by Underwriters are financial intermediaries that help companies raise capital by guaranteeing the sale of new securities. In exchange for this guarantee, underwriters receive a fee or commission.
History:
Underwriting has a long history that dates back to the 18th century. In those days, underwriters were individuals who would provide insurance for marine cargo. They would assess the risks associated with transporting goods and provide insurance coverage to the shipper in exchange for a premium.
Over time, underwriting evolved to include the issuance of securities. In the early 20th century, investment banks started to specialize in underwriting new securities offerings. These banks would analyze the creditworthiness of the issuer, set the terms of the offering, and then distribute the securities to institutional and retail investors.
In India, the Securities and Exchange Board of India (SEBI) was established in 1988, and it began regulating the securities market in 1992. The introduction of SEBI regulations led to a significant increase in the number of underwriters in India. Today, there are many underwriters operating in India, including both domestic and international investment banks.
The role of underwriters has also evolved over time. Today, underwriters not only help companies issue new securities, but they also provide a range of other services such as mergers and acquisitions advisory, asset management, and securities trading. Underwriters continue to play a critical role in the capital markets by providing issuers with access to capital and investors with access to new investment opportunities.
Process:
When a company wants to issue new securities such as stocks, bonds, or debentures, it approaches an underwriter who assesses the feasibility of the issue and provides a commitment to purchase the securities at a predetermined price. The underwriter then sells the securities to the public or to institutional investors.
The underwriting process typically involves the following steps:
- Initial discussions: The underwriter meets with the issuer to discuss the proposed securities offering and the issuer’s financial condition.
- Due diligence: The underwriter conducts a thorough investigation of the issuer’s financial and operating history, including its financial statements, business plan, and industry trends.
- Securities pricing: The underwriter determines the price and other terms of the securities offering, such as the amount of securities to be issued and the timing of the offering.
- Offering memorandum: The underwriter prepares an offering memorandum that provides detailed information about the securities being offered and the risks associated with investing in them.
- Marketing the offering: The underwriter markets the securities offering to potential investors, typically through a roadshow or other marketing events.
- Securities distribution: Once the underwriter has received sufficient indications of interest from investors, it will allocate the securities and distribute them to investors.
- After-market support: After the securities are distributed, the underwriter may provide after-market support to ensure the securities continue to trade smoothly.
Types of Underwriting
There are two types of underwriting in India; firm commitment underwriting and best efforts underwriting. In firm commitment underwriting, the underwriter guarantees the sale of the entire issue and bears the risk of any unsold securities. In best efforts underwriting, the underwriter agrees to use its best efforts to sell the securities, but does not guarantee the entire issue.
- Firm commitment underwriting: In this type of underwriting, the underwriter agrees to purchase the entire issue of securities from the issuer and assumes the risk of selling them to investors. The underwriter guarantees a specific price to the issuer and is responsible for any unsold securities. Firm commitment underwriting is typically used for larger, well-established companies that have a history of profitability and a strong market position.
- Best efforts underwriting: In this type of underwriting, the underwriter does not commit to purchase the entire issue of securities from the issuer. Instead, the underwriter agrees to use its best efforts to sell the securities to investors, but does not guarantee a specific price or purchase any unsold securities. Best efforts underwriting is typically used for smaller, less established companies or for securities that are more difficult to sell.
Within these two main types of underwriting, there are several variations:
- Bought deal underwriting: In this type of underwriting, the underwriter agrees to purchase the entire issue of securities from the issuer at a fixed price, with the understanding that the securities will be resold to investors.
- All-or-none underwriting: In this type of underwriting, the underwriter agrees to sell all of the securities offered by the issuer, or none at all. If the underwriter is unable to sell all of the securities, the offering is cancelled.
- Standby underwriting: In this type of underwriting, the underwriter agrees to purchase any unsold securities in a rights offering, ensuring that the issuer raises the necessary capital.
Regulation:
Underwriters in India are regulated by the Securities and Exchange Board of India (SEBI) and must comply with the guidelines set forth by SEBI. The guidelines cover aspects such as eligibility criteria for underwriters, minimum net worth requirements, and the responsibilities of underwriters.
SEBI has issued regulations and guidelines for underwriters in India, which cover areas such as eligibility criteria, obligations and responsibilities, code of conduct, and penalties for non-compliance. Some of the key regulations for underwriters in India include:
- SEBI (Underwriters) Regulations, 1993: These regulations define the eligibility criteria for underwriters, including the minimum net worth and experience requirements, and outline the obligations and responsibilities of underwriters.
- SEBI (Merchant Bankers) Regulations, 1992: These regulations cover the eligibility criteria, code of conduct, and obligations and responsibilities of merchant bankers, who often act as underwriters in securities offerings.
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: These regulations specify the disclosure requirements for issuers and underwriters in public offerings of securities, including the disclosure of risks and financial information.
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011: These regulations cover the obligations of underwriters in the event of a takeover or acquisition of shares of a company.
Benefits:
Underwriters play a critical role in the capital raising process by providing companies with the confidence that their securities will be sold. This helps companies raise capital at a lower cost and provides investors with access to new investment opportunities.
Some of the key benefits of underwriters include:
- Access to Capital: Underwriters provide issuers with access to capital by underwriting the issuance of securities, ensuring that the securities are sold to investors at the agreed-upon price. This helps issuers to raise capital for various purposes, such as expanding their business, investing in new projects, or paying off debt.
- Market Liquidity: Underwriters help to create market liquidity by facilitating the trading of securities on the secondary market. By underwriting the securities, underwriters help to ensure that there is a sufficient supply of securities available for investors to buy and sell, which helps to ensure a healthy and active market.
- Price Discovery: Underwriters help to discover the fair market price for securities by setting the initial price of the securities based on market demand and supply. This helps issuers to get a fair price for their securities and helps investors to make informed investment decisions based on market price.
- Due Diligence: Underwriters conduct due diligence on the issuer and the securities being offered to ensure that the information provided to investors is accurate and complete. This helps to protect investors from fraud and misrepresentation and helps to maintain the integrity of the capital markets.
- Risk Management: Underwriters help to manage the risks associated with securities issuance by agreeing to purchase the securities from the issuer at a fixed price, thereby assuming the risk of any unsold securities. This helps to reduce the risk for issuers and investors and encourages the issuance of securities.
Risks:
Underwriters face several risks, such as market risk, credit risk, and reputational risk. If the underwriter is unable to sell the securities or if the market price of the securities falls below the issue price, the underwriter may face losses.
- Market risk: Underwriters assume the risk that the securities they are underwriting will not sell at the expected price. In the case of stocks, this means that the stock may not perform as expected in the market, resulting in a loss of investment.
- Credit risk: Underwriters bear the risk of default by the issuer of the security. If the issuer fails to make interest payments or repay the principal amount, the underwriter may be liable to investors for the shortfall.
- Legal risk: Underwriters are responsible for ensuring that all securities they underwrite comply with applicable laws and regulations. If any violation is discovered, the underwriter may be held liable for any damages.
- Reputation risk: A poorly underwritten offering can damage the reputation of the underwriter, which can affect future business opportunities.
