Grey market Premium Meaning IPO
For many individuals living in this colourful world, for them, Black and white are two ends of the same paradigm, with black conveying all that is wrong and white standing for all that is pure and correct. But when you come out of the imaginary world, “only” Black or white life is impossible. Thus, at some point, we adopt a middle path, the grey.
A grey market, also known as a parallel market, is one where trading of goods takes place outside the realm of the manufacturer’s official trading channels.
A grey market in the securities markets is an over-the-counter market where dealers execute orders for stocks and bonds for preferred customers before they have been issued. These sales are contingent upon the issuance actually taking place, and allows underwriters and the issuer to determine demand and price the securities accordingly before the initial public offering or bond issue. In grey market trading, while the trade is binding, it cannot be settled until official trading begins.
A typical example of a grey market is a small business selling merchandise of a particular company even though they are not the authorised dealers in the market. But it is important to note that the small businesses doing this are legal entities.
In comparison, a black-market deal with goods that are generally smuggled into the country to avoid paying import duty and other charges.
Since stocks are bought and sold in the stock market (like any other market), a parallel market exists here too.
What is IPO grey market?
An IPO grey market is one where a company’s shares are bid and offered by traders unofficially. This takes place before the shares are even issued by the company in an Initial Public Offering.
Since this is an unofficial market, there are no rules and regulations. Market regulators like Securities and Exchange Board of India (SEBI) are not involved in these transactions. The regulator doesn’t endorse this either.
Grey markets are generally run by a small set of individuals. All deals are based on mutual trust.
Grey Market Premium
Grey market premium is a premium amount at which grey market IPO shares are traded before they get listed in the stock exchange. In simple words, the stock of the company that came up with the IPO bought and sold outside the stock market.
The GPM reflects how the IPO might react on a listing day. For instance, if the company introduces an IPO or Rs.100 and the grey market premium is around Rs.20 then we can assume the IPO to list around 120 rupees on listing day. There is no reliability but, in most cases, the GMP works properly and IPO list around the given price.
For instance, let’s assume the issue price for stock X is Rs 200.
If the grey market premium is Rs 400, it means that people are ready to buy the shares of company X for Rs 600; (i.e., 200+400).
This is how a typical deal works out in the grey market.
As stated earlier, the grey market is an unofficial market. For a regular investor, the grey market can be best seen as an indicator of how the stock performs after it gets listed.
How does Grey Market work?
In the grey market, there are 2 ways to earn income. The first method is you can buy/sell the IPO shares in the grey market before they are listed on the stock exchange. The second method is you can sell your IPO application at a certain price.
Trading IPO Shares in the Grey Market:
Investors apply for shares via IPO. They take a financial risk as they may not get allocated any share or they receive the shares but shares may list below the issue price. These are referred to as sellers.
Few individuals who think that the share values more than its issue price. They start collecting these shares even before they are allocated through the IPO allotment process. These are referred to as buyers.
Buyers place the order to buy IPO shares at a certain premium by contacting the grey market dealers.
Next, the dealer contacts the sellers who applied in the IPO and ask them if they are willing to sell their IPO shares at a certain premium at this time.
Meanwhile, if the sellers are not willing to take risk of stock market listing and like the premium, they may sell the IPO shares to the grey market dealer and book the profit. However, the seller has to finalize the deal with the grey market dealer at a certain price.
The dealer gets the application detail from the seller and sends a notification to the buyer that he bought a certain number of shares from the sellers in the grey market.
The allotment is done and sellers may or may not receive an allotment of shares.
If shares are allocated to the investor, he may either get a call from the dealer to sell them at a certain price or transfer allocated shares to some Demat account.
If the investor is selling the shares, the settlement is done depending on the profit or loss and the grey market premium at which buyers and sellers made a deal.
In case if no shares are allocated to the sellers the deal gets canceled without any settlement.
Trading IPO Applications in the Grey Market:
Similar to IPO shares trading, even IPO applications include sellers and buyers.
Buyers determine the price of the application depending on multiple assumptions and market conditions. They give an offer to the sellers that they are willing to buy an IPO Application at a certain premium.
To be on the safe side, sellers may sell their application at a certain premium to the buyer through a grey market dealer.
Here, there is no need for the seller to worry about the share allotment in IPO. Even if he didn’t get any allotment, he still gets the grey market premium at which he sold his IPO allocation.
The seller sends a detailed form to the dealer. Further, the dealer sends a notification to the buyer that he bought an IPO application at a certain premium from the sellers in the grey market.
The allotment is done by the issuing registrar. The application seller sold may or may not receive an allotment of shares.
If shares are allocated to the sold application, either seller may get a call from the dealer to transfer allocated shares to some Demat account or sell them at a certain price.
In the case of selling the shares, the settlement is done based on the profit or loss.
If there are no shares allocated to the sellers, the deal is said to be over without any settlement. However, the seller still gets his premium as he sold his application.
How is the price arrived at?
Usually, it the merchant banker, company promoter and market operators connected to the promoters who set the initial price in the grey market. This is done to create an impression of a strong demand for the issue.
Does this strategy always work?
Like the official market, the grey market too pays attention to fundamentals. If the company’s fundamentals are good, players are willing to pay a decent premium. If not, merchant bankers cannot influence the price beyond a point.
Are there other factors which decide the grey market price?
The grey market price also factors in the cost of funding for high networth individuals, who make big bets using borrowed money. Remember, it is the market operators and HNIs who are the biggest players in the grey market.
Also, the pricing of the issue and overall market sentiment also influences grey market trends. If the issue is perceived to be overpriced, grey market premium will shrink. That is because of the assumption that there may not be too many takers for the stock on listing day if it is seen to be expensive. Also, if the overall market trend is downward, follow-up buying on listing day may not be much.
If the shares are yet to be allotted, then how are the trades done?
The trades are done purely on faith, and then ‘regularised’ on listing day by entering the orders into the trading system.
Sellers in the grey market are usually those who feel that the shares are overvalued. The moment they get their allotment, they hand it over to their brokers through whom they had sold in the grey market.
Advantages of the grey market
IPO Grey Market allows the investors to back out of the IPO, even before its listing. The investors can take advantage of the price movement before its listing.
In the case of financial securities, this market provides the issuer and the underwriter with an estimated figure of share price and valuation before going public.
Such a Market of goods provides the same authorized product by the same authorized manufacturer at a discount price. Lower prices attract customers towards this market.
All those securities which have suspension from trading on the stock exchange get an opportunity to trade in IPO Gray Market.
This market helps the manufacturer in the short run. It helps the producer to enhance its incremental sales and gain profits from both unofficial and official distribution channels, in the short run.
Sometimes, official distributors are often the ones who are supplying goods to the Gray Market. Since they get bulk discounts from the manufacturers and in order to get rid of excess supply, they make a higher profit by supplying directly to Gray Market.
IPO Grey Market is the best market place for start-ups, to decide on whether to go public or not. It helps the startups in their valuation process.
Disadvantages of grey market
The price estimates on the basis of the premium are not always reliable in the IPO Grey Market. Sometimes due to additional subscriptions from the institutional investors, there is a great influence on the price range.
As there is a very a smaller number of people in the IPO Gray Market, the estimates not always show the true picture.
In the case of goods, since the delivery takes place through an unauthorized channel and dealer, there is no ‘After Sales Service’ for the customers.
Products under this market come up with a high risk. Irrespective of manufactured under the same brand same, it does not guarantee the quality of the products.
Gray Market of financial securities is not under any regulatory authority. This enhances manipulation and makes it risky.
Due to riskiness, many institutional investors like Pension Funds, Foreign Direct Investments (FDIs), Foreign Portfolio Investments (FPIs), Mutual Funds; etc avoids investing in Gray Market.
It negatively hampers the brand name of the manufacturer. If the product does not qualify the quality standards, ultimately the brand name of the manufacturers suffers.
Such unauthorized delivery channels also negatively impact the regular supply channel of the company which includes designated retailers, distributors, and wholesalers. Thereby hampering the price stability of products.
Official distributors of the company help in advertising and business development. Unofficial distributors of this market do not provide any such assistance to the manufacturer.
How did the grey market in IPOs come about?
In case they are not allotted the same number of shares they had sold in the grey market, they will have to buy the shares from the market and give it to their broker.
In the majority of the cases, they give the power of attorney to their brokers to sell the shares as soon as it lands in their demat accounts.
What if somebody refuses to honour a grey market commitment?
The counterparty has no recourse because this arrangement is not legal in the first place.
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