Primary Market Definition The primary market refers to the market where equity or debt capital is raised by issuers from public investors through an offer of securities. It is called the primary market because investors purchase the security from the issuer. Itis also called the “new issue market” where securities are issued for the first time. The process of expanding the ability of an issuer to raise capital from public investors, who may not have been associated with the initial stages of the business, is also known as “going public.” The issuance of securities in the primary markets expands the reach of an issuer and makes long-term capital available to the issuer from a larger number of investors Raising capital for a company may also be conducted through a syndicate of institutional investors who buy equity or debt securities through a private placement. This is also a primary market activity but the investors in these securities are a few pre-identified institutional investors. An issuer who seeks capital through the primary market has to work with an investment banker. The investment banker gauges the readiness of the business. to raise fresh capital, structures the instrument to be issued, enables pricing the issue, identifies the investors to whom the securities will be offered and manages the entire capital mobilization process. The investment banker earns fee for such services. Primary market issues may also need arrangements such asa syndicate of investors to buy a portion of the issue, or underwriters, who would subscribe to the securities being offered, for a fee, if the issue fails to garner the required response Securities offered in the primary market are distributed through a network of brokers to prospective investors.The security issuance process varies depending on the nature of the issue, the size and the target investors. © The ability of a company to raise funds from such external sources will depend upon the performance of the company in the past and the expected performance in the future. * Outside investors will also require protection against a possible default on getting their dues or their rights getting diluted. This protection is available to them. ‘* Investors may also require the flexibility to review their investment and exit the investment if need be. A security provides this facility as itis listed on the exchanges. © The primary market for equity shares is regulated by SEBI. A number of market intermediaries are involved in the primary market and all these are regulated by SEBL. * The primary market for debt securities has two regulators VThe primary market for government securities is regulated by the RBI. vThe primary market for corporate bonds is regulated by SEBI VThe primary market for depository receipts (ADRs/GDRs) is regulated by SEBI Functions of the Primary Market The primary markets serve the following functions: 1. Explorelarger markets for capital By involving other investors in raising money for an issuer, the primary market enables tapping 2 larger market for its capital requirements. When an Indian company issues 2 global depository receipt (GDR) in the Euro markets, it reaches out to institutional and retail investors in those markets who may find investing in a growing Indian enterprise an attractive proposition. For raising capital, the primary market enables a company to shift from the known sources of funding (i.e. from its promoters, interested parties,banks and such close-knit arrangements) to the new investors who can potentially subscribe to the company’s capital. 2. Encourage Competitive Process Seourities are issued for public subscription at a price that is determined by the demand and supply conditions in the market. The rate of interest a debt instrument will have to offer and the price at which an equity share will be purchased are dependent on the pricing mechanisms operating in the primary market. For example, government securities, which are issued by RBI on behalf of the goverment, are priced through an auction process. Banks and institutional investors are the main buyers of government securities, and they bid the rates they are willing to accept and the final pricing of the inetrument depends on the outcome of the auction. This enables fair pricing of securities in the primary market. 3. Diversify Ownership As new subscribers of equity capital come in, the stakes of existing shareholders reduce and the ownershio of the business becomes more broad-based and diversified. As the company expands and seeks capital from the public, ownership and management gets separated. Since it is not feasible for thousands of shareholders holding a small proportion of capital each, to be involved in managing the company, professional managers workin the broad interest of a large group of diverse shareholders. Publicly held companies also have professional independent directors who represent the interest of common small shareholders which enhances the governance standards of the companies. Thus, the primary market facilitates diversification of ownership which in turn strengthens governance norms. 4, Better Disclosures A business that seeks to raise capital from new investors has to meet higher standards of disclosure and transparency. Investors need to have adequate, relevant, accurate and verifiable financial and other information about the business before buying the securities being offered. Thus, the primary market brings about transparency between the businesses and the investors through means of disclosures by various firms raising capital. 5. Evaluation by InvestorsThe infomation provided by the issuer company is evaluated by a large number of prospective investors. Thus, investor evaluation forms another layer of scrutiny of the operations and performance of the company, apart from its auditors and regulators. Apart from these groups (investors, auditors and regulators), the publicly disclosed financial statements, reports, prospectus and other information are scrutinized and discussed by the analysts, researchers, activists, and media Thus, evaluation by various groups helps the investors to make informed decisions 6. Exit for Early Investor Promoters, private and inside investors who subscribed to the initial capital requirements (early requirements for capital of a business) are able to seek an exit in the primary markets by selling their stakes fully or parlly as required. They invest in early- stage business with the intent to nurture the business to a level at which public and other investors would be interested Aprimary market offer of securities provides them the opportunity to exit their investments at a profit. 7. Liquidity for Securities When capital is held by a few inside investors, the equity and debt securities held are not liquid, unless sold in a chunk to another set of interested investors. A primary market, issue distributes the securities to a large number of investors and it is mandatory to list a public issue of securities in the stock exchange. This opens up the secondary market where the securities can be bought and sold between investors, without impacting the capital raised and used by the business 8 Regulatory Supervision Inviting outside investors to subscribe to the capital or buy securities of an issuer comes under a comprehensive regulatory supervision. The issue process, intermediaries involved, the disclosure norms, and every step of the primary issue process is subject to regulatory provisions and supervision. The objective is to protect the interest of investors who contribute capital to 2 business which they may not directly control or manage. While there is no assurance of retum, risk, safety or security, regulatory processes are designed to ensure that fair procedures are used to raise capital in the primary market, adequate and accurate information is provided, and rights of all parties is well defined, balanced and protectedIntermediaries in Primary Market The different intermediaries that function in the primary market for equity and debt securities include: Merchant bankers - These are entities that provide services connected with the management of a primary issue of securities. Such services include advising the issuer regarding the pricing of the issue, preparation of the issue document, application for listing of securities, advertising the issue, finalizing the allotment and generally managing all aspects of the issue process Merchant bankers also act as the undenwriters to the issuei.e. they provide a commitment to subscribe to the issue of securities in the event of failure of the issue to get full subscription from the public. They receive a commission for providing such commitment. Their obligations are defined in their agreement. Book Running Lead Managers (BRLM) - An issuer may appoint several merchant bankers for managing @ primary issue of securities. One of these merchant bankers is known as the Book Running Lead Manager (BRLM). The BRLM is specifically responsible for some activities such as the due diligence of the issuer's operations, drafting and vetting of the prospectus and other issue documents, compliance with requirements of SEBI, stock exchanges and other laws and the marketing of the issue. Key postissue responsibilities of the BRLM include finalizing the basis of allotment, managing the money in the escrow account and coordinating the activities of the other intermediaries such as bankers to the issue and registrars to the issue. Registrar and Transfer Agents (RTA) ~ Registrars are entities that maintain a record of, applications and money received from investors in a primary issue. They assist the issuer in determining the basis of allotment of securities. After the allotment is finalized, registrars are responsible for processing and dispatching allotment letters, refund orders etc. Share Transfer Agents maintain records of holdings of securities. They handle matters relating to transfer and redemption of securities and act as DPs. Bankers to the issue-These are banks that are specifically appointed by the issuer for managing the sale proceeds of the issue of securities. They are engaged in acceptance of applications for securities along with application money from investors and also refund of application money to unsuccessful applicants. They are required to maintain daily records regarding number of applications and application money received and refunds made. Brokers to the issue-These are stock brokers that are responsible for procuring subscription tothe issue. They serve as the link between prospective investors and the issuer.Depositories and Depository Participants A depository holds sacutities in electronic fom and enables processing of securities transactions by means of a book entry. The process of conversion of physical securities to electronic form is known as dematerialization. The depository becomes the registered owner of securities that are dematerialized while the investor remains the beneficial owner. A Depository Participant (OP) isan agent of the depository through which it interfaces with the investor and provides depository services. The actual process of dematerialization is undertaken by the DP. Debenture Trustees- These are appointed to safeguard interests of debenture holders. They arerequired to be appointed before an issue of debt securities. They must exercise due diligence to ensure that the secured assets are sufficient to discharge claims of debenture holders. They must ensure calling of a meeting of all debenture holders when is required by at least one-tenth of debenture holders or in the event of any default by the issuer. Portfolio Managers-These are entities that advise clients regarding investments or manage a portfolio of investments on behalf of the client in accordance with an agreement. Portfolio managers can be categorized as discretionary or non-discretionary. A discretionary portfolio manager manages the funds of each client in an independent menner but in accordance with the needs of the client. A non-discretionary portfolio manager manages the funds in accordance with the directions of the client. Primary Dealers - These are entities that are licensed by the RBI to act as underwriters for securities issued by the RBI on behalf of the government. Primary dealers have an agreement with the RBI which defines their underwriting obligations. They receive an underwriting commission in return for their commitment. Primary dealers subscribe to government securities in auctions announced by the RBI and then resell these securities in the secondary market. All these intermediaries (except the primary dealers) must be registered with SEBI 10 function as intermediaries. Each intermediary is required to follow the Code of Conduct framed under the applicable SEB! regulations. Primary dealers are authorized by the RBI to act as such. Types of Issues All primary market issues need not be public issues. A primary issue of securities is made to promoters when a company is set up and equity shares are issued to them; ifbonds are issued to institutions that lend to a company, that is also a primary issue, but issued privately only toa select set of investors. it is common for companies in early stages to issue equity capital to venture capitalists and private equity investors, who help the business to grow in size and scale. When an issuer does not choose any specific group of investors, but offers securities inviting anyone interested in buying the securities of the business, we have a public issue. Issuance of capital in the primary market can be classified under four broad heads: + a. Publicissue: Securities are issued to the members of the public and anyone eligible to invest can participate in the issue. +b. Private placement: Securities are issued to a select set of institutional investors and other eligible investors, who can bid and purchase the securities on offer. This is primarily a wholesale issue of securities to institutional investors. +. Preferential issue: Securities are issued to an identified set of investors, on preferential terms, along with or independent of a public issue or private placement. This may include promoters, strategic investors, employees and such specified preferential groups. + d. Rights and bonus issues: Securities are issued to existing investors as ona specific cut-off date, enabling them to buy more securities at a specific price (rights) or get an allotment of additional shares without any consideration (bonus) When a public issue is made, it is common to have a portion issued preferentially, or as tights, and for a portion to be privately placed to institutional investors, before the issue is open for subscription by retail investors. The investment banker who is responsible for the issue will work out how much has to be offered to whom and at what prices, within the framework of regulation and in consultation with the issuing company. Types of Issuers An issuer in the primary market is the entity seeking capital through the issue of securities. The securities are part of the equity or debt capital of the entity, on its balance sheet. The primary responsibility to meet obligations associated with the security being issued rests on the issuer. For example, an issuer of bonds is responsible for paying interest and returning the principal on maturity; an issuer of equity shares is responsible to pay dividends as and when declared and notify equity shareholders about resolutions being brought for their approval through voting in the annual general meeting. The following is a summary of issuers in the primary markets for securities’ Issuer ‘Type of Securities Specific Needs and‘Structures Central, State and Local Governments Bonds (G-secs) Treasury bills Sovereign Gold Bonds (cB) Donotissue equity capital Only Central Government issues T-bills Instruments carry government guarantee Issued only in domestic markets in India Public Sector Units Equity shares Bonds May offer equity held by the Government to the public as disinvestment Bonds may have special tax concessions Private Sector Companies Equity shares Preference shares Bonds Convertible bonds Commercial Paper Securitized paper High dependence on securities markets for raising capital May issue equity and debt instruments in intemational markets Banks, Non-banking Finance Companies, and Financial Institutions Equity shares Preference shares Bonds Convertible bonds Securitized paper Commercial paper Certificates of deposit Banks have low dependence on securities market due to access to public deposits May offer long- term bonds and preference shares as Tier-2 capital Issues may have special tax concessions May issue ininternational markets Mutual Funds Units © Capitalis raised for specifically defined schemes * Schemes may be issued fora fixed tenor (closed-end) or as open ended schemes ‘Types of Investors:- * Association of Persons + Banks + Companies * Limited Liability Partnerships (LLP) + Financial Institutions + Mutual Funds + Insurance companies * Foreign Portfolio Investors (FPls) * Hindu Undivided Family (HUF) + Minors through guardians * Non-resident Indians (NRI) + Persons of Indian Origin (PIO) + Registered societies and clubs + Resident individuals + Partnership firms + Trusts Individual investors are further categorized based on the amount invested as: + Retail Individual Investors who invest not more than Rs.2 lakhs in a single issue and;+ Non-Institutional Buyers (NIBs) who invest more than Rs. 2 lakhs in a single issue. The other category of investors is the institutional investors and is also known as Qualified institutional Buyers (QIBs) The foreign investors may use foreign currency to buy securities, but their purchase and sale is subject to the foreign exchange rules and regulations in force. ‘Some securities may be available only to specific categories of investors. The information about who can purchase securities being offered is provided in the offer document. Regulatory Framework for Primary Markets The detailed guidelines on raising capital through issue of securities by a company are given by = * The Companies Act, 2013 * Securities Contracts (Regulation) Act, 1956, ‘* SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 Government securities are issued by RBI on behalf of the government and are subsequently listed on stock exchanges. Government Securities are govemed by (The primary issue of government securities does not come under the regulatory purview of SEBI) > ‘* The Government Securities Act, 2006 © The Government Securities Regulations, 2007 Instruments such as certificates of deposit and commercial paper are money market securities, whose issuance is governed by RBI. The provisions of these aforementioned Acts and Regulations regulate the following with respect to public issues: + Eligibility to make public issue + Information to be provided to the public and regulators + Reservation for different categories of investors + Methods of making the offer to investors+ Timelines for the public issue process + Usage of funds raised in issues + Continued involvement and accountability of promoters and other inside investors + Provision for investors to continuously evaluate the investment and execute investment and exit decisions.