SME stocks face liquidity issues after listing and to solve this problem to some extent, SEBI has made market-making mandatory for at least three years from the date of listing of an SME IPO. The main role of a market maker is to quote bids and offer prices (of minimum depth and within the range specified by the exchange) for securities listed on the SME platforms of the NSE or BSE. By providing two-way quptes, market makers play an important role in injecting liquidity into SME stocks.
Here is our detailed guide on who the market makers are, why market making is necessary for SME shares, what the benefits are, market maker minimum reservation, and how market makers maintain liquidity in SME stocks.
Who are market makers in SME IPOs?
A market maker is an individual member or company that provides two-way quotes for a particular security. Members registered with the Exchange can act as “market makers" for SME IPOs provided they meet the criteria set by the Exchange (see below)
Market makers provide the “bid” price for the purchase of SME shares and the “ask/offer” price for the sale of shares to investors. In this way, market makers provide liquidity for SME stocks.
SEBI's ICDR regulations require all SMEs to enter into the market making arrangements for at least 3 years after listing.
Who can become a market maker? Eligibility Criteria
The most important requirements for becoming a market maker are
- One-time registration with an exchange: An individual or a company must have registered once as a market maker with an SME exchange (NSE SME or BSE SME). For registration, the market maker has to fill a specific form online and submit relevant documents to the exchange.
- The registered member must be a trading member of the capital market segment of the NSE.
- Market makers must have a minimum net worth of Rs 1 crore when registering with the exchange or acting as a market maker.
BSE and NSE Emerge Market Makers
You can find BSE SME and NSE SME market makers list on the exchange website. Click on the link provided below;
Market Maker Reservation Portion
Every SME IPO, has a minimum of 5% of the issue size reserved for market makers. As per SEBI's ICDR regulations, the stock of market makers must be at least 5% of the issue size on the date of allotment. This means that the issuing company has to allot at least 5% of the shares offered to the designated market makers.
Let’s take an example of one of the most popular SME IPOs in 2024, HOAC Foods. The company has offered 11,55,000 equity shares to the public and allotted 93,000 shares, i.e. 8.05%, to Giriraj Stock Broking as the market maker of the issue. The issue less the market maker reservation portion or the net issue amounted to 10,62,000 shares available for subscription by the public.
Other examples of market maker reservations;
| Company name | Total IPO Shares offered | Shares reserved for Market Maker | Market Maker allocation (In % to the issue size) |
|---|---|---|---|
| Kay Cee Energy & Infra | 29,50,000 shares | 1,90,000 shares | 6.44% |
| Medicamen Organics | 31,00,000 shares | 1,72,000 shares | 5.55% |
| Maxposure Limited | 61,40,000 shares | 3,72,000 shares | 6.06% |
How do market makers provide liquidity in SME stocks?
Injecting liquidity into SME stocks is the main objective of market making. Let us understand how do market makers infuses liquidity in SME shares post-listing;
The market makers of the issue provide two-sided prices, buy and sell prices for SME shares. The difference between the bid and ask price is called the spread, which represents the market marker's profit.
For example, a market maker places a buy order at a bid price of Rs 50 and an ask price of Rs 50.25. For an SME trading lot size of 3000 shares, the bid-ask spread of 0.25 multiplied by 3000 shares, i.e. Rs 750, is the market maker's remuneration. The bid-ask spread must be within the guidelines set by the exchange.
Market makers must be present for 75% of the trading time during a trading session. Since they provide buy and sell quotes most of the time, they maintain trading activity and ensure that there are always buyers and sellers in the market.
Market Makers Roles and Responsibilities
- Create a market for SME stocks: Market makers create a market for SME shares by providing two-way quotes for 75% of trading hours from the day of listing. They ensure continuous buying and selling activity in SME shares.
- The minimum depth should be 1 lakh: Market makers must quote for a minimum depth of Rs 100,000. Even though the minimum investment in an SME IPO is Rs 100,000, the value of investors' holding after listing may vary depending on the trading price. However, irrespective of the price, the market maker's quotation must be at least Rs 1 lakh. Suppose an SME IPO trading lot is 6000 shares and a market maker submits buy and sell offers at Rs 20 and Rs 21, so the order value is Rs 1,20,000 and Rs 1,26,000. Investors with a share value of less than Rs 100,000 can sell their entire holdings to market makers.
- Minimum trading lot: The market maker's quotation should be for a minimum of one trading lot. Since in the above example the lot size was 6000 shares, market makers should buy and sell at least 6000 shares or multiples thereof. After listing, the SME exchange may change the trading lot size from time to time.
- Bid-ask spread: The bid-ask spread shall be in accordance with the market maker spread requirements specified by the Exchange and SEBI from time to time. (See below)
- Price discovery of SME shares: The bid and offer prices of market makers help in determining the current trading price of SME shares.
- A company can appoint a minimum of 1 and a maximum of 5 market makers for its shares.
- After 3 months of market making, the market makers are exempted from providing quotations, if the market makers' inventory reach 25% of the issue size, including the shares allocated to the market maker.
- Market makers are not allowed to buy equity shares from promoters or promoter groups.
- Market makers are only responsible for facilitating liquidity through 2-way quotes, but not for maintaining the share price.
- Market makers must guarantee the execution of orders at the quoted price and quantity.
Market Maker Bid-Ask Spread Requirements
The market maker buys and sells price differences or spreads, which must comply with the exchange-stipulated bid-ask spread. The spread for their quotes shall not exceed 10% at any point in time. The BSE SME and NSE Emerge specified bid-ask spread is;
| Market price | Bid-Ask Spread (% to sale price) |
|---|---|
| Upto Rs 50 | 9% |
| Rs 50 - Rs 75 | 8% |
| Rs 75 - Rs 100 | 6% |
| Above Rs 100 | 5% |
Market Making Agreement
The market-making agreement is an agreement between the merchant banker, the issuing company and the market maker for the purpose of market making of SME securities for a period of at least 3 years from the date of listing. The terms and aspects of the agreement shall be subject to the regulations, laws and norms issued by the Stock Exchange or SEBI.
Merchant Bankers are required to specify who is the market maker of the issue while filing the offer documents with the stock exchange. Therefore, the merchant bankers shall attach a copy of the market-making agreement with the offer prospectus to be filed with the SME Exchange.
The market maker continues to quote buy and sell quotes for SME securities until it withdraws from the market or becomes ineligible to do so. The market maker must notify the exchange at least one month in advance that it is voluntarily withdrawing. In this case, the merchant banker must appoint another market maker within one month for the mandatory market-making period of 3 years.
Market Maker Inventory Level
In a circular issued by SEBI on November 27, 2012, limits have been imposed on the market maker inventory level, based on the total IPO offer size. If the market maker's holding exceeds the specified threshold, the market maker will be exempted from providing buy quotes and will not be allowed to re-enter until the holding reaches the specified threshold. The threshold is calculated taking into account a 5% mandatory allocation of the issue size. Initial holdings over the 5% reservation are not taken into account when calculating the market maker's mandatory holding.
Market makers quote buy and sell quotes until the holding reaches the threshold value, after which only sell quotes are quoted. Find below the market maker’s maximum inventory level;
| Issue size | Buy quote exemption threshold | Re-entry threshold for buy quote |
|---|---|---|
| Upto Rs 20 Cr | 25% | 24% |
| Rs 20 Cr - Rs 50 Cr | 20% | 19% |
| Rs 50 Cr - Rs 80 Cr | 15% | 14% |
| Above Rs 20 Cr | 12% | 11% |
The above exemption limit is subject to change by SEBI and the stock exchange from time to time.
Benefits of Market Making
- SMEs are less traded than large companies. Therefore, market-making for SME securities is beneficial to inject liquidity into the stocks and enable better price discovery based on the supply and demand forces of the market.
- Since market makers place buy-and-sell quotes most of the time, investors can easily buy and sell SME shares.
- To provide 2-way eligible quotes, market makers collect and analyze all the necessary information about the scrip.
- Market makers may compete with other market makers for better pricing for shares.
- Market making encourages investor engagement and trading frequency (buying and selling activity of shares).
- Market makers closely monitor the price fluctuations of securities and report any irregularities or anomalies to the exchange.
In a Nutshell
Market makers ensure smooth trading in SME shares. They offer buy and sell orders, which promotes liquidity in SME stocks and stimulates trading activity. The two-sided quotes provided by market makers help to maintain the fair value of shares. While they are not authorized to maintain securities prices, continuous trading contributes to better price discovery.
