FAQs on IPO Financing

• Ajay Kumar KV, Manager ( finserv@vinodkothari.com)

IPO Financing, as the name suggests, is providing finance for the purpose of subscribing to initial public offers done by companies. In case of IPO Financing, the exposure is based on the borrower, and the securities/ shares, if allotted, are taken as collateral for securing the obligations under the loan. The investor will realise the shares so allotted in the IPO and pay-off the loan taken from the Banks/NBFCs.

How does IPO Financing work?

IPO Financing is widely used by High Networth Individuals (HNIs) as a tool to leverage the funds available with an intent to make profits from the IPO allotment price and the price at the time of listing. Typically, the lender would provide a short-term loan to the borrower at a certain interest rate, till the shares are listed. The transaction forces the investor to sell the shares once listed. Out of the proceeds, the lender would retain the repayment of loan and payment of interest plus other charges, as may be levied; and the balance is taken home by the investor as profits.  Hence, the idea is not to “invest” in an IPO and eventually earn investment rewards; rather, the intent usually is to “enter” and “exit” by booking possible gains in the shortest time span.

Recently, the RBI has released Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs (SBR) on October 22, 2021. While the SBR provides for broad contours of the revised framework, concrete regulations in the form of ‘Directions’ are awaited from RBI. SBR fixes a ceiling of Rs. 1 crore per borrower in case of IPO financing by any NBFC.

We have tried to figure out the probable questions arising out of the aforesaid proposal and respond to the same in the form of these FAQs. However, these are subject to final directions yet to be issued by RBI in this regard. We shall update this FAQ once there are clear directions in this regard. These FAQs shall be read accordingly.

1. What is IPO financing?

IPO funding is a short-term loan provided by a lending institution which allows an investor to invest a higher amount in an IPO. One the investor is alloted shares pursuant to IPO, the shares are immediately sold and the proceeds are utlised to repay the loan of the lender and balance, if any, goes to the investor.

2. Is IPO financing the same as lending against shares (LAS)?

A loan against securities (LAS) is a loan given against the collateral of shares or securities. LAS enables one to borrow funds against securities such as shares, mutual funds, insurance and bonds to meet current financial needs.

LAS is a broader term that covers IPO Financing. However, unlike LAS, in IPO Financing, the exposure is based on the borrower and the securities/ shares, if allotted, are taken as collateral for securing the obligations under the loan. One should look for the substance of the transaction and intent of the parties rather than only the nomenclature to determine if the facility is LAS or IPO finance.

There have been norms on LAs for banks as well as both kinds of NBFCs vide Master Circular – Exposure Norms and Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 respectively, as amended by RBI from time to time. However, while Exposure Norms for banks have been clear on IPO financing limits; there has been no similar stipulations under the norms applicable to NBFCs.

3. Is IPO financing secured or unsecured?

The IPO funding is always secured on the shares to which the investor has applied for in the IPO. The lender will have a lien on the shares so allotted to the investor and the investor needs to liquidate the shares on listing and from the sales proceeds, the loan taken have to be repaid.

In case, the amount realised from shares is not sufficient to repay the loan, the borrower will have to bring in money to meet the shortfall in the total loan amount and the money realised from the sale. In such a situation, it will be the personal liability of the investor/borrower to repay the loan amount in full as per the financing agreement with the financial institution.

4. What does the revised regulatory framework have to say on IPO financing?

SBR stipulates a ceiling limit of INR 1 crore per borrower in case of IPO financing by NBFCs. That is,

• Lender should be an NBFC
• The funds should be lent for IPO financing (see above, for what exactly is IPO financing and how it is different from LAS)
• The ceiling limit is Rs. 1 crore
• The limit is applicable per borrower

As also indicated in the Discussion paper on SBR, the proposal to fix a ceiling limit for NBFCs was to prevent abuse of the facility in the capital market.

Leveraged IPO bids also result in turning the allotment process in favour of short-term players in the market, edging out the genuine long-term investors and affecting the fair price discovery.

5. How is the Revised Framework different from extant norms on IPO financing?

As stated earlier, there have been exposure norms on IPO financing for banks but not for NBFCs.

For NBFCs, although there has been no such restriction on IPO financing; however, there have been exposure norms and norms for LAS (please refer to our discussion in Q. No. 2 above). SBR specifies limits for IPO financing specifically.

6. How are the norms for IPO financing different for banks and for NBFCs?

Refer para 4.1 of Master Circular on Exposure Norms for Banks (2015). It stipulates the following:

• Banks are allowed to lend to ‘individuals’ for subscribing to IPOs
• Banks cannot provide finance to NBFCs for on-lending to individuals for IPOs
• IPO financing cannot be done to corporates for investing in other companies’ IPOs.
• The limit is Rs. 10 lakh per individual
• Such exposure of banks towards IPO financing is reckoned as capital market exposure

The stipulations in SBR for NBFCs seem to be little different, as :

• The limit is Rs. 1 crore
• The limit is to be reckoned per “borrower”. That is, reference is not to an ‘individual’ but to a borrower.
• Hence, possibly, there is no restriction on IPO financing to corporates too, subject to the ceiling limits

7. Are the revised norms applicable immediately?

No. SBR as a whole is applicable from October 1, 2022. However, guidelines relating to IPO financing are applicable with effect from April 1, 2022. Hence, one may expect detailed guidelines from RBI any time before April, 2022.

8. Which type of NBFC is covered under the ambit of these Guidelines?

The ceiling is applicable to all NBFCs, that is, NBFC falling in any layer. Notably, under the Discussion paper, it was proposed to fix the ceiling limit only to NBFC-Middle Layer and NBFC-Upper Layer. However, when the guidelines were issued on 1st October 2021, the same was made applicable to all NBFCs.

Therefore, no NBFC shall be able to provide IPO finance beyond the ceiling.

9. Does the limit apply on all kinds of borrowers intending to avail IPO finance?

Yes – the limit applies on every borrower. SBR does not limit the expression “borrower” – it appears that it would include all kinds of persons. Notably, the Discussion Paper used the word “individual”. However, one might need to wait for final directions in this regard.

10. Whether this ceiling limit is applicable for Follow On Public Offer (FPO) or only to an IPO?

Looking at the intent of the revised framework, it should be noted that the regulator wants to prevent abuse of the funds which may result in market volatility when there is an extreme concentration of funds with specific individuals or groups of individuals.

Thus, one should not limit themselves to a literal interpretation of the same and an FPO should also be considered for fixation of the limits.

However, it may be noted that the Exposure Norms for Banks include FPO under the expression IPO for the purpose of ESOP funding (see, para 4.3), but there is no such explicit inclusion for the purpose of IPO financing.

11. Whether the IPO financing covers financing investment in freshly listed debt?

The term Initial Public Offer is defined in Reg. 2(1)(w) of SEBI (Issue of Capital and Disclosure Requirements) Regulation, 2018 as:

“initial public offer” means an offer of specified securities by an unlisted issuer to the public for subscription and includes an offer for sale of specified securities to the public by any existing holders of such specified securities in an unlisted issuer.

The term specified securities is defined in Reg. 2(1)(eee) of SEBI (Issue of Capital and Disclosure Requirements) Regulation, 2018 as:

 “specified securities” means equity shares and convertible securities

It is clear that IPO refers to the issue of equity shares by an unlisted company in compliance with all applicable SEBI regulations wherein such company becomes a public listed company.

Thus, the issue of debt securities will not be covered by the revised framework.

12. Suppose Mr. A & Mr. B makes a joint application to an NBFC for IPO financing. Whether the limit will be 1 crore for each of the borrowers or a maximum limit of 1 crore for both considering them as one applicant?

The intent of the revised framework is to ensure that the NBFC funds shall not be used for market abuse and to limit risk exposure in the capital market. Thus, where a joint application is made for such financing, in our view, it should be considered as one individual applicant with a ceiling limit of 1 crore.

13. Whether the IPO finance availed by borrower’s immediate relatives/related parties shall be included for the purpose of computation of limits?

At present, there is no guidance under SBR as to whether loans availed by immediate relatives (say, spouse) or by group companies would have the benefit of separate ceiling limits. However, from the intent of the proposed framework as well as extant norms on capital market exposure for banks, it appears that any collusive action on the part of borrowers to circumvent the limits must be discouraged. One may have to see what the final instructions provide in this regard.

14. Does the ceiling limit is for one IPO or all IPOs taken together (in which the borrower proposes invests)?

15. How is the ceiling limit calculated?  Is it a recurring limit?

The ceiling limit of 1 crore will be calculated on a recurring basis. That is where an individual avail a IPO financing facility, once the loan is repaid after the tenure, such individual can again avail the financing for another IPO from the same NBFC. At present, we understand, there is no limit proposed on the frequency up to which IPO finance can be availed by a single borrower from a particular NBFC. However, the total outstanding facility, at any point of time, shall not go beyond Rs. 1 crore.

16. Is there a tenure for IPO funding?

The financing is typically provided for a short duration, usually around a week (6-8 trading days), from the day the IPO subscription closes until the listing day.

You can read our article on the “revised regulatory framework for the NBFC sector” here

To read our article on various forms of secured lending – https://vinodkothari.com/2021/06/various-forms-of-secured-lending/