From light regulation to accountability: How Sebi is rethinking SME IPO rules
Source: Live Mint
Markets regulator Securities and Exchange Board of India (Sebi) has recently identified several concerns plaguing the SME space such as misuse of IPO proceeds, fund diversion, promoter exits and market misconduct. These issues pose threats to investor protection and market integrity. A Sebi analysis reveals that many SMEs have engaged in substantial related party transactions (RPTs) with nearly half of these companies undertaking such transactions exceeding ₹10 crore, and one in five surpassing ₹50 crore. Additionally, it has been observed that SMEs are promoter-driven or family-run businesses with minimal private equity or sophisticated investors, which limits check on promoter influence. Recent cases of misuse of IPO proceeds, underscore the urgency for regulatory intervention.
Sebi’s well-thought-out light regulatory framework was introduced in 2012 to boost SME listings aimed at contributing to economic growth. The results were promising: as of October 2024, 745 companies are listed on SME exchanges with a market capitalization of ₹2 trillion. In 2023-24, 196 IPOs raised over ₹6,000 crore and by October 2024, ₹5,700 crore was raised through 159 SME IPOs. Investor participation, too, has grown in FY2022 to 46 times. Regulatory-lite models have typically been adopted by successful SME exchanges (Korea’s Konex and China’s ChiNext) worldwide to give the necessary push. These involved less rigorous compliance requirements compared to the main-board listings and delegating responsibility to stock exchanges to drive these listings.
However, the rapid growth and increased participation have exposed vulnerabilities in the light-touch approach. To address these challenges, Sebi now proposes to tighten the framework by introducing stricter eligibility criteria, increasing the application value, enhanced lock-in requirements for promoters, tighter migration norms to the main board and improved corporate governance measures. Let’s analyse few proposed changes.
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Stricter eligibility criteria: Stricter eligibility criteria (i.e. requiring an issue size of ₹10 crore and operating profit of ₹3 crore in two of the last three years) would enhance the credibility of SME listings, allowing only financially viable companies to issue public offerings. The current lack of minimum requirements for SMEs is akin to the dotcom bubble, where companies were listed simply because they had ‘dotcom’ in their names—leading to a market crash.
Being an SME should not serve as a gate pass for entering stock exchanges, exposing vulnerable investors to undue risk. This stringency is thus crucial as SME’s without any track record were getting oversubscribed (2024: 199% and 2023: 86%). This had to be checked.
Application value: Increasing the application value for SME listing to ₹2 lakh (instead of ₹4 lakh) should be enough to limit participation of vulnerable retail investors, thereby protecting them. This approach mirrors the entry barriers in futures and options markets, where a higher threshold helps reduce risk. It also discourages speculative behaviour such as pump and dump schemes or manipulation akin to trading in penny stocks. Limiting participation to well-informed investors with a higher risk appetite will strengthen the SME segment. Although listing gains averaging 75.6% in 2024-25 and 51.21% in 2023-24 may tempt retail investors, they must recognise that sentiments can change post-listing.
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Skin in the game and purpose of IPO: Measures to prevent promoters from reducing their holdings post-listing are important. Furthermore, disallowing corporates from using IPO funds for repayment of loans is a much appreciated step, as primarily the funds of investors should be deployed towards growth and not for loan repayment.
Market making: While Sebi’s efforts to streamline SME listings are commendable, addressing liquidity should also be a key area of focus. The market-making mechanism has been laid down to ensure liquidity. Despite this, it was seen that to create a “positive sentiment” to induce investors into purchasing the SME stocks, companies resorted to circular dealings to artificially inflate revenue and create a positive environment. Thus, incorporating a stronger emphasis on market-making within the proposed framework would help foster genuine market participation, enhance valuations and ensure better liquidity.
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Increased disclosures: The misconduct of some entities has prompted stricter regulations. These include proposals for enhanced disclosures/compliances and also having monitoring agencies for transparency in accountability and fund utilization. This could overall become a costlier affair which has been necessitated due to the conduct of listed SME companies. Nevertheless, governance cannot be comprised.
The potential of SME exchanges remains largely untapped. Out of ₹7.96 lakh SMEs in India, only 750 have been listed so far—a clear indication of the long road ahead. To bridge this gap, it is crucial to educate the SMEs on benefits of raising capital through stock exchanges rather than relying on traditional bank financing. Additionally, SMEs should also proactively seek support from the stock exchanges to better understand the fund-raising process through stock exchange ecosystem.
Kohli is senior AGM at National Institute of Securities Markets (NISM), and Panda is assistant professor at the Indian Institute of Management (IIM), Raipur. Views are personal.
