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BW Businessworld

Column_Do Away With Quotas

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It might be worthwhile to consider what IPO quotas were intended for: to increase retail participation directly as well as via mutual funds, and to reduce the probability of FIIs dominating the issue with their financial muscle. Unlike Indian mutual funds, which usually don’t bid for more than they can pick-up, FIIs do not have such restrictions.
Also, most Indian funds are a fraction of their size. Retail investors applying in their individual capacity would stand no chance at all, in a quota free system.
However, quotas in IPOs, the ultimate celebration of capital market fund raising, seem ridiculous to me. Let’s look at the parts, and then decide about the whole.

Quotas for retail investors in IPOs are like asking for a quota for grandmothers in a bungee-jumping park. The retail investor who is not savvy should stick to funds; the other kind does not need protection much less a quota. This quota helps merchant bankers make an issue look good and creates an artificial appearance of demand. I cannot see it benefiting the mom-and-pop savers in any way. So, to begin with, quotas for retail should be eliminated completely.
A natural query to this conclusion is then: do fund managers need more quotas? To be able to answer that, we need to take a look at the way most IPOs are priced. They owe more to the merchant banker’s imagination and the ability of his team to sell hard, than to any real merits in the pricing.
A quota would make sense if the stock were being made available cheap: i.e., at a substantial discount to what it would go for in the market. Generally, as we all know, IPOs are priced at a substantial premium to what they are really worth: the price of the packaging blended with dreams is added to their net worth.
Most domestic fund managers tend to be able to see through these stories, and temper their optimism with caution. In many IPOs, prudent fund managers prefer to await the listing and buy gradually at a better price, even if they do believe in the fundamental opportunity.
Would a bigger quota help prudent domestic fund managers? I don’t think so.
Lastly, let us look at a situation where that rare cosmic event occurs: the issuer and the merchant banker decide to leave enough on the table for the investor and the price is exceptionally attractive. Merchant bankers are not paid to leave anything on the table for investors. But suppose there is such a situation. I believe a quota-free bidding process would help the investor arrive at a better estimate of the actual demand and the possible upside. Thus, in the interests of market transparency, it may be advisable to do away with quotas.
Looked at dispassionately, the quota system is born of a scarcity mindset: we are unable to create more basic resources and, therefore, we control how this scarce resource is distributed. To my mind, IPO stocks are not essential commodities which have to be rationed.
So, to get back to the point: would higher quotas be needed for mutual fund managers? I think not. In fact, I would go one step further: I would suggest we keep quotas out of IPOs totally.
The author is CEO of JP Morgan. The views expressed by him are his own
(Businessworld Issue 25 Feb-3 Mar 2008)