GRADING OF INITIAL PUBLIC OFFER

[Mr. M. GOVINDARAJAN]

     A company can raise fund from the public by means of debt instruments, debentures, equity shares etc., up to the limit of authorized capital.  People invest their hard earned money in such ways expecting for a definite return.  In investing the money they have to consider the various factors of the company about its credit worthiness.  Credit rating is made compulsory in case of debenture issue, debt instruments etc.,  Credit rating, in general sense, is the evaluation of the credit worthiness of an individual or of a business concern or of an instrument of a business based on relevant factors indicating ability and willingness to pay obligations as well as net worth.  Credit ratings establish a link between risk and return.  An investor or any other interested person uses the rating to assess the risk level and compares the offered rate of return with the expected rate of return.  It is also benefiting the industry as a whole in terms of direct mobilization of savings from individuals.

     Credit rating does not bound the investor to decide whether to hold or sell an instrument as it does not take into consideration factors such as market prices, personal risk preferences and other consideration which may influence an investment decision.   It does not create any fiduciary relationship between the rating agency and the user of rating.   A credit rating does not perform the functions of an audit but relies on information provided by the issuer and collected by the analysis from different sources hence it does not guarantee the completeness or accuracy of the information on which the rating is based.

     Initial public offer is common now a days but the issue is less now due to financial crunch prevailing not only in India but also in other parts of the world.   Initial public offer fetches a company a considerable quantum of capital from the public.   The issuer is having right to fix the premium rate on his own and there is no control on fixing the premium rate.   The SEBI regulations made the issuer to disclose all the information to the investors.  The credit rating was not made applicable to Initial public offer.   Thereafter option was given to the investors to grade their initial public offer rated by credit rating agencies.   Now it is made mandatory to incorporate the grading of Initial public offer in the offer documents.   The grading of IPO made by the agencies will be helpful for the investors to make a decision.

     IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI to the initial public offering of equity shares or any other security which may be converted into or exchanged with equity shares at a later date.  The grade represents a relative assessment of the fundamentals of that issue in relation to the other listed equity shares in India.   The grading is on a five point scale as detailed below:

·        IPO Grade 1 - Poor fundamentals;

·        IPO Grade 2 - Below Average fundamentals;

·        IPO Grade 3 - Average fundamentals;

·        IPO Grade 4 - Above average fundamentals;

·        IPO Grade 5 -Strong fundamentals.

The issuer is at liberty to do the grading of IPO either before filing the draft offer documents with SEBI or thereafter.  The company desirous of making the IPO is required to bear the expenses incurred for grading an IPO.  Any issuer who decides to offer shares through an IPO, is required to obtain a grade for the IPOs from at least one Credit Rating Agency.

     Grading done by Credit Rating Agency cannot be rejected irrespective of the fact whether the issuer finds the grade given is acceptable or not.   The grade has to be disclosed as required as required under SEBI DIP Guidelines.  If the issuer is not satisfied with the grade he has the option of opting another grading by a different agency.  In such an event all grades obtained for the IPO will have to be disclosed in the offer documents, advertisements etc.,

     IPO grading is not expected to delay the process of initial public offer.  While assigning grade  the Agency is expected to take into account the prospects of the industry in which the company operates, the competitive strengths of the company that would allow it to address the risk inherent in the business and capitalize on the opportunities available, as well as the company's financial position.

     While the actual factors considered for grading may not be identical or limited to the following, the areas listed below are generally looked into by the rating agencies:

·        Business prospects and competitive position

§         Industry prospects;

§         Company prospects.

·        Financial position;

·        Management quality;

·        Corporate Governance Practices;

·        Compliance and litigation history;

·        New projects - risks and prospects,

It is to be noted here that IPO grading is done without taking into account the price at which the security is offered.  Therefore the investor is needed to make an independent judgment regarding the price at which to bid for or subscribe to the shares offered through the IPO.

     SEBI does not play any role in the assessment made by the grading agency.  The grading is intended to be an independent and unbiased opinion of that agency.   All grades obtained for the IPO along with a description of the grades can be found in the prospectus, abridged prospectus, issue advertisement or any other place where the issuer company is making its advertisement for its issue.  The grading letter of the Credit Rating Agency which contains the detailed rationale for assigning the particular grade will be included among the material documents available for inspection at the registered office of the company.

     As already mentioned SEBI does not have a role in assigning the grade of IPO and further it does not pass any judgment on the quality of the issuer company.  Further IPO grade is not a suggestion or recommendation as to whether one should subscribe to the IPO or not.   It is investor to read the grade of IPO with the disclosures made in the prospectus including the risk factors as well as the price at which the shares are offered in the issue and to make his own independent decision regarding investing in any issue.