval 5. The requirement of 25 percent of the securities to be offered to the public will be continued. There have been several amendments/revisions to the above guidelines; the first one in December 1996 made available the option of book-building to all corporate bodies which were otherwise eligible to make an issue of capital to the public, and in case of under subscription, the spill-over from the public portion could be permitted to the placement area and vice-versa. In 1997, the restriction of the facility to 75 % of the issue was thought to severely constrain the benefits arising out of price and demand discovery, and the facility was extended to 100 percent of the issue, available only if the issue amount was Rs. 100 crore and above, compulsorily offering an additional 10 percent of the issue to the public through prospectus, and reserving at least 15 percent of the issue size to individual investors applying up to ten tradable lots. Further, audited financial ratios had to be disclosed, namely, EPS, P/E, average return on net worth for the last three years and net
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asset value based on last year’s balance sheet. However, there were no takers for the 100 percent book-building facility. Based on suggestions made by leading merchant bankers, the following amendments were made to the guidelines in 1999: 1. The issuer may be allowed to disclose either the issue size or the number of securities to be offered to the public; 2. Allotment should be in demat mode only; and 3. Reservation of 15 percent of issue amount for individual investors need to the public at a fixed price. Some of the earliest mega issues through the book-building route were those of Larsen & Toubro, ICICI, TISCO and others.
Book Building and Fixed Price Option in the IPOs A company may raise capital in the primary capital market through initial public offers (IPOs), rights issues and private placement. IPOs, the largest sources of funds in the primary capital market, to the company are basically an invitation by a company to the public to subscribe to its securities offered through prospectus. In fixed price process in IPOs, allotments of shares to all investors are made on proportionate basis. Institutional investors normally are not interested to participate in fixed price public issues due to uncertainty of allotment and lack of opportunity cost. On the other, they like to participate largely in book built transactions as in this process the costs of public issue and the time taken for the completion of the entire process are much lesser than the fixed price issues. In Book Building the price is determined on the basis of demand received or at price above or equal to the floor price whereas in fixed price option the price of issues is fixed first and then the securities are offered to the investors. In case of Book Building process book is built by Book Runner Lead Manager (BRLM) to know the everyday demand whereas in case of fixed price of public issues, the demand is known at the close of the issue.
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How is Book Built in India? The main parties who are directly associated with book building process are the issuer company, the Book Runner Lead Manager (BRLM) and the syndicate members. The Book Runner Lead Manager (i.e. merchant banker) and the syndicate members who are the intermediaries are both eligible to act as underwriters. The steps which are usually followed in the book building process can be summarized below: 1. The issuer company proposing an IPO appoints a lead merchant banker as a BRLM. 2. Initially, the issuer company consults with the BRLM in drawing up a draft prospectus (i.e. offer document) which does not mention the price of the issues, but includes other details about the size of the issue, past history of the company, and a price band. The securities available to the public are separately identified as “net offer to the public”. 3. The draft prospectus is filed with SEBI which gives it a legal standing. 4. A definite period is fixed as the bid period and BRLM conducts awareness campaigns like advertisement, road shows etc. 5. The BRLM appoints a syndicate member, a SEBI registered intermediary to underwrite the issues to the extent of “net offer to the public”. 6. The BRLM is entitled to remuneration for conducting the Book Building process. 7. The copy of the draft prospectus may be circulated by the BRLM to the institutional investors as well as to the syndicate members. 8. The syndicate members create demand and ask each investor for the number of shares and the offer price. 9. The BRLM receives the feedback about the investor’s bids through syndicate members. 10. The prospective investors may revise their bids at any time during the bid period. 11. The BRLM on receipts of the feedback from the syndicate members about the bid price and the quantity of shares applied has to build up an order book showing the demand for the shares of the company at various prices. The syndicate members must also maintain a record book for orders received from institutional investors for subscribing to the issue out of the placement portion.
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12. On receipts of the above information, the BRLM and the issuer company determine the issue price. This is known as the market-clearing price. 13. The BRLM then closes the book in consultation with the issuer company and determine the issue size of (a) placement portion and (b) public offer portion. 14. Once the final price is determined, the allocation of securities should be made by the BRLM based on prior commitment, investor’s quality, price aggression, earliness of bids etc. The bid of an institutional bidder, even if he has paid full amount may be rejected without being assigned any reason as the Book Building portion of institutional investors is left entirely at the discretion of the issuer company and the BRLM. 15. The Final prospectus is filed with the registrar of companies within 2 days of determination of issue price and receipts of acknowledgement card from SEBI. 16. Two different accounts for collection of application money, one for the private placement portion and the other for the public subscription should be opened by the issuer company. 17. The placement portion is closed a day before the opening of the public issue through fixed price method. The BRLM is required to have the application forms along with the application money from the institutional buyers and the underwriters to the private placement portion. 18. The allotment for the private placement portion shall be made on the 2nd day from the closure of the issue and the private placement portion is ready to be listed. 19. The allotment and listing of issues under the public portion (i.e. fixed price portion) must be as per the existing statutory requirements. 20. Finally, the SEBI has the right to inspect such records and books which are maintained by the BRLM and other intermediaries involved in the Book Building process
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Book Building Process
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Steps involved in Book Building Process: Nominate Book Runner
Form Syndicate of Brokers, Arrangers,Underwriters, Financial Institutions, etc.
Submit Draft Offer Document to SEBI without mentioning Coupon Rate or Price
Circulate offer Document among the Syndicate Members
Ask for Bids on Price and Quality of Securities
Aggregate and forward all offers to Book Runner
Run the Book to maintain a record of Subscribers and their Orders
Consult with Issuer and Determine the issue Price as Weighted Average of the Offers Received
Firm up Underwriting Commitments
Allot Securities Among Syndicate Members
Securities Issued and Listed
Trading Commences on Exchanges
Regulatory Framework The Book Building guidelines were first introduced by SEBI in 1995 (clarification XIII, dated 12.10.95) for optimum price discovery of corporate securities. The SEBI, from time to time modifies the guidelines in order to upgrading the existing mechanism. The SEBI in its press release dated 7th September, 1998 prescribed the fresh guidelines for book building mechanism after thorough modification and it was again modified in 2001(Circular No.2, dated 6.12.2001) and 2003(Circular No. 11, dated 14.08.2003).
Some of the guidelines of SEBI are: 1. In January 2000, SEBI has issued a compendium of guidelines, circulars and instructions to merchant bankers relating to issue of capital, including those on the book-building mechanism. The compendium includes a model time frame for book-building: “After the price has been determined on the basis of bidding, statutory public advertisements for a continuous three days containing, inter alia, the price as well as a table showing the number of securities and the amount payable by an investor, based on the price determined, shall be issued and the interval between the advertisement and issue opening date should be a minimum of five days.” 2. The draft prospectus to be circulated has to indicate the price band within which the securities are being offered for subscription. The bids have to be within the price bands. Bidding is permissible only if an electronically- linked transparent facility is used. An issuing company can also fix a minimum bid size. An initial bid can be changed before the final rate is determined. 3. The Prospective bidders were advised to read the “Red herring prospectus” carefully. According to the Act, a “Red herring prospectus” means a prospectus that does not have complete particulars on the price and the quantum of securities offered. 4. The year 2000, Amendment to the Act gave legal cloak to the book-building route by allowing circulation of the information memorandum and the red herring prospectus. According to the Act, a process is to be undertaken prior to the filing of a prospectus by which a demand for the securities proposed to be issued by a company is elicited, the price and the terms of the issue of such securities are assessed by means of a notice, circular, advertisement or document. Incidentally, the working group on the Comprehensive Companies Bill, 1997 (since lapsed) had advocated introduction of book-building. It defined the term as “an international practice that refers to collecting orders from investment bankers and large investors based on an indicative price range. In capital markets, with sufficient width and depth, such a pre-issue exercise often allows the issue to get a better idea of the demand and the final offer price of an intended public offer.”
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5. SEBI (Disclosure and Investor Protection) Guidelines, 2000 contains provisions for book building under chapter XI that includes guidelines for 75 per cent bookbuilding process, 100 per cent book-building process, disclosure requirements, allocation/allotment procedure and maintenance of books and records. According to the SEBI, a public issue through Book Building route should consist of two portions: (a) The Book Building portion and (b) The fixed price portion. The fixed price portion is conducted like normal public issues (conventionally followed earlier) after the book built portion during which the issue price is fixed after the bid closing date. Basically, an issuer company proposing to issue capital through book building shall comply with the guidelines prescribed by SEBI. However, the main theme of SEBI guidelines regarding book building can be presented at a glance in the following manner:
1. 75% Book Building process: Under this process 25% of the issue is to be sold at a fixed price and the balance 75% through the Book Building process.
TOTAL PUBLIC ISSUE (i.e.net offer to the public)
BOOKBUILDING METHOD
75% of the public issue can be offered to institutional investors who had participated in the bidding process.
FIXED PRICE METHOD
25% of the public issue can be offered to the public through prospectus and shall be reserved for allocation to individual investors who had not participated in the bidding process.
75% Book Building Process
2. Offer to public through Book building process: The process specifies that an issuer company may make an issue of securities to the public through prospectus in the following manner: a. 100% of the net offer to the public through book-building process, or b. 75% of the net offer to the public through book-building process and 25% of the net offer to the public at the price determined through book building process.
100% of the net offer to the public through 100% Book Building process
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75% of the net offer to the public through Book Building process
The net offer to the public, under this process shall be fully underwritten by the syndicate members/book running lead managers. The syndicate members are to enter into an underwritten agreement with the BRLMs indicating the number of securities which they would like to subscribe at the pre-determined price and BRLMs shall in turn enter into an underwritten agreement with the issuer company. If the syndicate members are not able to fulfill their underwritten obligations, the BRLMs shall be responsible for bringing in the amount involved. The bid remains open for at least five days. The date of opening as well as closing of the bidding, the names and addresses of BRLMs, syndicate members, bidding terminals for accepting the bids must be mentioned in the advertisement.
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Recent Changes in Book- Building Mechanism: The Securities and Exchange Board of India on March 29, 2005 announced sweeping changes in the IPO norms. They are as follows: 1. Increased allocation for retail investors in book-built issue from 25 per cent to 35 per cent and has also changed the definition of the retail category. 2. The market regulator has now permitted retail investors to apply for Rs. 1 lakh worth of shares in a book-built issue against Rs. 50,000 earlier. For this purpose, SEBI has redefined the retail individual investor as one who applies or bids for securities of or for a value not exceeding Rs. 1 lakh. 3. It has reduced the non institutional category, popularly known as high net worth individuals (HNI), allocation from 25 per cent to 15 per cent. 4. Institutional investors include foreign financial institutions (FII) banks, mutual funds and Indian financial institutions like LIC or IDBI. 5. The changes have been made in the SEBI (DIP) Guidelines, 2000 on the basis of recommendations made by SEBI’s primary market advisory committee. 6. The new norms will be applicable to all public issues whose draft offers documents are filed with SEBI on or after April 4, 2005. 7. SEBI has decided to reduce the bidding period from the current 5 to 10 days (including holidays) to 3 to 7 working days. 8. It has also provided more flexibility for listed companies to disclose price band/floor price for public issues one day before bid opening. 9. SEBI has decided to give an option to listed issuers to either disclose price band in RHP/application form/abridged prospectus (current practice) or to disclose the price band/ floor price at least one day before bid opening. 10. It is proposed to amend the guidelines to improve contents and ensure uniformity in data display on the
websites of the stock exchanges. The date will be made
available for a further period of three days after the closure of the bids/issue.
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Limitations of Book Building Mechanism Retail investors are not free from certain disadvantages compared to institutional investors in Book Building, which does not provide an appropriate price discovery mechanism. It is the main reason why small investors have stayed away from the market. It needs changes to make it more suitable to the Indian context and the conditions prevailing in the Indian capital market. In the IPOs through the Book-Building route, it would be difficult to find dubious issues of the kind that put off investors. The book-building system has various limitations. Some of them are as are as follows: 1. Book-building is appropriate for mega issues only. In the case of the potential investors, the companies can adjust the attributes of the offer according to the preferences of the potential investors. It may not be possible in big issues since the risk-return preference of the investors cannot be estimated easily; 2. The issuer company should be fundamentally strong and well known to the investors; 3. The book-building system works very efficiently in matured market conditions. In such circumstances, 4. The investors are aware of the various parameters affecting the market price of the securities. But, such conditions are not commonly found in practice; 5. There is a possibility of price rigging on listing as promoters may try to bail out syndicate members.
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Green Shoe Option In most of the cases, it is experienced that IPO through Book Building method in India turns out to be overpriced or underpriced after their listing of them and ultimately the small investors become a net looser. If the IPO is overpriced it creates a bad feeling in investor’s mind as initial returns to them may be negative at that point of time. On the other side, if the prices in the open market fall below the issue price, small investors may start selling their securities to minimize losses. Therefore, there was a vital need of a market stabilizer to smoothen the swings in the open market price of a newly listed share, after an initial public offering. Market stabilization is the mechanism by which stabilizing agent acts on behalf of the issuer company, buys a newly issued security for the limited purpose of preventing a declining in the new security’s open market price in order to facilitate its distribution to the public. It can prevent the IPO from huge price fluctuations and save investors from potential loss. Such mechanism is known as Green Shoe Option (GSO) which is an internationally recognized for market stabilization. So, GSO can rectify the demand and supply imbalances and can stabilize the price of the stock. It owes its origin to the Green Shoe Company which used this option for the first time throughout the World. ICICI Bank has, used Green Shoe Option in first time in case of its public issue through the book building mechanism in India. As such, such important mechanism i.e. GSO in the system of initial public offerings (IPOs) using book building method was recognized by
SEBI
in
India
through
its
new
guidelines
on
14.08.2003
(vide
SEBI/CFD/DIL/DIP/Circular No.11). In case an initial public offer of equity shares is made by an issuer company through the book building mechanism, the Green Shoe option (GSO) can be used by such company for stabilizing the post listing price of its shares, subject to the guidelines prescribed by SEBI. According to SEBI guidelines, “a company desirous of availing the GSO shall in the resolution of the general meeting authorizing the public issue, seek authorization also for the possibility of allotment of further shares to the ‘stabilizing agent’ (SA). The company shall appoint one of the lead book runners, amongst the issue management team, as the “stabilizing agent” (SA), who will be responsible for the price stabilization process, if required. The SA shall enter into an agreement with the issuer company, prior to filing of
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offer document with SEBI, clearly stating all the terms and conditions relating to this option including fees charged / expenses to be incurred by SA for this purpose. The SA shall also enter into an agreement with the promoter(s) who will lend their shares, specifying the maximum number of shares that may be borrowed from the promoters, which shall not be in excess of 15% of the total issue size. The stabilization mechanism shall be available for the period disclosed by the company in the prospectus, which shall not exceed 30 days from the date when trading permission was given by the exchange(s)”.
Conclusion Book Building process aims at fair pricing of the issue which is supposed to emerge out of offers made by various investors. One question may arise whether book b uilding is the right mechanism for fair pricing discovery in IPOs? The answer may be in the negative because a floor price is fixed for the Book Building below which no bid can be accepted. Since investors participate through Book Building process in making fair pricing of IPOs where there is no ceiling price, there should not be any floor price. In addition to this, unlike international market, India has not reached the stage of development of the institutional framework to experiment with the book building process because retail investors (i.e. individual investors) are still now an integral part of Indian capital market. If the interests of the small investors are not safeguarded appropriately, this may be very dangerous to the primary capital market. Although only two book built issues — Hughes software and HCL Technologies have given proper returns to the shareholders in 1999 and Maruti Udyog in 2003 but the other four book built issues of Shree Rama Multitech, Cadila, Cinevista and Mascot system were trading at huge discounts to their issue price ranging between 35-50%.
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