Unlisted Securities: A High-Stakes Gamble That Attracts India’s Retail Investors

Interest is growing. According to analysts, monthly trading volumes of unregistered securities will increase to $300 million in 2024 from $50-60 million last year. The reason: The total return of the Primex 40 index, which tracks leading private companies, has reached 25.85% compared to 15% in the Nifty 500. However, over the past three years, the Primex 40 has lagged behind, delivering 12.62% compared to 17.91% in the Nifty-500 Multicap.

The top three unlisted companies by market capitalization are NSE, Tata Capital and Nayara Energy, while BIRA and NCDEX remain at the bottom.

Here’s how it works. Equity platforms help ESOP holders or early stage investors sell their shares before the company goes public. They do this by buying shares from investors and selling them to other investors.

Arjun Jaiswal, an investor for four years, exemplifies this growing trend. Frustrated by the limited opportunities in the listed market, he recently ventured into unlisted securities. “I wanted to get some early-stage companies in to get better returns,” he said. Despite the risks, including whether the shares will ever go public, he’s undaunted by setting aside a small portion of his portfolio as he continues to look for new opportunities.

Sandeep Nirwan, an Ahmedabad-based investor, has applied for more than 100 initial public offerings (IPOs) and received allocations in only three. Then he turned his attention to private space. Its portfolio includes investments in Swiggy, Five Star Business Finance, Ixigo, Capital Small Business Finance, OYO, API Holdings, Metropolitan Exchange and NSE.

“Out of more than 100 applications, I was allocated only three, and one of them is marked as premium. This is the main reason why I started investing in the pre-IPO stage,” explained Nirvan.

The potential for significant profits compels him to invest in this space. “Swiggy has almost doubled, Five Star is up 40%, Ixigo is showing 60% growth and OYO has 70% growth. Only API (PharmEasy) is trading 40% below my purchase price,” he added.

Lower brokerage fees and stamp duty increase the attractiveness of pre-IPO investments, Nirvan noted.

The pre-IPO segment has been a significant driver of this surge, as investors flock to companies preparing for a public listing, attracted by the potential for lucrative returns. Mint reported in August.

Standard heat on the platforms

However, the rapid expansion of the market did not go unnoticed by regulators. Over the past two months, Sebi has stepped up scrutiny of platforms that facilitate trading in unlisted securities.

In November, the regulator flagged three platforms for offering non-convertible debentures (NCDs) in violation of the Companies Act. In December, it issued a broader warning highlighting the lack of investor protections, such as grievance and dispute resolution mechanisms, on unregistered platforms.

“The unlisted space has attracted a significant number of investors over the past three years, driven by a wave of IPO exits. Investors feel that if they cannot get direct access to the IPO, they can still take advantage of the opportunities through pre-IPO investments,” explained Narinder Wadhwa, managing director of brokerage SKI Capitals.

“This space is gaining popularity, in part due to a sense of FOMO (fear of missing out) as investors see others participating. There is significant trading activity in shares of companies such as NSE, NSDL and OYO, especially those that have filed their DRHPs and are awaiting IPO launch,” Wadhwa said.

Suvajit Ray, head of product and distribution at IIFL Capital, stressed that major brokerages refrain from advising investors to trade in unlisted securities due to low liquidity and high risks, but added that there are several websites that offer such services.

What the platforms say

Platforms play a key role in the over-the-counter securities market, acting as intermediaries that provide liquidity to early stage investors or Esop holders in companies preparing for public offerings. These platforms allow investors to buy shares from these early stakeholders and sell them to others who expect to profit after the IPO.

Kashish Sharma, chief executive of Equity List, a platform for capitalization and stock option management, noted that many venture capital-backed companies use these secondary trading platforms to gauge IPO readiness, functioning somewhat as a pre-roadshow.

However, “there are no clear accreditation checks, which lowers the barriers to entry,” he explained, highlighting the lack of oversight compared to other investment platforms.

SKI Capitals’ Wadhwa noted that platforms associated with regulated entities, such as brokerage firms, tend to instill more investor confidence. Investors feel confident that their obligations will be met when platforms have links to regulated activities, he said.

Amid rising demand, Sebi warned investors against trading on unauthorized platforms and urged them to exercise caution. However, some platforms argue that the current regulatory vacuum requires a more structured system to meet market needs.

Precize, an unregulated platform, has approached Sebi for advice on obtaining regulatory clearance. “Obtaining regulatory approval to operate as a trading platform for unregistered securities presents significant challenges. We welcome Sebi’s clarity and guidance on navigating this process and will adapt as the regulatory landscape evolves,” the platform said in a statement.

A recent Sebi advisory highlighted the illegal nature of trading on unregistered platforms, stressing that only recognized stock exchanges are allowed to facilitate trading in securities that are “registered” and “quoted”.

Ketan Mukhia, senior partner at Burgeon Law, described the advisory as a clear warning to unauthorized platforms to cease operations and obtain proper authorization.

Wadhwa pointed out that this is not Sebi’s first intervention. Similar recommendations were issued in 2016, but many investors continued to use these platforms despite the risks. Sebi’s latest warning highlights the challenges in regulating this unstructured space, he said.

Another unregulated, unlisted platform, Kart, has argued that India could adopt the practice of the US pre-IPO market, where accredited investors are allowed to trade shares before companies go public. He suggested that off-market transactions, where buyers and sellers connect directly, could mitigate regulatory problems.

“In case of fraud, investors can file complaints with the police, but there is no guarantee of protection,” he warns, advising investors to deal only with verified dealers.

Debt securities

A recent Sebi surveillance found that some unlisted platforms solicited and sold unlisted non-convertible debentures (NCDs) to retail investors in violation of the Companies Act, 2013.

The regulator highlighted the differences between public issues and private placements, warning that uncontrolled operations of these platforms expose the public to significant risks. Sebi also highlighted the lack of investor protections, such as grievance mechanisms and online dispute resolution, making these transactions particularly risky.

According to Damodar Desai, partner, Little & Co, those who list securities on unauthorized platforms can face significant penalties both under the Securities Contracts (Regulation) Act and Sebi rules. Penalties include fines up to ₹25 crores or imprisonment up to 10 years.

Several companies whose shares are traded on these unregulated platforms have distanced themselves from such activities. For example, consumer electronics company Unicorn BoAt explained that it is not affiliated with any platform and is not involved in listing its shares on such platforms. “Those who participate in these platforms do so at their own risk,” a boAt spokesperson said.

Raja Singh Bhurjee, chief executive of The StepUp Ventures, noted that while pre-IPO trading offers early access to fast-growing companies, it also creates risks for startup workers, who often sell their ESOPs on unregulated platforms because of the lack of buybacks. parameters.

While Sebi’s warning may initially reduce liquidity for such operators, Bhurji believes the focus on compliance and investor protection will eventually lead to safer alternatives such as trading through recognized exchanges.

Looking ahead

Legal experts predict that Sebi will increase supervision, strengthen regulations and impose penalties against unauthorized activities in unlisted securities.

Sanjay Israni, partner, Desai & Diwanji, advised platforms to comply with Sebi’s guidelines, which include proper registration, disclosure requirements and grievance redressal systems. It also recommended strong cyber security measures and regular audits to maintain compliance.

As the unlisted securities market continues to grow, Sebi’s evolving regulatory framework will play a key role in balancing investor protection with promoting a more transparent and secure environment for secondary trading.

And read | IPOs will increase after the average size doubles ₹2,000 crore this year: Kotak’s S Ramesh