Has SEBI got this one wrong? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Has SEBI got this one wrong? 

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In this issue:
» UPA's populist tap refuses to turn off
» Why Bill Gross prefers to avoid China?
» Marc Faber's worst fear
» Asian government take central banks' help to come out of the current mess
» ...and more!


00:00
 
In what could be dubbed as an uncharacteristic move, market regulator SEBI has decided to do away with the mandatory grading of Initial Public Offers (IPOs). The grades are typically assigned by rating agencies based on the financial strength of the company and disclosed in the prospectus. However, with grading now becoming voluntary there would be no external watchdog to vouch company financials.

Before deciding whether this move is beneficial or not to retail investors, let us first try and understand SEBI's motto behind it. The primary reason for making grading voluntary is to boost the inactive primary market. As per a consulting firm, SEBI approved IPO mandates worth Rs 720 bn are yet to hit the market. Voluntary grading would reduce regulatory hurdles and expenses incurred to get one-self rated. This would make the listing process hassle free.

However, the most important factor in making the grading process voluntary was to reduce the reliance on external rating agencies. Ratings from these agencies are typically fraught with conflict of interest. Rating agencies get paid by the company whom they rate. Thus, there are chances of their ethics being compromised. We know what happened to the sub-prime mortgage debt that was rated AAA by renowned rating agencies. It was effectively a junk debt which saw a series of defaults later. Hence, reducing the role of such rating agencies in investment decision making was a good move in some sense.

But will excluding them all together do investors good?

We do not think so. Agreed, there are chances that ratings are fraught with conflict of interest. But a grade at least gives investor a sense of comfort. Not having it all together means that companies which have poor financials can easily escape retail investors' eyes. A rating grade made that pretty evident in the first place.

Also, if the regulator feels that conflict of interest is a bigger risk and can mis-guide investors it should look for alternatives to assess the financial quality of companies. Here it is giving them a leeway of eschewing the entire process.

Access to management for such companies is already constrained. By not having someone assess the financial quality the grey area expands. Further, the very rationale of activating the IPO market through voluntary reporting does not seem to gel well with us.

The duty of any regulator is to protect the interest of investors. At the same time it should make sure that the investing environment is healthy. However, we feel that in an effort to bolster the latter, former agenda seems to have been sidelined.

Do you rely on IPO grading to apply to public offers? Let us know your comments or share your views in the Equitymaster Club.

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01:50  Chart of the day
 
Now that the elections are approaching, the Government is trying to woo public with pleasant surprises. The latest surprise came in the energy sector. After a series of price hikes, the prices of compressed natural gas (CNG) and piped natural gas (PNG) are to be slashed by around 30% and 20% respectively. It is to be noted that the gas prices for city gas distribution (CGD) companies have gone up significantly in the last few years due to fall in domestic supplies and higher share of costlier imported gas. However, post the Central Government's decision to meet the full need for CGD through domestic gas, the price curve is likely to take a reverse turn.

But an obvious question is: Where is this supply coming from when domestic gas supply scenario remains broadly unchanged? It is the non priority sectors like steel, refineries and petrochemicals bearing the brunt of reallocation of domestic (excluding NELP) gas. It is their share of domestic gas that will now be diverted for CGD, on a pro rata basis. Well, the best part about this is that the benefits of reallocation will be passed on to the end users. Further, the order to provide same share of domestic gas to all CGD entities at the same base price will help to remove price distortions across different regions as seen in today's chart. Also, the lower prices will aid in further spread of CGD network.

The move may be cheered by the public in the short term. However, it will not help to resolve the issue of shortage of domestic gas supply. Further, post the gas price hike applicable in few months from now, we wonder if the benefit from price cuts will remain.

Average CNG price of city gas distribution companies
#Bhagyanagar Gas Ltd


02:20
 
Do you remember the year when the famous farm loan waiver of Rs 700 bn was provided by the UPA government? 2009, isn't it? And what was so special about this year? Well, it was the year when the country went to elections. Consequently, it won't be too much of a stretch to imagine that the waiver was undertaken with an eye firmly on the elections. Well, its election year again. However, there's no sign of any waiver of any kind just yet. Moreover, given the Government's fiscal health, we won't be surprised if the idea of the waiver has been put to rest. But that doesn't mean the tap of populist measures has been turned off completely. There have been a slew of them in recent times, all in the hope of garnering more votes.

We have had an increase in the number of subsidized cooking gas cylinders and also the implementation of the budget 2013 promise to provide loans to rural women's self help groups at attractive interest rates. Besides granting minority status to a certain community and special education schemes for another minority group can also be construed as means towards pleasing the vote bank. In fact, even financial jugglery has been resorted to. What else explains the hand wringing of PSUs like Coal India for paying out more dividends and also postponing oil subsidy payments? So, while there has been no shortage of effort on the part of the Government to salvage its reputation somehow, we wonder if it's a case of too little too late.

03:00
 
It is not for nothing that investors in Indian markets have been paying more attention to Dr Raghuram Rajan than to Mr Chidambaram. After all, the RBI governor and his predecessors have been doing most of the fire fighting than occupants of the North Block! And it seems this is not the case just with India. Dr Rajan's peers in Japan and China, despite strong and stable political leaderships, appear to be doing the tougher job. As the flow of easy money gets withdrawn by the US, it is the central bankers that are left to clear the mess. As per an article in Reuters, the mandate for central banks has shifted over the years. From just maintaining price and financial stability it is more about shoring up weak economies. For conservative bankers like the RBI, it means keeping a fine balance between stability and growth. And with little help from policymakers, the RBI's job is getting tougher by the day. In the case of aggressive central banks, like Bank of Japan, massive cash injections are doing away the benefits of economic reforms. Thus unless and until governments and central banks commit to working together towards a single goal, Asia's macro economic problems are here to stay.

03:35
 
The slowdown in China has raised questions about how lucrative it is to invest there. Opinions vary and one such is that of Bill Gross, who oversees the world's biggest bond fund at Pimco. According to him, the slowdown in the dragon nation is the biggest risk not only for the Chinese economy but for the whole of the emerging markets. He is of the view that there is too much uncertainty with respect to Chinese growth. No one is sure whether the economy will expand by 5%, 7% or more than that. Not just China, emerging markets themselves have been losing favour among foreign investors.

As the central banks of the developed printed money, most of it found its way into emerging markets on the hopes that growth will be robust there. That has not been happening. Emerging markets have been beset by a slew of problems ranging from high inflation to widening current account deficits. This coupled with the US Fed tapering its bond program has led to a huge outflow of money from these markets. This has hampered exchange rates as well. Indeed, when the world economy slowed down in 2008-09 post the crisis, all hopes were pinned on China to rebalance global growth. But obviously China is not ready to take on such a big responsibility just yet.

04:10
 
Just recently we saw panic sell-offs in emerging markets on the news of the US Fed taper. The flood of cheap money from the West has been one of the major drivers of asset prices in emerging markets. So now if the cheap money slows down, investors are worried that it would have a cascading effect on asset prices, albeit in the opposite direction.

If Mark Faber aka Dr Doom is to be believed, it is not just the Fed taper that is a matter of worry. One of the major reasons for the fast-faced economic growth in the previous decade was soaring asset prices. As per Faber, emerging markets have lost steam now and are not growing much. Moreover, the Chinese slowdown could have far more adverse repercussions than expected.

An interesting point that strikes us is that the world could be at the beginning of 'a vicious circle to the downside'. The thing is that when times are good, the economic growth enters a virtuous cycle. As it is said, money makes more money. But when the tide turns, the exact opposite tends to happen. So is the world heading towards another major financial crisis? Only time will tell...

04:30
 
Indian stock markets have bounced back from day's lows and are trading flat. At the time of writing, the benchmark BSE-Sensex was down by 4 points (0.02%). consumer durables and FMCG stocks were trading weak while Auto and Realty stocks were trading strong. Asian stocks were trading mixed. Japanese stocks were the biggest gainers. The European markets also opened on a mixed note.

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16 Responses to "Has SEBI got this one wrong?"

Sarat Palat

Feb 7, 2014


Stay away from IPO's

Like (1)

josethazhath

Feb 6, 2014

IF POLITICIANS ARE KEPT APART, SEBI MADE A GOOD WORK.

Like (1)

PULIN C BARTHAKUR

Feb 6, 2014

In one sentence, this SEBI move would immediately invoke the analogy of someone resorting to the self-deceiving measure of shaving his entire crop of hair from his head as a way of dealing with a nagging lice infestation.

Like (1)

parimal shah

Feb 6, 2014

I think SEBI's move is the right one.
It is better to be aware that whatever is said is said by the company (may be boasted) rather than being under the false impression that someone has cross-checked the claims/project etc (which in fact are all only on paper in most cases if we go by the recent past). And the valuations are usually goldplated.

Like (1)

Dr. Arun Draviam

Feb 5, 2014

Long before grading of IPOs was introduced, SEBI used to do detailed vetting of the prospectus based on the prospects and risk factors disclosed. Then SEBI agreed to allow management to add its perception with regard to the risk factors. Shameless disclosures started appearing in the prospectus since they could be explained away under the so-called ‘management perception’. More prospectus started coming and SEBI started saying that if nothing adverse was communicated by the SEBI within a certain period the issuers of capital could assume that SEBI has vetted the same. Then started the era of red herring prospectus that are filed with the SEBI and the issue price could be announced just a tad before the opening of the IPO. At this stage grading by credit rating agencies was permitted / insisted. Rating shopping followed, though that was also disclosed. But at least some vetting was done by an independent agency. Now, making grading voluntary in IPO is wrought with serious consequence. In short there will be no vetting of prospectus by an independent or a statutory body like the SEBI. More issues will come as was the case in the early 1990s, when SEBI was learning the tricks of the market. SEBI has learnt enough of the market tricks and it can afford to do the vetting now. It will at the least have a moral suasion upon the issuers that their actions are being overseen by the Regulator. However, SEBI must be having strong reasons for its proposed act. The 5 Minutes Wrap has not brought out that dimension.

Like (1)

Anand

Feb 5, 2014

yes, definitely. Now even junk/bad companies will rate themselves 4-5/5 and after few months/IPO they will get away.

Like (1)

T K DAS

Feb 5, 2014

While credit rating does have its advantages, it is good that credit rating is made optional in asmuch as it saves substantial expenses for the company . Further,there is certainly some conflict of interest as the credit rating agency can make or mar a company that does not reward it well.

Like (1)

S.K.Aggarwal

Feb 5, 2014

Since every investor can not do the research for every public issue so an authentic body should do this & give rating to every public issue. This will help small investors in avoiding bad issues.

Like (1)

SANJAY KR TIWARY

Feb 5, 2014

Its always good to get fair rating by fair rating agencies in the interest of investor. Its pathetic to learn that rating agencies are compromising with their morals. But regulatory is also not far behind, they should have strict restrictions on rating agencies.

Sanjay kr tiwari

Like (1)

K.V.Nayak

Feb 5, 2014

To do away with the mandatory rating of Public IPOs is not at all a wise move. It certainly gives room for a few unscrupulous promoters to fool the public by painting a rosy picture of their financial position,their track record etc.which are very important while investing our hard earned money in their proposed venture. One can give a number of cases where some of the promoters have taken gullible investors for a ride.

Like (1)
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