Last week, Securities and Exchange Board of India chairman Tuhin Kanta Pandey mooted the idea of a regulated pre-IPO share trading platform. The idea, if implemented, has the potential to replace the current unregulated grey market & lead to better price discovery for IPO-bound companies
What did the SEBI chief say?
In his speech last week at a Ficci event, Securities and Exchange Board of India (SEBI) chairperson Tuhin Kanta Pandey had said that with the booming initial public offer (IPO) market, investors are eagerly anticipating what is next, yet pre-listing information is not enough to take an investment decision. “Can we think of an initiative on a pilot basis for a regulated venue where pre-IPO companies can choose to trade subject to certain disclosures?” he asked. Consultations with the corporate affairs ministry and the stock exchanges would be needed to establish a regulated platform for pre-IPO or unlisted companies, he added.
Currently, shares of IPO-bound companies are traded in the grey market where investors speculate on the potential increase in prices when the IPO finally lists. Thus, one of the prime functions of this market is price discovery through the grey market premium which helps investors gauge the listing performance. However, due to increasing demand from retail investors in the bigger IPOs, prices quoted shoot up irrationally. While it is legal and governed by the Companies Act, grey market trade is not regulated by the SEBI.
How does the grey market operate?
Shares of companies not listed on the exchanges are traded over-the-counter between two people who know each other or through a broker. The intermediaries buy shares from employees who have received these under employee stock options (ESOPs) or from existing investors and offer them to buyers. These shares are held in demat form. While this helps in investing in a company at an early stage and avoid the IPO allotment stress, these are not as liquid as listed stocks. They also require a higher investment amount as the minimum lot size is bigger.
While the grey market makes it easier for buyers and sellers to connect, price determination is not transparent and there is no recourse available in cases of a crash in value. The recent surge in investor interest in this market is because of the rise of electronic platforms enabling such transactions. These platforms have turned what was once an informal trading channel into a risky affair for investors.
Are such digital platforms legal?
When securities are offered for sale to unidentified persons without limiting the number of purchasers, it could effectively constitute an indirect public offer. Legal experts say listing securities for sale on a publicly accessible platform may transform a private arrangement into an offer resembling a public offer, which are subject to stringent regulatory norms. Often, such fintech platforms subscribe to securities offered via private placement by a company, later listing them as available for investment by way of transfers from itself to individual investors, presenting them as secondary market transactions.
In its warning in December 2024, SEBI said such activities are in violation of Securities Contract (Regulation) Act, 1956 and SEBI Act, 1992. It had then advised investors not to transact on such electronic platforms.
PIL against such platforms
A Public Interest Litigation (PIL) in the Bombay High Court in June highlighted several risks inherent in such platforms including lack of transparency, and a distorted method of price discovery, with no investor protection or mandatory disclosures.
It said that many platforms misuse the Section 56 (2) of the Companies Act, which permits the transferability of shares to justify broad public solicitation. Such transactions are deliberately structured as secondary sales to avoid regulatory scrutiny and illegally grant retail access to high-risk investments without protection.
The judge observed that the issues raised involve a regulatory vacuum or legislative gap concerning SEBI’s enforcement, and policy-level directives are needed. Hence the PIL was withdrawn with liberty to approach the markets regulator.
Recent cases of price mismatches
The IPO price of HDB Financial Serviceslisted in July, was nearly half of the level it had traded in the grey market. Again, National Securities Depository Limited (Nsdl) had set its IPO band between Rs 700-800 while the grey market had valued it at Rs 1,275per share. Currently, unlisted shares of companies large IPO-bound firms such as Tata Capital and the National Stock Exchange (NSE) are actively traded in the grey markets with high liquidity. Tata Capital is trading at Rs 835 in the unlisted market while its last rights issue was at Rs 343 per share. Similarly, the retail investor base of NSE has risen massively to more than 1 trillion and its share price is currently at Rs 2,095 against the expected IPO price of Rs 1,500. Many retail investors have enter the unlisted space as a short cut to make listing gains, ignoring the fact that the supply of these is limited, leading to a spike in the price.
Thus, better transparency before IPOs via a regulated platform would ultimately benefit retail investors by having fairer listing prices and reducing speculation. The move, if implemented, may also allow investors to trade shares in a transparent environment during the three-day gap between allotment and listing of shares on the stock exchanges.