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Chapter 3: Primary Markets

Concept and Functions of the Primary Market

The Primary Market (also referred to as the New Issue Market) is the financial platform where corporate issuers, governments, and financial institutions issue new securities to the public or private investors to mobilize fresh capital for productive deployment. The primary market performs three vital economic functions:

  1. Origination: Encompasses the preliminary research, project feasibility analysis, legal due diligence, capital structuring, timing of issuance, and regulatory document preparation.
  2. Underwriting: The contractual commitment by merchant bankers or financial institutions to subscribe to the unallotted portion of an issue if public demand falls below the statutory minimum subscription threshold (90% for public equity issues), guaranteeing capital certainty for the issuer.
  3. Distribution: The widespread marketing, syndication, and retail/institutional collection of bids and funds across national and global networks.

Interplay Between Primary and Secondary Markets

The primary and secondary markets are mutually interdependent:

  • Without a vibrant primary market, the secondary market would lack fresh securities and corporate growth opportunities.
  • Without a liquid, transparent secondary market, investors would be unwilling to commit capital to primary market issues, because they would have no guaranteed exit mechanism to liquidate holdings at fair market value.

Key Intermediaries in Issue Management

A public issuance of securities requires a syndicate of SEBI-registered intermediaries:

  1. Merchant Banker / Lead Manager:
    • Acts as the principal architect of the issue.
    • Conducts independent due diligence on corporate accounts, promoter backgrounds, and pending litigations.
    • Drafts the Draft Red Herring Prospectus (DRHP), files it with SEBI and stock exchanges, and addresses regulatory observations.
    • Manages price discovery, marketing roadshows, and the institutional order book.
  2. Registrar to the Issue (RTA):
    • Collects bidding data from stock exchange electronic bidding engines.
    • Reconciles application money with Self-Certified Syndicate Banks (SCSBs) and UPI interfaces.
    • Finalizes the basis of allotment in consultation with the Designated Stock Exchange (DSE).
    • Coordinates electronic credit of shares to allottees' demat accounts and unblocking of funds for non-allottees.
  3. Self-Certified Syndicate Banks (SCSBs):
    • Commercial banks certified by SEBI to provide Application Supported by Blocked Amount (ASBA) services.
    • Block application funds in investor bank accounts upon bid submission and transfer funds to the public issue escrow account only upon receipt of allotment instructions.
  4. Debenture Trustee (for Debt Issues):
    • Mandatory for all public issues of debentures and private placements exceeding statutory thresholds.
    • Holds legal charge over company collateral assets on behalf of debenture holders.
  5. Credit Rating Agencies (CRAs):
    • Mandatory for public issuances of debt securities; assess creditworthiness and assign standardized rating grades (e.g., AAA, AA+, BBB).

Taxonomy of Capital Issuances

Capital issues are classified by the target investor base and offering mechanism:

Workflow & Structure Diagram
graph TD
    A[Capital Issues] --> B[Public Issue]
    A --> C[Rights Issue]
    A --> D[Bonus Issue]
    A --> E[Private Placement]
    B --> B1[Initial Public Offering - IPO]
    B --> B2[Follow-on Public Offering - FPO]
    B1 --> B1a[Fresh Issue]
    B1 --> B1b[Offer for Sale - OFS]
    E --> E1[Qualified Institutional Placement - QIP]
    E --> E2[Preferential Allotment]
  1. Initial Public Offering (IPO):
    • The first sale of equity shares by an unlisted company to the public, leading to subsequent listing on recognized stock exchanges.
    • Fresh Issue: New shares created and issued by the company; capital proceeds flow directly into the company's balance sheet.
    • Offer for Sale (OFS): Existing shareholders (promoters, venture capital funds, private equity investors) sell their holdings to the public; proceeds flow directly to selling shareholders without increasing company net worth.
  2. Follow-on Public Offering (FPO):
    • An already listed company issues additional fresh shares or facilitates an OFS to the public.
  3. Rights Issue:
    • An offer of additional shares to existing shareholders in proportion to their existing holding as on a record date at a concessional price (Section 62 of Companies Act).
  4. Bonus Issue:
    • Capitalization of free reserves by allocating additional fully paid-up shares to existing shareholders for zero monetary consideration.
  5. Private Placement:
    • Issuance of securities to a selected group of persons (maximum 200 persons in a financial year, excluding QIBs and employees under ESOPs) under Section 42 of Companies Act:
      • Qualified Institutional Placement (QIP): Exclusive private placement by listed companies to Qualified Institutional Buyers (QIBs) governed by SEBI ICDR regulations.
      • Preferential Allotment: Bulk issuance of shares or warrants to specific promoters, strategic partners, or anchor investors.

Regulatory Framework under SEBI ICDR Regulations, 2018

The issuance of capital and public disclosures in India is governed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR).

Eligibility Criteria for an IPO under Regulation 6(1) (Profitability Route)

An unlisted company seeking a public equity offering through the standard profitability route must satisfy:

  1. Net Tangible Assets: Net tangible assets of at least Rs. 3 Crores in each of the preceding three full years (of which not more than 50% are held in monetary assets).
  2. Operating Profit History: Minimum average operating profit of at least Rs. 15 Crores (calculated on a restated basis) during the three most profitable years out of the immediately preceding five years.
  3. Net Worth Requirement: Net worth of at least Rs. 1 Crore in each of the preceding three full years.
  4. Name Change Criterion: If the company has changed its name within the last one year, at least 50% of the revenue for the preceding one full year must have been earned from the activity indicated by the new name.

Alternative Route under Regulation 6(2) (QIB Route for Startups / Loss-Making Companies)

If a company does not satisfy the profitability criteria under Regulation 6(1):

  • It can still access the public equity market via an IPO provided the issue is conducted strictly through the Book Building Process, AND
  • At least 75% of the Net Offer to the Public is mandatorily allocated to Qualified Institutional Buyers (QIBs). If the 75% QIB subscription is not achieved, the entire issue fails and all application money must be refunded.

Promoters' Contribution and Mandatory Lock-in

  • Minimum Promoters' Contribution (MPC): Promoters must contribute at least 20% of the post-issue capital of the company.
  • Lock-in Restrictions:
    • The minimum 20% MPC is locked in for 18 months from the date of allotment (reduced from 3 years for eligible issuers).
    • Any promoter holding in excess of the 20% MPC is locked in for 6 months from the date of allotment.
    • Pre-issue capital held by non-promoters (AIFs, venture capital funds) is locked in for 6 months from allotment.

Book Building vs Fixed Price Issue

  • Fixed Price Issue: The issuer and lead manager determine a single fixed price at which shares are offered to the public prior to issue opening.
  • Book Building Issue: A dynamic price discovery mechanism where the issuer specifies a Price Band (Floor Price and Cap Price), and investors submit bids indicating the price and quantity of shares they are willing to purchase.
    • SEBI mandates that the Cap Price cannot exceed 120% of the Floor Price (a maximum spread of 20%).
    • The final price at which the issue is subscribed is called the Cut-off Price. Retail investors have the statutory option to bid at the "Cut-off" price.

Allocation Quotas in Book-Built Public Issues

For issues compliant with Regulation 6(1) profitability route:

  • Qualified Institutional Buyers (QIBs): Minimum 50% of Net Offer (5% of which is reserved for mutual funds; Anchor Investors can be allocated up to 60% of the QIB portion).
  • Non-Institutional Investors (NIIs / HNIs): Minimum 15% of Net Offer (split into 1/3rd for bids between Rs. 2L - Rs. 10L, and 2/3rds for bids > Rs. 10L).
  • Retail Individual Investors (RIIs): Minimum 35% of Net Offer (individual bid value capped at Rs. 2,00,000).

Application Supported by Blocked Amount (ASBA) and UPI Mandates

  • ASBA Mandatory: In India, 100% of public issue applications must be processed through ASBA. Application money remains safely in the investor's own bank account, earning bank interest, with an electronic lien / block created.
  • UPI Mechanism for Retail Bids: Retail individual investors bidding through syndicate brokers use their Unified Payments Interface (UPI) virtual payment address (VPA) with an elevated transaction block limit of Rs. 5,00,000 for IPO bids.
  • Listing Timeline (T+3 Standard): SEBI made the T+3 listing timeline mandatory for all public issues. The shares must be listed and commence electronic trading on recognized stock exchanges within three working days from the issue closure date (T).

Regulatory Framework for Public Issue of Debt

Public issuances of non-convertible debentures (NCDs) are governed by the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS Regulations):

  • Mandatory Requirements:
    1. Appointment of an independent SEBI-registered Debenture Trustee.
    2. Obtaining at least one investment-grade Credit Rating from a registered CRA.
    3. Creation of a Debenture Redemption Reserve (DRR) and recovery expense fund.
    4. Execution of a registered Debenture Trust Deed creating security charge over immovable/movable assets with a minimum asset cover ratio (typically 100% to 125% of issue value).

Electronic Book Provider (EBP) Platform for Private Placements

To enhance transparency, prevent private deal-making, and ensure competitive price discovery in corporate bond private placements, SEBI introduced the Electronic Book Provider (EBP) Platform operated by stock exchanges:

  • Mandatory Threshold: All private placements of non-convertible securities and commercial papers with an issue size of Rs. 50 Crores or more (inclusive of green-shoe option) must be mandatorily executed through the EBP platform.
  • Bidding Dynamics: Institutional investors and eligible participants place electronic price/yield bids on the platform during designated trading hours, with automated transparent allocation based on yield-price priority.
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