Underwriter according to SEBI guidelines

-

SEBI Guidelines for Mutual Funds

1. Formation:

  • Structural Requirements: Mutual funds must establish asset management companies (AMCs) with at least 50% independent directors. This ensures that the AMCs operate transparently and without undue influence from sponsors. Additionally, mutual funds are required to have separate boards of trustees, comprising at least 50% independent trustees, and independent custodians. The custodians are responsible for safeguarding the assets of the fund, while the trustees oversee the operations of the AMC. This tripartite structure—trustees, AMCs, and custodians—helps in maintaining an arm's length relationship between all parties, reducing the risk of conflicts of interest and ensuring that each entity performs its role effectively.

2. Registration:

  • Approval Process: SEBI's registration process requires mutual funds to meet specific criteria, including a proven track record of the sponsor, integrity in business transactions, and financial soundness. This vetting process aims to ensure that only reputable and financially stable entities are allowed to operate mutual funds, protecting investors from potential fraud or mismanagement. In February 1993, SEBI approved several private sector mutual funds, including 20th Century Finance Corporation and Tata Sons, as part of expanding the mutual fund industry.

3. Documents:

  • Prospectus Requirements: Mutual fund schemes must have their offer documents, including prospectuses, reviewed and approved by SEBI. This ensures that the documents provide clear, comprehensive, and accurate information to investors about the scheme's objectives, risks, and terms. SEBI also enforces a standard format for these documents to maintain consistency and transparency in the information provided to investors.

4. Code of Advertisement:

  • Advertising Standards: Mutual funds are required to follow a specific code of conduct for advertisements. This code aims to ensure that all promotional materials are honest, clear, and not misleading. Advertisements must accurately represent the fund’s performance, risks, and investment strategies to prevent deceptive practices and ensure that investors make informed decisions.

5. Assurance on Returns:

  • Return Guarantees: Mutual funds are generally prohibited from guaranteeing returns due to the inherent risks in investment markets. However, mutual funds that have been operational for at least five years are allowed to offer a maximum return guarantee of 12% for one year under certain conditions. This provision helps manage investor expectations and highlights the risks associated with investing in mutual funds.

6. Minimum Corpus:

  • Capital Requirements: SEBI mandates a minimum corpus of ₹50 crore for open-ended mutual funds and ₹20 crore for closed-ended mutual funds before they can accept investor money. This requirement ensures that funds have sufficient scale to operate efficiently and manage investor assets effectively. If a fund does not meet the minimum corpus, it must refund the application money to investors.

7. Institutionalisation:

  • Market Practices: SEBI has introduced measures to promote institutional investment in mutual funds, such as proportionate allotment and raising minimum deposit amounts to ₹5000. These steps aim to encourage more substantial investments from institutional and individual investors, enhancing the stability and growth of the mutual fund industry.

8. Investment of Funds:

  • Investment Timelines: Mutual funds are required to invest the capital raised within nine months, extended from the previous six months. This extension helps protect funds from investing at peak market prices, which could lead to poor Net Asset Value (NAV) performance. By allowing more time, mutual funds can better manage investments and reduce the risk of buying high during market peaks.

9. Investment in Money Market:

  • Exposure Limits: SEBI allows mutual funds to invest up to 25% of their mobilized resources in money market instruments within the first six months after closing the fund. After this period, the limit is reduced to 15%. These limits help mutual funds maintain liquidity to meet short-term needs while ensuring that a substantial portion of the funds is invested in longer-term assets.

10. Valuation of Investment:

  • NAV Declaration: SEBI emphasizes the importance of transparent and accurate Net Asset Value (NAV) calculations. NAV represents the value of the mutual fund's assets minus liabilities, divided by the number of outstanding shares. Accurate NAVs provide investors with a clear picture of the fund's performance and help ensure fair pricing of mutual fund units.

11. Inspection:

  • Regulatory Oversight: SEBI conducts annual inspections of mutual funds to ensure compliance with regulations and protect investor interests. These inspections help identify and address any regulatory breaches or operational issues, maintaining the integrity of the mutual fund industry.

12. Underwriting:

  • Underwriting Permission: SEBI allowed mutual funds to underwrite primary issues starting July 1994. Underwriting involves guaranteeing the purchase of a certain amount of new issue securities. This permission helps mutual funds diversify their investment activities and potentially enhance returns through underwriting fees.

13. Conduct:

  • Regulation of Schemes: In September 1994, SEBI clarified that mutual funds could not offer buy-back schemes or guaranteed returns to corporate investors. This regulation ensures that mutual funds operate transparently and fairly, avoiding practices that could distort investment outcomes or mislead investors.

14. Voting Rights:

  • Shareholder Participation: SEBI granted mutual funds the right to vote as shareholders in companies where they hold equity investments in September 1993. This allows mutual funds to participate in corporate governance and influence company decisions, aligning the interests of mutual fund investors with those of the companies in which they invest.

Key Points to Note:

  • Transparency and Accountability: SEBI’s guidelines aim to promote transparency, protect investor interests, and ensure fair practices within the mutual fund industry.
  • Regulatory Oversight: Regular inspections and stringent registration processes help maintain the integrity of mutual funds and safeguard investor funds.
  • Investor Protection: By regulating advertising, return assurances, and investment practices, SEBI ensures that investors receive accurate information and fair treatment.

Underwriting of Shares and Debentures

1. Definition and Purpose:

  • Underwriting:
    • Definition: Underwriting is a financial arrangement where an underwriter (individual, firm, or joint-stock company) agrees to purchase shares or debentures of a company if the public does not fully subscribe to them. This ensures the company will raise the needed capital even if public interest falls short.
    • Purpose: Provides a safety net for companies issuing securities by guaranteeing a minimum level of subscription. This reduces the risk of not raising the required funds and makes the issue more attractive to potential investors.

2. Types of Underwriting:

  • Complete (Full) Underwriting:
    • Definition: The underwriter agrees to purchase the entire issue of shares or debentures if the public does not fully subscribe to them. This type of underwriting may be done by a single underwriter or multiple underwriters.
    • Process: If the issue is under-subscribed, the underwriter buys the remaining shares or debentures. If the issue is over-subscribed, the underwriter still earns a commission but may not need to purchase any securities.
    • Example: A company issues 1,000 shares, and an underwriter agrees to buy all shares if not fully subscribed. If only 700 shares are subscribed by the public, the underwriter will purchase the remaining 300 shares.
  • Partial Underwriting:
    • Definition: The underwriter agrees to take up only a portion of the issue. The remaining part is covered by the company itself.
    • Process: The company is responsible for selling the un-underwritten portion. The underwriter's liability is limited to their portion of the issue.
    • Example: If a company issues 1,000 shares and 40% is underwritten by an underwriter, they would cover 400 shares. If only 350 shares are applied for, the underwriter must purchase the remaining 50 shares.
  • Firm Underwriting:
    • Definition: The underwriter agrees to buy a specific number of shares or debentures regardless of the public subscription. This type of underwriting guarantees that the underwriter will take up a predetermined number of securities.
    • Process: Firm underwriting includes an agreement to buy a set number of shares in addition to covering any unsubscribed portion. This provides more assurance to the issuing company.
    • Example: If an underwriter agrees to buy 100,000 shares regardless of public response, they will buy these shares even if the public only subscribes for 70,000 shares.

3. Functions and Differences:

  • Underwriter:
    • Function: Assumes the risk of unsold shares or debentures and ensures that the issuing company meets its capital raising goals. The underwriter receives an underwriting commission for taking this risk.
    • Risk Assumption: The underwriter bears the financial risk of the issue not being fully subscribed. They are compensated with a commission for this risk.
    • Commission: The underwriter earns an underwriting commission, which is a fee paid for guaranteeing the subscription of the issue.
  • Broker:
    • Function: Facilitates the sale of shares or debentures by finding buyers but does not assume the risk of unsold securities. The broker earns brokerage fees for placing the securities with investors.
    • No Risk Assumption: Unlike underwriters, brokers do not guarantee the success of the issue. They simply assist in selling the securities.
    • Brokerage: Brokers receive a fee or commission based on the number of shares or debentures they sell.

4. Sub-Underwriting:

  • Definition: An arrangement where an underwriter enters into a secondary agreement with sub-underwriters to share the underwriting risk. This spreads the risk among multiple parties.
  • Process: Sub-underwriters take a portion of the underwriting risk and receive a commission from the primary underwriter. They do not have a direct contractual relationship with the issuing company.
  • Example: An underwriter who has committed to 1,000 shares may delegate 400 shares to a sub-underwriter. The sub-underwriter is responsible for their share of the risk and receives a commission from the primary underwriter.

5. Underwriting Commission:

  • Regulations (Companies Act, 1956):
    • Authorization: Payment of commission must be authorized by the company’s Articles of Association.
    • Limits:
      • Shares: Commission cannot exceed 5% of the issue price or a lower rate specified in the Articles.
      • Debentures: Commission cannot exceed 2.5% of the issue price or a lower rate specified in the Articles.
    • Disclosure: The rate of commission and the number of shares or debentures underwritten must be disclosed in the prospectus. Brokerage is in addition to the underwriting commission.
    • Exclusion: Commission is not paid on shares not issued to the public.

6. Importance of Underwriting:

  • Risk Management: Acts as insurance against the risk of insufficient subscription. Ensures the company can meet its capital raising goals.
  • Market Confidence: Enhances investor confidence by showing that reputable underwriters back the issue.
  • Company Reputation: Improves the company’s image and goodwill, as underwriters typically back financially sound and promising companies.

7. Marked vs. Unmarked Applications:

  • Marked Applications:
    • Definition: Application forms stamped by underwriters to indicate they are handled by specific underwriters. Helps in tracking and allocating subscriptions.
    • Process: Helps companies identify applications from specific underwriters and manage their allocation.
  • Unmarked Applications:
    • Definition: Direct applications from the public without any underwriter's stamp. Processed separately and not attributed to any specific underwriter.
    • Process: These applications are treated as part of the general subscription and are not linked to any underwriting guarantee.

By understanding these concepts, companies can effectively manage their capital-raising efforts and investors can better navigate the underwriting process in securities offerings.