Market making is a compulsory part of the SME IPO structure in India. Its purpose is to support liquidity after listing. A market maker gives buy and sell quotes in the shares so investors have a mechanism through which they may trade even when natural demand or supply is limited.
The important question is not only who pays the market maker, but also who ultimately bears the economic cost.
The answer requires some care. The company generally bears the direct contractual cost of the market-making arrangement. However, that does not necessarily mean that the company is the final economic bearer of the entire cost. The cost forms part of the overall economics of raising capital. Depending on the issue structure and pricing, part of that economic burden may ultimately affect existing shareholders or IPO investors.
The distinction between direct payment and ultimate economic burden is therefore important.
Market Making Is a Regulatory Requirement
For an SME issue, compulsory market making applies for a minimum period of three years from the date of listing, subject to the applicable regulatory and exchange framework.
The requirement exists to provide a basic level of liquidity in SME securities. Under the applicable exchange framework, a market maker has to provide two-way quotes for at least 75% of the trading time in a day. The market maker also has to comply with requirements related to quote depth, inventory and other market-making conditions.
This means the market maker is not merely a broker who waits for buyers and sellers to appear. It has an affirmative role in providing two-way quotes within the applicable rules.
The arrangement therefore has both a regulatory side and a commercial side.
The regulatory side determines what the market maker must do. The commercial side determines what the market maker receives for taking on that obligation and the related risks.
Who Pays the Market-Making Fee?
The direct commercial payment normally comes from the issuer under the market-making arrangement.
In simple terms, the structure can be viewed as follows:
| Item | Direct economic relationship |
|---|---|
| SME issuer | Appoints or arranges the market maker |
| Market maker | Provides the required market-making service |
| IPO investors | Purchase securities from the issue |
| Secondary-market investors | Trade after listing |
| Stock exchange | Sets and monitors applicable market-making requirements |
The exact fee is not one universal amount fixed for every SME IPO. It depends on the contractual arrangement and the relevant issue.
The commercial model of market makers can include fixed fees from corporate clients, such as one-time and annual fees. A market maker can also earn income from spreads and other secondary-market trading activity.
That distinction matters.
The market maker can therefore have two broad sources of economics. One is the contractual fee received from the corporate client. The other is the potential income or loss that arises from its market-making activity, including spreads and its own trading position.
The company should not be assumed to bear every economic risk of the market maker merely because it pays a market-making fee.
The Company Bears the Direct Expense
From the issuer’s perspective, the market-making fee is part of the cost associated with the IPO and listing process.
This means that if an SME pays a market maker a fee under its agreement, the company bears that expense directly.
For example, assume an SME raises ₹50 crore through an IPO. If the company has to incur a market-making expense as part of the issue and listing structure, that expense reduces the economic benefit that the company receives from the capital-raising exercise.
The company does not receive ₹50 crore of unrestricted economic benefit merely because investors subscribe for ₹50 crore of shares. There are issue-related expenses.
The final amount available to the company is affected by those expenses.
This is why an analysis of an SME IPO should distinguish between gross issue proceeds and net proceeds.
Does the IPO Investor Pay the Market Maker?
Not in the ordinary direct sense.
An IPO investor does not normally receive a separate bill for the market maker’s fee. The investor pays the issue price for the securities.
The contractual relationship for the market-making fee is generally between the issuer and the market maker. The investor is not simply paying the market maker a separate service charge.
However, saying that the IPO investor does not directly pay the fee does not mean that the cost has no economic effect on the investor.
That is where the analysis becomes more important.
The Economic Cost Can Flow Through the IPO Price
A company has limited sources of capital. If it has to spend money on an IPO, that money forms part of the overall cost of raising capital.
Suppose, purely as an illustration, that a company wants to obtain ₹50 crore of net capital from an IPO.
Assume that its total issue-related expenses are ₹2 crore.
The company may need to raise approximately ₹52 crore in gross proceeds to obtain ₹50 crore after those expenses, subject to the actual structure and other applicable costs.
The ₹2 crore has not disappeared. It is an economic cost associated with the capital-raising exercise.
The same principle applies to market-making costs.
However, it would be too strong to say that every rupee paid to the market maker is automatically passed to IPO investors.
There is no simple one-to-one transfer.
The final economic effect depends on factors such as the issue price, demand for the IPO, valuation, issue size, expenses, dilution and the commercial terms agreed with the market maker.
Existing Shareholders Can Also Bear the Cost
There is another side to the analysis.
An IPO can involve the issue of new shares, an offer for sale, or a combination of both. The economic consequences can therefore differ.
If the company issues new shares, the company receives the issue proceeds, subject to expenses. Existing shareholders experience dilution.
If shares are sold by existing shareholders through an offer for sale, the proceeds can go to those selling shareholders rather than to the company, depending on the structure.
Therefore, it would not be legally or economically precise to state that the IPO investor always bears the market-making cost.
The more accurate statement is that the cost forms part of the overall economics of the transaction and can affect the issuer, existing shareholders and investors in different ways.
Market Maker Inventory Is a Separate Issue
The market-making fee should also be separated from the market maker’s inventory.
The market maker may have to maintain an initial inventory under the applicable SME framework. The applicable framework has historically required initial inventory equal to 5% of the securities proposed to be listed.
This inventory is not the same thing as a fee.
A fee is a payment for the market-making service.
Inventory is securities held by the market maker for the purpose of carrying out its market-making obligations.
The market maker can therefore face a separate economic risk.
Suppose the market maker acquires shares and later sells them at a lower price. It can suffer a trading loss. If it sells at a higher price, it may earn a trading gain, subject to market conditions and applicable costs.
The issuer does not automatically reimburse the market maker for such trading losses merely because the issuer has appointed it.
This is a key distinction.
| Economic item | Main bearer of the direct risk |
|---|---|
| Contractual market-making fee | Issuer |
| Market maker’s inventory | Market maker |
| Gain or loss on market-making trades | Market maker, subject to the contractual and regulatory structure |
| Bid-ask spread earned by market maker | Market maker |
| IPO issue expenses | Issuer |
| Effect of issue expenses on valuation and dilution | May affect issuer and shareholders economically |
Why Does the Market Maker Accept This Risk?
The market maker is a commercial participant.
It does not normally undertake the activity solely because it is required to provide liquidity.
The commercial model can include fixed fees and trading-related income.
This helps explain the economic arrangement.
The market maker receives compensation for taking on the obligations associated with the role. At the same time, it operates with its own capital and may face inventory and trading risks.
The market maker therefore does not simply act as an agent whose every loss belongs to the issuer.
What Does the Market Maker Actually Provide?
Under the SME market-making framework, the market maker has to provide two-way quotes for the prescribed portion of trading time. The framework also contains requirements concerning minimum quote depth and execution of the quotes provided.
This is important because the market-making fee is not simply a payment for placing a name on the exchange’s list.
There are continuing obligations attached to the role.
The market maker has to maintain the required presence and comply with applicable quote, spread, inventory and other conditions.
Why the Cost Should Not Be Viewed in Isolation
From an investor’s perspective, looking only at the market-making fee can produce an incomplete picture.
The more relevant question is the total cost of the IPO.
An SME IPO can have several categories of expenditure, including merchant-banking expenses, legal and professional fees, exchange and listing-related expenses, registrar expenses, advertising expenses and market-making costs.
Market making is one component of that larger cost structure.
Therefore, a statement such as “the market maker costs ₹X, so investors lose ₹X” would normally be too simplistic.
The better approach is to examine the issue as a whole.
The offer document can provide information about the market-making arrangement and the related commercial terms. Investors can use that information alongside the issue size, valuation, fresh issue proceeds, offer-for-sale component and other expenses.
A Simple Economic Example
Consider a hypothetical SME with the following structure:
| Particular | Amount |
|---|---|
| Gross IPO proceeds | ₹50 crore |
| Market-making cost | ₹0.50 crore |
| Other issue expenses | ₹1.50 crore |
| Total stated issue expenses | ₹2 crore |
| Approximate proceeds after these expenses | ₹48 crore |
This example does not state that ₹0.50 crore is a standard market-making fee. It is only an illustration of the economic effect.
The company raises ₹50 crore in gross proceeds.
It then incurs ₹2 crore in issue-related expenses, of which ₹0.50 crore is assumed to relate to market making.
The company therefore has approximately ₹48 crore left after those two categories of cost.
In economic terms, the company has spent money to obtain the capital.
But the cost does not automatically become a direct loss to the IPO investor.
The investor still owns the shares purchased at the IPO price. Whether the investor receives adequate economic value depends on the price paid, the company’s future performance, liquidity, valuation and other factors.
Market Making Does Not Guarantee a Particular Share Price
Another important legal and analytical distinction is between liquidity support and price support.
Market making is designed to provide two-way quotes and liquidity under the applicable rules. It should not be described as a guarantee that the share price will remain at the IPO price.
A market maker can provide a quote without guaranteeing that the security will retain its issue price.
The market price after listing can move because of supply, demand, company performance, market conditions, investor sentiment and other factors.
The market maker’s obligation is therefore not equivalent to an assurance that investors will not suffer a loss.
The 5% Inventory Rule Needs Careful Treatment
The 5% inventory figure should not be confused with a 5% fee.
If an issue is ₹20 crore, 5% would be ₹1 crore in value.
That does not mean the market maker pays ₹1 crore to the company as a market-making fee.
It refers to inventory.
The economic treatment of that inventory is different from the treatment of a service fee.
The market maker may deploy its own funds or use the permitted structure to hold the required securities and then use them in its market-making activity.
The eventual economic result depends on the prices at which those securities are acquired and sold, together with other costs and revenues.
Who Ultimately Pays?
The safest conclusion is that there are three different levels of payment.
At the first level, the issuer pays the contractual market-making fee.
At the second level, the market maker bears the commercial risk associated with its own market-making activity, including relevant inventory and trading risk, unless a specific contractual or regulatory arrangement provides otherwise.
At the third level, the economic cost of the IPO is borne through the overall capital-raising economics. That can affect the issuer and existing shareholders and can also affect investors indirectly through the issue price and valuation.
It is therefore not technically accurate to say that IPO investors pay the market maker.
It is also too narrow to say that only the company pays.
The first statement ignores the contractual structure. The second ignores the economic effect of raising capital.
Practical Investor Interpretation
For an investor examining an SME IPO, the better question is not simply whether a market-making fee exists.
The more useful questions are the amount of the fee, the total IPO expenses, the net proceeds available to the company, the size of the fresh issue, the offer-for-sale component, the valuation and the market-making obligations.
The investor can then assess how much capital the company actually receives compared with the amount raised from the public.
For example, if an SME raises ₹50 crore but has substantial expenses, the investor should look at the amount that actually reaches the company and the stated use of those proceeds.
This gives a clearer picture than looking at the headline IPO size alone.
Conclusion
In an Indian SME IPO, the direct contractual cost of market making is generally an issuer-side expense. The market maker receives compensation for providing the required service and may also earn from spreads and other trading activity.
At the same time, the market maker takes on its own commercial risks. It may hold inventory and may make or lose money through its market-making activity. Those risks should not be treated as an automatic liability of the issuer.
The economic burden is more complex.
An issuer’s market-making expense reduces the economic benefit from the IPO, just as other issue expenses do. That cost can therefore affect the overall economics for shareholders. But it does not follow that the IPO investor directly pays the market maker or that the entire fee is automatically transferred to the investor through the IPO price.
The most legally careful formulation is therefore:
The issuer generally bears the direct contractual cost of SME IPO market making. The market maker bears the commercial risk associated with its market-making activity. The broader economic cost of the arrangement forms part of the issuer’s overall cost of raising capital and may ultimately affect the economics of existing shareholders and investors, depending on the issue structure and pricing.
That distinction between direct payment, risk bearing and ultimate economic incidence is the key to understanding who bears the cost of SME IPO market making.
