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IPO Grading consigned to the dustbins of history

As some of you may re-collect, during periods of boom in the stock markets India had, time and again, witnessed hundreds of companies with "suspect" fundamentals raising thousands of crores through the IPOs... and then vanishing with the people's money.

Alarmed by this trend, in 2007 SEBI introduced the concept of grading the IPO (Initial Public Offer) of equity shares, as one of the measures to protect investor interest. Until then only the issuance of debt products required mandatory rating from an independent rating agency.

As per SEBI "IPO Grading is intended to provide the investor with an informed and objective opinion expressed by a professional rating agency after analyzing factors like business and financial prospects, management quality and corporate governance practices etc.".  Of course, it came with the usual warning that the investor should "make his/her own independent decision regarding investing in any issue after studying the contents of the prospectus including risk factors carefully".

The grade represented a relative assessment of the fundamentals of that issue in relation to the other listed equity securities in India and was assigned on a five-point scale — with Grade 1 representing Poor Fundamentals and going up to Grade 5 denoting Strong Fundamentals.

One critical point that the IPO Grading did not cover was the Issue Price.   

Moving to present times, SEBI has recently done away with the mandatory grading of the IPOs. It is now a voluntary step left to the issuing company to decide whether to get its IPO rated or not. The reasoning being that the IPO Grading was not serving its intended purpose. Not only the retail, but even the institutional investors, were willingly putting their money in poorly graded IPOs. And many highly graded IPOs lost money (possibly due to aggressive pricing).

So that is curtains down for, what was all along, a debatable provision. 

Since grading process excluded the issue price, the expert opinion was silent on what is otherwise one of the most important decision-making parameters. Price, as we all know, is an extremely important number.... because an average company available at a very cheap price is likely to deliver better returns for the investor than a great company which is over-priced. 

Moreover, rating an inherently risky and market-linked product was considered an anomaly.

Despite these obvious drawbacks (and the not so happy track record of the rating agencies worldwide), IPO Grading was a good concept to get an expert opinion on the fundamentals of the company. At least one significant aspect of whether to invest or not was addressed through this grading. 

Therefore, instead of doing away with the grading process itself, it would have been more appropriate to
... spread awareness among investors about IPO Grading
... to bring in more objectivity the cost of rating to be borne by Investor Protection Fund and not the issuing company
... if feasible, include some from of opinion on the price.

Informed investors will surely miss the IPO Grades.

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