Has SEBI got this one wrong?

Feb 5, 2014

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!

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.

--- Advertisement ---
3 "Rare" Small Caps That Pay Regular Dividends Too...

Finding Strong Small Cap businesses that are selling at a low price is a tough task.

And finding Strong Small Caps that pay out Regular Dividends too is in fact... "Rare".

However today, we have 3 such "Rare" Small Caps you could BUY today.

And we've published full information on these 3 in our Latest Special Report...

Steady Income Small Caps - II.

And you can claim your copy of this Special Report Right Away!

Just click here for full details...

 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

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.

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.

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.

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...

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.

 Today's investing mantra
"Wishing makes dreams come true only in Disney movies; it's poison in business"- Warren Buffett

Today's Premium Edition.

Humans or systems: Who should you trust?

System based investing has really caught on in recent times. But is it any better than what humans do?
Read On...Get Access

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Has SEBI got this one wrong?". Click here!

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

K Sujatha

Feb 5, 2014

Yes, grading is required for knowing the health of such company and investor comfort to apply in such IPO/FPOs.

SEBI should also look at calling for all documentary proofs prior to giving approval to launch for IPO/FPOs, as well cross check for last 3 to 4 years records filed with respective ROCs for authenticity by these companies rather than allow another Satyam to happen again which impacts over all market image


R K Gogate

Feb 5, 2014

Yes. I do note the ratings over and above the general info gathered thro magazine articles



Feb 5, 2014

Has any one giving AAA grade to junk IPOs been punished.
Is there any provision for penalising false grading by self promotion. Unless these two areas get attention we will continue to see "South sea bubbles";
How does PWC continue merrily after Satyam fiasco?


N Nagaraja rao

Feb 5, 2014

With voluntary grading in effect there can be a boom in the primary market and the government will have something to showcase before the elections or raise election expenses.It is the case of a drowning man clinging to a straw



Feb 5, 2014

The CNG decision to to give 100% of city domestic and public transportation demand is in line with a supreme court court decision. So not correct to term it an election sop



Feb 5, 2014

I think SEBI should involve the rating agencies directly to rate such IPOs. SEBI can cover the expenses by receiving it from the company itself as part of IPO/document charges.

Equitymaster requests your view! Post a comment on "Has SEBI got this one wrong?". Click here!