Underwriting is an agreement, entered into by a company
with a financial agency, in order to ensure that the public will subscribe
for the entire issue of shares or debentures made by the company. The
financial agency is known as the underwriter and it agrees to buy that
part of the company issues which are not subscribed to by the public in
consideration of a specified underwriting commission. The underwriting
agreement, among others, must provide for the period during which the
agreement is in force, the amount of underwriting obligations, the period
within which the underwriter has to subscribe to the issue after being
intimated by the issuer, the amount of commission and details of arrangements,
if any, made by the underwriter for fulfilling the underwriting obligations.
The underwriting commission may not exceed 5 percent on shares and 2.5
percent in case of debentures. Underwriters get their commission irrespective
of whether they have to buy a single security or not.
Underwriting has become very important in recent years
with the growth of the corporate sector. It provides several benefits
to a company:-
- It relieves the company of the risk and uncertainty of
marketing the securities.
- Underwriters have an intimate and specialised knowledge
of the capital market. They offer valuable advice to the issuing company
in the preparation of the prospectus, time of floatation and the price
of securities, etc. They also provide publicity service to the companies
which have entered into underwriting agreements with them.
- It helps in financing of new enterprises and in the
expansion of the existing projects.
- It builds up investors' confidence in the issue of securities.
The association of well-known underwriters lends prestige to the company
and the investors feel that the issue is sound enough for profitable
investment. Also, the securities underwritten by reputed underwriters
receives better response from the public.
- The issuing company is assured of the availability of
funds. Important projects are not delayed for want of funds.
- It facilitates the geographical dispersal of securities
because generally, the underwriters maintain contacts with investors
throughout the country.
Types of underwriting
- Syndicate Underwriting:- is one in which, two or more
agencies or underwriters jointly underwrite an issue of securities.
Such an arrangement is entered into when the total issue is beyond the
resources of one underwriter or when he does not want to block up large
amount of funds in one issue.
- Sub-Underwriting:- is one in which an underwriter gets
a part of the issue further underwritten by another agency. This is
done to diffuse the risk involved in underwriting. The name of every
under-writer is mentioned in the prospectus along with the amount of
securities underwritten by him.
- Firm Underwriting:- is one in which the underwriters
apply for a block of securities. Under it, the underwriters
agree to take up and pay for this block of securities as ordinary subscribers
in addition to their commitment as underwriters. The underwriter need
not take up the whole of the securities underwritten by him. For example,
if the underwriter has underwritten the entire issue of 5 lakh shares
offered by a company and has in addition applied for 1 lakh shares for
firm allotment. If the public subscribes to the entire issue, the underwriter
would be allotted 1 lakh shares even though he is not required to take
up any of the shares.
Types of underwriters
Underwriting of capital issues has become very popular
due to the development of the capital market and special financial institutions.
The lead taken by public financial institutions has encouraged banks,
insurance companies and stock brokers to underwrite on a regular basis.
The various types of underwriters differ in their approach and attitude
towards underwriting:-
- Development banks like IFCI,
ICICI and IDBI:- they follow an entirely objective approach. They stress upon the long-term
viability of the enterprise rather than immediate profitability of the
capital issue. They attempt to encourage public response to new issues
of securities.
- Institutional investors like LIC
and AXIS:- their
underwriting policy is governed by their investment policy.
- Financial and development corporations:- they also follow
an objective policy while underwriting capital issues.
- Investment and insurance companies and stock-brokers:-
they put primary emphasis on the short term prospects of the issuing
company as they cannot afford to block large amount of money for long
periods of time.
To act as an underwriter, a certificate of registration
must be obtained from Securities
and Exchange Board of India (SEBI) . The certificate is granted by
SEBI under the Securities
and Exchanges Board of India (Underwriters) Regulations, 1993. These
regulations deal primarily with issues such as registration, capital adequacy,
obligation and responsibilities of the underwriters. Under it, an underwriter
is required to enter into a valid agreement with the issuer entity and
the said agreement among other things should define the allocation of
duties and responsibilities between him and the issuer entity. These regulations
have ben further amended by the Securities
and Exchange Board of India (Underwriters) (Amendment) Regulations, 2006.
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