UNDERWRITING

MODULE VI

Underwriting• Underwriting, as per rule 2(g) of the

Regulations, of SEBI is defined to mean “an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them”.

• A contract by means of which a person gives an assurance to the issuer to the effect that the former would subscribe to the securities offered in the event of non subscription by the person to whom they were offered

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Types of underwriting

• Firm underwriting –– Agreement of subscribe a specific number

of securities, irrespective of the securities being offered to the public

– Out right purchase of securities

– Creates confidence in the mind of public

– Commitment from underwriters even in case of over subscription

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• Sub – underwriting –– Underwriter of an issue enters into a contract

with other underwriters to underwrite a part of securities to be under written

– Generally the large issue is been sub-underwritten

– Two parties – main & sub underwriters– Transfers the risk of main underwriters to the

sub-underwriters– Best suitable if issue is expected to be un

popular• Joint underwriting –

– Underwriting an issue by two or more underwriters

– Pools the available resources – Minimizes the risk– Small underwriters can underwrite the large

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• Syndicate underwriting –– Collectively underwriting the issue of

securities through agreement– Similar to joint underwriting– Corporate that issues the security enters

into an agreement with syndicate not with individual under writers

– Involves two agreements –– Agreement between company and

syndicate of underwriters– Agreement among underwriters stating

rules and regulations– Minimizes the potential risk– Used in risky issue with limited return

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Mechanism of underwriting©

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6Corporate

ent i tyUnder wr iter

Underwriting Agreement

Purchase of securities

Advice

MarketingSale of

securities

PublicStock

Market

Flow of funds

Flow of funds

Benefits \Functions©

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• Adequate funds

• Expert advice

• Enhances goodwill

• Assurance to investor

• Better marketing

• Benefits to buyer of security –advice etc.,

• Minimizes risk

Obstacles • Bashful investors – reserved\shy nature

• Private underwriting & issue

• Lack of specialized institutions

• Unsuccessful corporates

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Underwriter

• The financial institution which enteresinto an agreement with corporate entity to underwrite its securities, become underwriters to an issue

• Underwriters may be –– Financial institutions– Investment banks– Merchant banks– Insurance companies– MFs– NBFIs©

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SEBI guidelines

• Underwriting is optional• Number of underwriters is to be decided

by the issuer• Sub – underwriting needs approval• Registration of underwriters is

mandatory• Underwriters has to follow SEBI rules• Capital adequacy – net worth of Rs. 100

lacs• Underwriting commission has to be paid

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Underwriting commission

• Equity shares –– 2.5% both on amount devolving on

underwriters and amount of securities subscribed by public

• Preference shares and Debentures – both convertible and non convertible– 2.5% on the amount devolving on underwriters

– 1.5% on the amount subscribed by public

• Can be extended on the mutual consent of parties to the contract©

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Underwriting agreement©

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Grey market

• The trade of a security through distribution channels which, while legal, are unofficial, unauthorized, or unintended by the original issuer

• A grey market or gray market also known as parallel market

• It is done through –– Print media– Door to door– post©

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Book building

• Book building is actually a price discovery method.

• In this method, the company doesn't fix up a particular price for the shares, but instead gives a price range, e.g. Rs 80-100.

• When bidding for the shares, investors have to decide at which price they would like to bid for the shares at any price within this range.©

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• Based on the demand and supply of the shares, the final price is fixed.

• The lowest price (Rs 80) is known as the floor price

• The highest price (Rs 100) is known as cap price.

• The price at which the shares are allotted is known as cut off price.

• The entire process begins with the selection of the lead manager, an investment banker whose job is to bring the issue to the public.

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Process of Book Building

• The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'.

• The Issuer specifies the number of securities to be issued and the price band for the bids.

• The Issuer also appoints syndicate members with whom orders are to be placed by the investors.

• The syndicate members input the orders into an 'electronic book'. This process is called 'bidding' and is similar to open auction.

• The book normally remains open for a period of 5 days.

• Bids have to be entered within the specified price band.

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• Bids can be revised by the bidders before the book closes.

• On the close of the book building period, the book runners evaluate the bids on the basis of the demand at various price levels.

• The book runners and the Issuer decide the final price at which the securities shall be issued.

• Generally, the number of shares are fixed, the issue size gets frozen based on the final price per share.

• Allocation of securities is made to the successful bidders. The rest get refund orders.©

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Type of investors

• The retail individual investor (RII) – is an investor who applies for stocks for a value of not more than Rs 100,000. Any bid exceeding this amount is considered in the NII category.

• The non-institutional investor (NII) –are commonly referred to as high net-worth individuals. Each of these categories is allocated a certain percentage of the total issue©

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• Qualified Institutional Buyers (QIBs) –are to be issued not more than 50% of the total issue

• The total allotment to the RII category has to be at least 35% of the total issue.

• RIIs also have an option of applying at the cut-off price. This option is not available to other classes of investors.

• NIIs are to be given at least 15% of the total issue

• Allotment to RIIs and NIIs is made through a proportionate allotment system.

• The allotment to the QIBs is at the discretion of the BRLM.©

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Allotment process• Minimum 15% to individual investor• Minimum 10% to individual investor who have

not participated in book building process• Allotment shall be on the basis of

proportionate basis• In case of under subscription BRLM can issue

at his discretion• Allotment to other categories is at the

discretion of BRLM• Allotment should be made within 15 days• Failing to which should pay 15% p.a interest• Issue must be open for 21 days©

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Thank You