Introduction 

The Securities and Exchange Board of India (SEBI) released a consultation paper on February 22, 2023, which discussed various proposed amendments to the underwriting framework for public offerings under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (SEBI ICDR Regulations). On March 29, 2023, SEBI approved the changes, and these amendments became effective on May 23, 2023, through the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2023 (ICDR Amendment).

Under the ICDR Amendment, certain requirements have been introduced regarding underwriting for public offerings through the book-built route. The mandate is that if an issuer wishes to have the offering underwritten to cover under-subscription, they must enter into an underwriting agreement with the underwriters before filing the Red Herring prospectus (RHP). The issuer is also required to disclose in the RHP the maximum number of securities that the underwriters will subscribe to, either personally or through subscriptions they secure.

Concept of Underwriting and Underwriters

In offering IPOs, the term “underwriting” means a purchase of shares by evaluating the risks of the securities, and “Underwriters” are a group of banks or stockbrokers that are registered with SEBI and works very closely with the company for the underwriting of issue of shares.

SEBI’s released paper primarily recognizes underwriting in two different forms:

Soft Underwriting – Soft underwriting is a common practice in Indian public offerings, particularly in the book-building process. In this arrangement, the underwriter and the issuer enter into an underwriting agreement after completing the book-building phase and agreeing on the pricing. Unlike traditional underwriting, the underwriter commits to procure subscribers or subscribe to the offered securities only for valid bids it has obtained. The underwriter assumes the “payment risk” associated with these bids, ensuring that the issuer is protected against any shortfall in funds resulting from rejected bids.

Hard Underwriting: One of the risks associated with a public offering is the possibility of a shortfall between the number of securities offered to investors and the number of bids received. This shortfall, known as “under-subscription,” can occur when there is insufficient demand for the securities. Hard underwriting is a guarantee provided by underwriters to the issuer, assuring that if such a gap exists, the underwriters will step in by either purchasing the offered securities themselves or finding additional buyers. Unlike a soft underwriting arrangement, in a hard underwriting, the underwriter takes on the risk of the securities not being fully subscribed and provides the issuer with protection against this subscription risk.

CHANGES IN THE UNDERWRITING FRAMEWORK

Underwriting will now serve two purposes, first to cover any shortfall in demand for securities during the book-building offer period, and second, protection against the risk of technical rejections that usually occur after the offer period is over. Additionally, the issuer will have the flexibility to choose the type of underwriting arrangement they prefer.

Now when it comes to underwriting for demand shortfall, the underwriting agreement needs to be signed before filing the RHP (Red Herring Prospectus). On the other hand, for underwriting to cover the risk of technical rejections, the underwriting agreement will be executed after pricing and before the filing of the final prospectus. According to the SEBI ICDR (Issue of Capital and Disclosure Requirements) Regulations, the underwriter is not obligated to personally subscribe to the securities. This provision expands on the previous regulations of SEBI (Securities and Exchange Board of India) pertaining to merchant bankers and stockbrokers, where the fulfilment of underwriting obligations through the procurement of subscribers was already addressed, but not explicitly covered under the SEBI ICDR Regulations and the predetermined price at which underwriters will subscribe to or procure subscribers for the offered securities cannot be lower than the issue price.

Implications

Guarantee to the issuer: Hard underwriting arrangement provides the issuer with assurance before launching the offering that they will receive the necessary capital, even if there is a lack of investor interest. Underwriters usually have the option to end their underwriting obligations in specific circumstances, such as force majeure events, but in practice, these events are rarely invoked.

Decrease stress to investors: The underwriting agreement will be signed before filing the RHP (Red Herring Prospectus) and disclosing the underwriter’s commitment to the RHP enables investors to consider this information when making investment decisions. Additionally, due to the increased risk involved, there could be pricing implications for the offering to make it more appealing to investors and generate higher demand.

Conclusion 

Hard underwriting has been uncommon in Indian book-built public offerings. The new framework provides issuers with the choice to opt for hard underwriting, which can be beneficial during slow market conditions. However, this choice also comes with increased risk for underwriters and potentially higher transactional costs for the issuer. It is uncertain whether this type of underwriting will become more prevalent in Indian book-built public offerings going forward.