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SEC plans grading system and independent research analysis of IPOs

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The Securities and Exchange Commission (SEC) plans to introduce a grading and rating system for Initial Public Offerings (IPOs) along with independent equity research on listed companies, and has issued a concept paper aimed at seeking public comments and suggestions.
The concept paper, available on the SEC website, says the purpose of rating/grading equity is to provide the potential retail or institutional investor with an independent view on the fundamentals and prospects of the company seeking to list on the stock exchange. “The investor (now) has only the lPO prospectus to go by and sometimes even the information contained in the prospectus may not be read or grasped by some investors. There is also a risk that a company that raises capital successfully from the public, ends up in financial difficulties, shortly after the IPO,” it said.

“A rating agency which is registered with the SEC can bridge this information gap with an IPO grading, by providing an independent and objective analysis which would help enhance an investor’s ability to make an informed investment decision. Also equally important is that prospective Issuers with strong fundamentals and good prospects can be in position to justify a higher share price, as a result of obtaining a higher IPO grade. The IPO grading will also help raise the profiles of Sri lankan Issuers I Corporates and develop a vibrant market place,” the paper suggested, adding that the deadline for public comments closes  on July 31.

The SEC said currently, there is no equivalent rating requirement to be eligible to list equity on the Colombo Stock Exchange (CSE). The eligibility requirements for an applicant entity seeking to list equity on the Diri Savi Board of the CSE are — stated capital of not less than Rs.100 million at the time of listing, positive net assets as per the consolidated audited financial statements for the financial year immediately preceding the date of application, minimum ‘Public Holding’ of 10% and a minimum of 100 ‘public’ shareholders holding not less than 100 shares each, and, an operating history of at least one year immediately preceding the date of application to the CSE.

IPO grade
An IPO grade is the grade assigned by a rating agency (registered with the SEC) to the IPO by a corporate seeking to list. The IPO grade represents a relative assessment of the fundamentals of that Issue in relation to the other listed equity securities. It is generally assigned on a five-point point scale with a higher score indicating stronger fundamentals and vice versa.

The IPO grade tells the investor about the prospects of the company seeking to list. It is issued based on a thorough study of fundamentals of the prospective issuer company, the industry in which it operates and the competitive strengths of the company amongst other factors. From the investor’s point of view, it provides an indicator to make a judgement that can also be used to assess the fairness of the IPO price, the paper said.

“However, it is important to note that IPO grading does not consider the IPO issue price. The IPO grade is an independent and credible input to aid the investor in the investment process and the investor needs to make his/her own independent decision regarding investing in the IPO. The test of the IPO grading is not in the market price, but in the overall financial performance of the company, as prices can vary depending on extraneous conditions. However the grading could be a useful indicator to justify whether the IPO price is fair or over-priced,” it said.

Independent equity research schemes
Stock exchanges in the Asian region have initiated independent equity research schemes for listed companies with the aim of providing unbiased research reports, with in-depth analysis of the fundamentals and valuation of listed companies, to encourage informed investment decision making by investors. This scheme is funded mainly through the stock exchange or the market development fund relating to the stock exchange. Such schemes exist in markets like India, Singapore, Malaysia, Indonesia, Australia, the US and Europe.
“Independent analyst advice is of crucial importance as they provide investors with an unbiased, analytical view by a third party,” the paper noted.

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