The Securities and Exchange Board of India (SEBI) is reviewing several rules that apply to small and medium enterprise (SME) initial public offerings, or IPOs. One area under review is the compulsory market-making system that applies to companies listed on the SME platform.
The market-making system has an important purpose. It is meant to support liquidity after an SME lists on the stock exchange. Under the current framework, a designated market maker provides buy and sell quotes for the stock. This can help investors find a counterparty when they want to buy or sell shares.
At the same time, the system creates a cost for the company and the market intermediary. A market maker has to commit capital and maintain inventory in the shares. Under the existing framework, the market maker must maintain an initial inventory of at least 5% of the securities proposed to be listed. The market-making obligation can continue for three years.
SEBI is now examining whether this structure remains appropriate for the SME market. According to recent comments from SEBI chairman Tuhin Kanta Pandey, market making can add to the cost of an SME IPO. Any change, however, would need to balance lower costs against the possible effect on liquidity and price discovery.
Why Market Making Exists
An SME stock can have fewer buyers and sellers than a stock on the main board. This can create a basic problem after an IPO. An investor may own shares but may not find another investor who wants to buy them at the same time.
A market maker is designed to address part of this problem. The market maker normally provides both buy and sell quotes. This gives the market a source of liquidity even when there is limited natural demand or supply.
The National Stock Exchange, for example, describes the SME market-maker framework as a system that provides two-way quotes, minimum presence requirements and liquidity support for three years.
This arrangement can be useful, but it is not free. The market maker has to hold shares and capital against the obligation. It also faces the commercial risk that the price of the security may move while it holds inventory.
For an SME, these costs can form part of the wider expense of accessing the public market. If SEBI reduces the compulsory requirement, some of these costs could fall.
The effect would not necessarily be the same for every company. An SME with strong investor demand and regular trading may have less need for compulsory market support. A thinly traded company may depend more heavily on such support.
SME Issuers Could See Lower Costs
SME issuers are among the parties that could receive a direct benefit from a relaxation of the rules.
A company that enters the SME IPO market already faces several expenses related to its public-market access. If the market-making obligation becomes less costly or less restrictive, the overall post-listing burden could decline.
This does not mean that every SME would see a large reduction in costs. The actual effect would depend on the final SEBI framework, the role assigned to market makers and the commercial terms agreed between the company and its intermediaries.
Still, the direction is important. A lower market-making burden could make the SME platform more economical for companies that seek public capital.
The benefit could matter more for smaller issuers. For a large company, the cost of a market-making arrangement may represent a relatively small part of its overall financial structure. For a smaller business, even a modest additional cost can have greater importance.
A regulatory change could therefore alter the cost calculation that a small company makes before it chooses the SME platform.
Merchant Bankers May Also Face Less Burden
Merchant bankers and lead managers could also see a reduction in operational and capital pressure if the rules become less strict.
Under the existing NSE framework, merchant bankers have responsibilities linked to the market-making arrangement. They must ensure that the market-making mechanism is in place along with their other responsibilities related to the IPO.
A change in the compulsory structure could therefore reduce some of the work and risk associated with the post-listing phase.
The precise benefit would depend on the final rules. It would not automatically mean that merchant bankers would have no responsibility for market liquidity. SEBI could replace the present requirement with another framework that continues to place duties on intermediaries.
It is therefore safer to view this as a possible reduction in regulatory and commercial burden rather than as a complete removal of responsibility.
Market Makers Face a Mixed Outcome
The effect on market makers is more complicated.
At first view, a weaker compulsory market-making requirement could reduce the amount of business available to market makers. A mandatory three-year arrangement creates a defined role for these intermediaries. If the obligation becomes optional or shorter, the volume of such mandated work could fall.
There is, however, another side to the issue.
Market makers currently have to commit inventory and capital to SME securities. The initial inventory requirement is at least 5% of the securities proposed to be listed. The market maker also has to provide quotes under the applicable rules.
For a stock with low trading activity, this can create a commercial burden. The market maker may have to hold shares even when there is limited natural demand.
If SEBI reduces the compulsory obligation, market makers could lose some mandated business. At the same time, they could gain greater freedom to decide which securities justify a market-making arrangement on commercial terms.
The net effect would therefore depend on how SEBI changes the rules and how market participants respond.
Investors Face a Different Set of Effects
For investors, the picture is less direct.
Lower market-making costs could support a cheaper and more accessible SME IPO market. If more companies can access public capital at a lower cost, investors may see a wider set of listed SME businesses.
But the market-making system also exists to support liquidity. Removing or reducing that support could have the opposite effect for some securities.
An investor who wants to sell an SME stock needs another market participant who is prepared to buy it. If trading activity is low, the investor may have to accept a lower price or wait longer for a suitable buyer.
This issue becomes more important in a thinly traded stock.
The current market-making framework is intended to provide two-way quotes and a minimum level of market presence. If those requirements are relaxed, the level of liquidity could vary more from one SME stock to another.
That does not mean that liquidity would necessarily fall in every company. Stocks with strong investor demand could continue to trade actively without extensive compulsory support. The effect could be greater in companies where natural trading activity is weak.
Price Discovery Is Another Key Issue
Liquidity is closely linked to price discovery.
A market price is more useful when there are enough buyers and sellers to establish a reasonable balance between demand and supply. A market with very few trades may produce sharp price movements from relatively small orders.
The market-making mechanism can provide additional buy and sell quotes. This can help create a more continuous market.
If SEBI reduces the requirement, the regulator would therefore need to consider not only the cost of market making but also its role in price discovery.
The policy question is not simply whether market making costs money. It is also whether the liquidity benefit created by the system justifies that cost.
The answer may differ across companies. A uniform requirement can protect liquidity but can also impose the same burden on companies with very different levels of investor demand.
A more flexible model could allow the market to distinguish between those cases.
The Three-Year Period Matters
The current three-year period is another important part of the discussion.
Under the existing framework, the market maker has an obligation that extends for three years. This gives the SME stock a defined period of liquidity support after listing.
For the issuer, however, a three-year requirement can increase the cost and complexity of the post-listing arrangement.
For the market maker, it means a longer commitment of capital and inventory.
For investors, the period provides a degree of continuity in the market-making mechanism.
Any reduction in this period could therefore have different consequences for different participants.
A shorter period could lower costs for companies and intermediaries. But it could also mean that some stocks lose formal liquidity support sooner.
The final impact would depend on the safeguards that SEBI adopts alongside any change.
Larger SMEs Could Also Be Affected
The market-making review appears to form part of a wider review of the SME IPO framework.
Recent reports have referred to proposals that could raise the SME-platform market-value threshold to ₹1,000 crore. Reports have also referred to a possible framework under which companies with a market value of up to ₹4,000 crore could have a choice between the SME platform and the main board.
These proposals are subject to the regulatory process and should not be treated as final rules unless SEBI formally adopts them.
If such changes take effect, larger SMEs could have greater flexibility in deciding how they access public markets.
This could make the question of market making more significant. A larger SME with a wider investor base may have less need for the same level of compulsory market support as a very small company.
At the same time, a larger company could attract more institutional investors and natural market activity. That could reduce the practical need for a market maker in some cases.
Institutional Investors Could Change the Equation
Institutional participation is another factor that matters.
Recent reports have pointed to a possible larger role for institutional investors in SME public offerings. If institutional participation increases, some SME stocks could develop deeper natural liquidity.
More professional investors can mean more regular research, trading and price formation. However, the actual effect would depend on the number of institutions that participate and the level of liquidity in individual stocks.
Institutional participation alone would not guarantee a liquid market.
The same principle applies to the removal of market making. Removing a compulsory requirement would not automatically create natural liquidity. The market would need sufficient buyers and sellers to replace the function that the market maker currently performs.
Who Could Gain?
The clearest potential gain is for SME issuers if the reform lowers the cost of remaining listed on the SME platform.
Merchant bankers and other intermediaries could also benefit if their operational responsibilities and capital commitments fall.
Market makers could experience both a loss and a gain. They could lose some mandated business but could also face fewer compulsory commitments to illiquid securities.
Investors could gain indirectly if lower costs lead to a larger and more efficient SME market. However, investors could also face greater liquidity risk in individual stocks if compulsory market support becomes weaker.
This makes the investor outcome more dependent on the design of the final rules than the issuer outcome.
A Shift Rather Than a Simple Removal
The proposed change should therefore not be viewed only as a question of removing market making.
The more important question is where the responsibility for liquidity would sit after a regulatory change.
Under the present system, the market maker carries a defined responsibility. If SEBI relaxes that requirement, part of the responsibility could move toward natural market demand, institutional participation or voluntary market-making arrangements.
Another possibility is a revised regulatory system with fewer compulsory requirements but additional safeguards.
The details will matter.
For example, a complete removal of the three-year requirement would have a different effect from a shorter mandatory period. A lower inventory requirement would have a different effect from a complete withdrawal of the obligation. A voluntary market-making model could produce a different outcome from a system in which exchanges retain minimum liquidity standards.
Until the final framework is known, the precise economic effect cannot be established with certainty.
The Main Trade-Off
At its core, the issue is a trade-off between cost and liquidity.
The existing framework gives SMEs a formal mechanism for post-listing liquidity, but that mechanism carries a financial and operational cost.
A relaxed framework could reduce that burden and make the SME IPO route more attractive to companies and intermediaries.
The other side is that a weaker market-making obligation could leave some investors with less support when they want to trade an illiquid stock.
The impact may also differ sharply from one SME to another. A company with strong demand and frequent trades may continue to have a liquid market without extensive compulsory support. Another company may depend much more on the market maker.
What SEBI May Need to Balance
Any final rule would need to consider the interests of several groups at the same time.
For issuers, the focus is likely to be on the cost and practicality of an SME listing.
For intermediaries, the issue includes capital use, compliance duties and commercial risk.
For market makers, the question involves the cost of holding inventory against a regulatory obligation.
For investors, the central concerns include liquidity, bid-ask spreads, price discovery and the ability to exit a position.
These interests do not always point in the same direction.
A lower cost for an issuer can coexist with a higher liquidity risk for an investor. A lower capital requirement for a market maker can coexist with less market support for a listed security.
The final regulatory structure will determine where that balance falls.
What the Reform Could Mean for the SME Market
If SEBI eases market-making requirements while preserving adequate safeguards, the SME platform could become less expensive for companies and intermediaries.
The change could also encourage more companies to consider the SME route. Larger SMEs may have additional choices if the wider proposals on market-value thresholds and platform selection become part of the final framework.
However, lower regulatory cost should not be confused with lower market risk.
SME shares can have limited liquidity, and investors may face different trading conditions from those seen in heavily traded main-board stocks. A reduction in compulsory market making could make this difference more important for certain securities.
The eventual impact will therefore depend on the complete package of reforms rather than on market making alone.
Conclusion
SEBI’s review of SME IPO rules could alter the economics of the SME public-market system.
If compulsory market making becomes less demanding, SME issuers could face lower post-listing costs. Merchant bankers and other intermediaries could also see lower operational and capital pressure. Market makers could lose some mandated business while gaining more flexibility over their capital commitments.
For investors, the effect is more mixed. A cheaper SME market could expand the investment universe, but weaker compulsory liquidity support could make it harder to trade some stocks. Bid-ask spreads, price discovery and the ability to exit a position could therefore become more dependent on the natural level of market activity.
The existing framework requires market makers to maintain an initial inventory of at least 5% of the securities proposed to be listed, with market-making support required for three years. Any change to these requirements could materially alter the balance between the cost of an SME listing and the liquidity protection available after listing.
The wider review also matters. Proposals reported in the market include a possible increase in the SME-platform market-value threshold to ₹1,000 crore and a possible choice between the SME platform and the main board for companies with market values of up to ₹4,000 crore. Reports have also pointed to a greater institutional role in SME public offers.
These proposals remain subject to the regulatory process unless and until SEBI formally adopts them.
The key issue, therefore, is not simply who gains from easier market making. It is how the final framework allocates the cost and responsibility for liquidity between companies, intermediaries, market makers and investors. The precise outcome will depend on the rules that SEBI ultimately notifies and on how market participants respond to them.
ALSO READ: When Foreign Flows Return but the Rupee Stays Weak
