The Long-run Performance of UK IPOs

Question: Discuss the underwriting risks facing the investment banks involved in an IPO. Explain the auction process for UK government securities. Answer: The risk of underwriting can be said to be the risk of loss on the underwriting activity that happens in the securities industries. Underwriting is an important activity of the investment bank when it comes to an IPO because it mitigates the risk. However when it comes to the investment banks, they face risks in an IPO (Goergen et. al, 2007). IPO is of a greater stature and high stake is involved in it. Firstly, an underwriting risk happens when an investment bank overestimates the demand considering an underwritten issue or when the condition of the market changes all of a sudden. This tends to bring more risk to the investment bank and can lead to financial loss if the demand is not ascertained in a proper and an accurate manner. In this scenario, the underwriter or the investment bank may be forced to hold that chunk of the issue or to sell it in a loss. Holding the issue tend to curb the financial freedom. Secondly, when the issuing firm underperforms subsequent to the issue and puts the investment of the shareholders at a loss, then the investment banks as an underwriter are likely to face class action lawsuit on them that destroys their image and reputations too. This also leads to problem in getting any underwriting assignment in the future leading to failure in future. Hence, it puts the investment bank into a serious problem. The issue may remain unsold and therefore, it may cause a huge to the investment banks. Therefore, underwriting is a risky venture and more when it comes to an IPO. The U.K. government has used auctions as the principle means for issuing its securities. For example, Gilt is a U.K. government security and bidders can choose to take part in the auction through (GEMM) Gilt-edged Market Maker who can directly bid by telephone to the (DMO) Debt Management Office on the behalf of the bidder and are accepted on both competitive and non-competitive basis. The Auction process can be broken down into various parts: Generally eight calendar days before the Auction, an Auction announcement is done that states the amount of stock to be auctioned. The announcement is done so that it comes to the forefront of the stock to be auctioned (Katehakis Puranam, 2012) The prospectus, as well as an application for the sale is published prior to the auction. This helps to brief the public about the auction and can be termed as a window through which the public can look into the prospect of the auction. Public of prospectus is the initial step and it informs the public that an issue is likely to be floated in the market. Listing of the stock takes place on the London Stock exchange with their temporary identification codes like ISIN or Sedol that enables the forward trading of the stock. When the completion of the auction happens, the Auction Result happens in the form of a Press Release that contains details about auctions success and includes the allotment of amount and total bids received, range of bids accepted, and Non-competitive allotment price. When the issue happens, the trade happens through the mechanism of the auction settlement date. After the process of auction, a new ISIN and Sedol number are provided. When the issue is a new one of a current stock then the codes of the current stock are allocated to the security. This leads to the completion of the process and after allocation of the numbers, the proceedings are done. References Goergen, M.; Khurshed, A.; Mudambi, R 2007, The Long-run Performance of UK IPOs: Can it be Predicted?, Managerial Finance, vol. 33, no. 6, pp. 401419 Katehakis, M; Puranam, K. S 2012, On optimal bidding in sequential procurement auctions, Operations Research Letters, vol. 40, no.4, pp. 244249