Underwriting

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Underwriting refers to the activity of taking a risk or part of it in return for a payment known as an insurance premium or commission. It is believed that underwriting originates from the idea and process of risk transferring. The risk is taken by a third party and in turn that party takes premium from the first party. The act of taking risk is termed as underwriting. The process of risk transfer or underwriting began in 1689 in London and it was given a legal coverage by the British Parliament in 1844 through the enactment of company act.

Underwriting new issues of shares means accepting the responsibility of selling them with a guarantee in advance that if the public does not buy the whole issue, the underwriter will take up the remainder. The underwriters work for a commission and after accepting the shares, usually wait for a convenient price and time to sell them in the market. Sometimes, some underwriters such as banks, insurance companies or specialised institutions hold those shares or part of them for enhancing permanent assets in their own investment portfolio. The underwriter also provides advice to a company issuing securities or to an issue manager.

The underwriters buy shares from the issuer under different arrangements namely 'firm commitment', 'best effort' or 'all or none' basis. Firm commitment is an arrangement, in which the underwriter takes the responsibility of selling the entire issue at a specific price. Under the best effort arrangement, the underwriter does not guarantee the sale of entire issue but promises to sell as much of the issue as possible at a mutually agreed price. If the issuing firm is not a reputed one, the two parties may sign and execute a best effort agreement that allows sharing of the risk. The underwriter sells the securities at the best market price it can obtain. Under all or none arrangement, if the entire issue cannot be sold at the offering price, the deal is called off and the issuing company receives nothing. In case of a very large issue, there is the tradition of distributing the securities through collective efforts of the underwriters organised in a syndicate.

The registration of the Karachi Stock Exchange in 1949 laid the foundation of a market place for gilt-edged securities and equity issues of public limited companies in Pakistan. Up to 1952, the equity section of the Karachi Stock Exchange was extremely limited because of the paucity of investment capital and indifference of the business community towards dealing in the stock exchange. In 1952-53, the Pakistan government initiated several steps to strengthen the dealing in the stock exchange. Later, the Pakistan Industrial Credit and Investment Corporation (PICIC), National Bank of Pakistan, Industrial Development Bank of Pakistan and the Investment Corporation of Pakistan were granted authority to underwrite shares to assist the development of the country's capital market. Between 1949 and 1971, these institutions played major role as underwriters both individually and in consortium to broaden the base of investments in the capital market of the country.

The East Pakistan Stock Exchange established at Dhaka in 1954, renamed as the Dhaka Stock Exchange (DSE) Ltd in 1962, remained a small centre until 1971 with only 9 listed companies. Its operations remained suspended during 1971-1975. DSE was reactivated in 1976 with a shift of the government policy toward privatisation. Establishment of the investment corporation of bangladesh (ICB) in 1976 was a major step undertaken by the government to accelerate the pace of industrialisation and develop a well-organised securities market. The underwriting of public issue of shares and debentures was a major responsibility of the ICB. Between 1976 and 1980, ICB underwrote shares of a total value of Tk 400 million. To stimulate the capital flow, the government later allowed bangladesh shilpa bank (BSB) and bangladesh shilpa rin sangstha (BSRS), as well as the public sector life and general insurance companies and the nationalised commercial banks to participate in underwriting of public issue of shares and debentures. BSB and BSRS took part in underwriting individually as well as jointly through consortium of commercial banks, insurance companies, and development finance institutions. As members of the consortium, janata bank, pubali bank, rupali bank and uttara bank participated in underwriting of shares and debentures.

Before granting authority to 17 non-bank financial institutions in 1997 to conduct merchant banking business in Bangladesh under the Securities and Exchange (Merchant Bankers and Portfolio Manager) Regulations 1995, specialised financial institutions, and the nationalised commercial banks and insurance companies were the key underwriters in the country's securities market. Along with the above institutions, 27 private merchant bankers are now engaged in underwriting shares and debentures in the capital market.

The volume of underwriting depends on the increase of new issues of shares (IPOs). Despite the existence of a strong interest of general people of Bangladesh to the capital market, the volume of new issues is too small. The capital market could not flourish due to slow pace of industrialisation. Moreover, investors quite often become least interested to the market due to the dominating role of banks in financing. So the number of IPOs appear in the capital market is very limited. It has been observed that only 14 IPOs were issued per year during 2005-10, whereas the numbers of underwriters were more than 60. In this context, the act of underwriting in Bangladesh became competitive and practically risk free. Because the number of new shares and issues is much lower than the number of investors. So the sell pressure remains always high. It has been observed that from 2005 onward, the number of intending buyers of IPOs was at least 6 to 7 times higher than the number of primary issues. So, not a single underwriter had to take any risk of unsold share. Moreover, the act of underwriting has become an easy source of income to them. [Abul Kalam Azad and Abdus Samad Sarkar]