The mandatory grading of initial public offers (IPOs) by credit rating agencies will continue for the time being. Market regulator SEBI’s Primary Markets Advisory Committee (PMAC), which had undertaken a review of the grading, has decided to let the process continue for now.

PMAC had examined the issue at its meeting last week following criticism from several quarters. “The general view was to let the grading continue for some more time. Though, globally such a condition was not applicable in any market, it was felt, any experience on this count would benefit other regulators as well,” said a person associated with the exercise.

Also, it was felt that though mandatory grading may not have yielded discernible benefits, at the same time, it had not been detrimental to the interest of the equity market in the country, the person said.

SEBI had asked PMAC to review the grading of IPOs that was made mandatory in May, 2007. The mandatory grading has come in for criticism from industry, which wants the process to remain optional. It has argued that the mandatory grading has increased the cost of raising funds but also led to delay in the IPO process which the market regulator was attempting to make faster and shorter.

Grading expenses can be as high as one percent of the total issue size. SEBI regulations require that no unlisted company can make an IPO of equity shares or any other security which may be converted into or exchanged with equity shares at a later date, unless it has obtained grading for the IPO from at least one credit rating agency.

Since market regulator also vets all public issues applications, the mandatory rating is seen as an unnecessary hurdle, especially for smaller firms. Moreover, it is felt that the rating of equity offers has real significance as it is not a comment on the pricing of offers, so offers could continue to be mispriced. Rating agencies typically assign grades ranging from 1-5 where grade 1 shows poor fundamentals while grade 5 is strong fundamentals. Thus, there is no real indication to investors in terms of valuation of IPOs.

While rating from at least one agency is mandatory for an IPO, a company has to disclose all grades it obtains in the prospectus. Mandatory rating of debt offers has been in practice for sometime now.

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