Sunday, September 25, 2011

SME Exchange - A Success Story?

SME Exchange – A Success Story?
In the coming months, we may see two new stock exchanges, dedicated for the SME sector – first from BSE, to be quickly followed by NSE.  It is easy to be skeptical about this development – what with so many failed regional stock exchanges, failure of a similar earlier attempt in OTCEI (Over The Counter Exchange of India) and the thin trading volumes in majority of the small- and mid-cap listed companies in BSE and NSE. So, what’s different this time?
New SME Listing Norms
SME listing norms are less onerous to comply than those in the regular stock exchanges. Key concessions for SME listing, all aimed at reducing cost and time for SME IPOs,  include Offer Document review only by the relevant Stock Exchange and not by SEBI, disclosure of half-yearly results instead of quarterly results, and no requirement for publishing results in newspapers. 
Few novel ideas are also being introduced in this serious attempt to make SME exchanges a reality, such as mandatory market making by the merchant bankers for 3 years, minimum lot size for application of Rs. 1 lakh and automatic approval of all existing brokers / sub-brokers in main exchanges to transact in SME exchanges. Are these enough?
Key Success Factors
Valuable learning is available from the failure of regional stock exchanges and OTCEI, as well as international experience such as Alternative Investment Market (AIM), a subsidiary of London Stock Exchange. Some of the key success factors include
Strong Gatekeepers to the Exchange: SME exchanges should adopt stringent, analytically determined entry criteria, not in terms of minimum net-worth, turnover or profitable track record, but in terms of strength of the business model, growth prospects, sustainability of profit margins, quality of disclosure, profile of promoters, minimum IPO grading, etc. Preventing crooked promoters from accessing this market will be a crucial element of success for this exchange. The gatekeepers should be equipped to screen applicants just as a Venture Capital or Private Equity investor would do.  Nominated Advisors (Nomads) as in AIM, rating agencies or few other accredited agencies of strong repute can act as gatekeepers.

Create a credible investor base: SME Exchanges, in collaboration with SEBI, RBI and other institutions, should take significant efforts to build a good class of investors – Banks and insurance companies can be encouraged to allocate a small portion of their investment portfolio; institutions such as SIDBI, NSIC and State Industrial Development Corporations can raise dedicated funds that can invest in SME IPOs; Private Banking firms and progressive investment firms can form angel funds of their clients, that will invest exclusively in SME Exchange. A credible investor base, which subscribes to IPOs and also provides adequate liquidity, is key to the success of this initiative.

Spare the small investor:  Investing in SMEs involves a higher degree of risk, given their position in the economic value chain, and vulnerability because of their size.  Retail investors may be ill-equipped to absorb such levels of risk, which are meant only for institutional investors and others who have resources to independently analyse in-depth before investing.  The proposed minimum investment lot of Rs. 1 lakh could still be increased to say, Rs. 5 lakhs, to ensure only institutional investors and HNIs participate in the market.  This could save much heartburn and adverse publicity for both the SME exchanges and the listed SMEs, in case of any failure, which is bound to happen with higher frequency in this asset class.

Create a supporting environment:  Adequate, timely and continuous analytical coverage is a pre-requisite for maintaining investor interest in listed SMEs.  Independent Equity Research reports, funded by stock exchanges or through Investor Protection and Education Fund could be a workable option.  Similarly, creating a set of credible market makers and providing them adequate funding support, much like RBI support for Primary Dealers in Govt. Securities market, would help improve liquidity.

Successful SME exchange, ably supported by large institutions that have a stake in growth of SME sector, can be a magnificent source of capital raising for SME sector. The progressive regulation to date, widespread appreciation of the need for SME exchange and the current vibrancy in the SME sector makes one cautiously optimistic! 

N. Muthuraman is ex-Director Ratings, CRISIL and Co-founder of RiverBridge Investment Advisors Pvt. Ltd., a boutique financial advisory firm.
This is the blog of the Print Version published in Business Line dated 26th Sep 2011

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