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Understanding SEBI Regulations for Underwriting of Shares: A Simple Guide
When a company issues new shares to the public, there's always a chance that some shares may not get sold. Underwriting helps reduce this risk. In simple terms, underwriting means that an entity (usually a bank or financial institution) promises to buy the shares that remain unsold during a public offering. This ensures that the company raising funds doesn’t miss out, even if the public response is lukewarm.
In India, the Securities and Exchange Board of India (SEBI) is the regulator that governs the rules around underwriting to protect investors and ensure transparency. Let’s break down SEBI’s regulations regarding the underwriting of shares in easy-to-understand terms.
What is Underwriting?
Underwriting is an agreement where an underwriter (usually a bank, investment firm, or a brokerage) guarantees that they will purchase the unsold shares from a public offering. This helps the issuing company by assuring them that the required capital will be raised, whether or not the public buys all the shares.
There are two main types of underwriting:
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Firm Underwriting: The underwriter commits to purchasing a fixed number of shares regardless of public interest.
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Conditional Underwriting: The underwriter agrees to buy only the shares that are not subscribed to by the public.
SEBI's Role in Underwriting
SEBI has laid down specific guidelines to ensure the underwriting process is transparent and fair for everyone involved—companies, underwriters, and investors. Here’s an overview of the key SEBI regulations related to underwriting:
1. Registration of Underwriters
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Requirement: Only SEBI-registered entities can act as underwriters. Registration ensures that only credible and financially sound entities are allowed to guarantee the buying of unsold shares.
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Eligibility Criteria: SEBI checks the financial strength, past performance, and professional competence of entities before granting them a license to act as underwriters.
2. Underwriting Agreement
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Written Contract: There must be a written agreement between the company issuing the shares (the issuer) and the underwriter. This contract outlines the terms, conditions, and the number of shares the underwriter agrees to underwrite.
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Clear Terms: The agreement should clearly define the obligations of both the underwriter and the issuing company, including the extent of underwriting (whether it is firm or conditional).
3. Disclosure of Underwriting
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Public Disclosure: Companies must disclose whether their shares are underwritten or not when they file their offer documents (like the prospectus). If the shares are underwritten, the names of the underwriters and the details of their commitment should be mentioned clearly.
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Risk Factor: If a public offering is not underwritten, this must also be disclosed as it is considered a risk for investors. Investors should be aware that there is no guarantee of a full subscription if there is no underwriter.
4. Commission for Underwriting
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Underwriting Commission: SEBI allows companies to pay a commission to the underwriters as a fee for the risk they take on. However, there is a cap on the commission rate that underwriters can charge, which is fixed by SEBI. Currently, the commission for public issue underwriting cannot exceed 5% of the issue price for equity shares and 2.5% for debentures.
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Payment: The commission is only paid if the underwriter fulfils their commitment, meaning they must buy the shares that were not sold to the public.
5. Liabilities of Underwriters
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Fulfilment of Commitment: SEBI holds underwriters accountable to honour their commitment to buy unsubscribed shares if necessary. Failure to do so can lead to penalties or loss of their SEBI registration.
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Financial Capacity: SEBI ensures that underwriters are financially sound enough to fulfil their obligations if they need to buy unsold shares. This safeguards the interests of both the issuing company and the public.
6. Underwriting in Book-Building Process
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Book-Building: In a book-building process (where investors bid for shares), SEBI allows underwriting to ensure a portion of the issue gets sold if public demand is not enough.
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Conditions: SEBI mandates that in such cases, underwriters must take a fixed percentage of the total shares that remain unsubscribed.
7. Penalties for Non-Compliance
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Non-Adherence: If an underwriter fails to comply with SEBI’s regulations or fulfil their underwriting obligations, they can face penalties. These may include monetary fines, suspension, or cancellation of their registration with SEBI.
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Investor Protection: SEBI takes strict action to protect the interests of investors and ensure the capital markets function smoothly. Any non-compliance with underwriting rules is treated seriously.
Why Are SEBI Regulations Important?
SEBI’s underwriting regulations help maintain a healthy, transparent, and fair market for companies and investors. These rules ensure that:
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Companies get the funds they need even if the public interest in the shares is low.
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Investors are protected from the risks involved in new share issues.
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Underwriters are accountable for their actions, ensuring they have enough financial strength to fulfil their commitments.
Conclusion
Underwriting plays a crucial role in the success of public offerings by providing a safety net to companies raising capital. SEBI’s regulations ensure that the underwriting process is fair, transparent, and secure for everyone involved. By understanding these rules, both companies and investors can better navigate the capital markets.
Read Also:- Overview of SEBI Research Analyst
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