Book building

Book building refers to the process of generating, capturing, and recording investor demand for shares during an IPO (or other securities during their issuance process) in order to support efficient price discovery.[1] Usually, the issuer appoints a major investment bank to act as a major securities underwriter or bookrunner. The book is the off-market collation of investor demand by the bookrunner and is confidential to the issuer and underwriter(bookrunner). Where shares are acquired, or transferred via a bookbuild, the transfer occurs off-market, and the transfer is not guaranteed by an exchanges clearing house. Where an underwriter has been appointed, the underwriter bears the risk of non-payment by an acquirer or non-delivery by the seller. Book building is a common practice in developed countries and has recently been making inroads into emerging markets as well. Bids may be submitted on-line, but the book is maintained off-market by the bookrunner and bids are confidential to the bookrunner. The price at which new shares are issued is determined after the book is closed at the discretion of the bookrunner in consultation with the issuer. Generally, bidding is by invitation only to clients of the bookrunner and, if any, lead manager, or co-manager. Generally, securities laws require additional disclosure requirements to be met if the issue is to be offered to all investors. Consequently, participation in a book build may be limited to certain classes of investors. If retail clients are invited to bid, retail bidders are generally required to bid at the final price, which is unknown at the time of the bid, due to the impracticability of collecting multiple price point bids from each retail client. Although bidding is by invitation, the issuer and bookrunner retain discretion to give some bidders a greater allocation of their bids than other investors. Typically, large institutional bidders receive preference over smaller retail bidders, by receiving a greater allocation as a proportion of their initial bid. All bookbuilding is conducted off-market and most stock exchanges have rules that require that on-market trading be halted during the bookbuilding process. The key differences between acquiring shares via a bookbuild (conducted off-market) and trading (conducted on-market) are: 1) bids into the book are confidential vs transparent bid and ask prices on a stock exchange; 2) bidding is by invitation only (only clients of the bookrunner and any co-managers may bid); 3) the bookrunner and the issuer determine the price of the shares to be issued and the allocations of shares between bidders in their absolute discretion; 4) all shares are issued or transferred at the same price whereas on-market acquisitions provide for a multiple trading prices. it is one of the meger process the bookrunner collects bids from investors at various prices, between the floor price and the cap price. Bids can be revised by the bidder before the book closes. The process aims at tapping both wholesale and retail investors. The final issue price is not determined until the end of the process when the book has closed. After the close of the book building period, the book runner evaluates the collected bids on the basis of certain evaluation criteria and sets the final issue price.

If demand is high enough, the book can be oversubscribed. In these case the greenshoe option is triggered. Book building is essentially a process used by companies raising capital through public offeringsboth initial public offers (IPOs) or follow-on public offers (FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process. An investment bank is a financial institution that assists individuals, corporations and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions, and provide ancillary services such as market making, trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities. Unlike commercial banks and retail banks, investment banks do not take deposits. From 1933 (GlassSteagall Act) until 1999 (GrammLeachBliley Act), the United States maintained a separation between investment banking and commercial banks. Other industrialized countries, including G8 countries, have historically not maintained such a separation. There are two main lines of business in investment banking. Trading securities for cash or for other securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) is the "sell side", while dealing with pension funds, mutual funds, hedge funds, and the investing public (who consume the products and services of the sell-side in order to maximize their return on investment) constitutes the "buy side". Many firms have buy and sell side components. An investment bank can also be split into private and public functions with a Chinese wall which separates the two to prevent information from crossing. The private areas of the bank deal with private insider information that may not be publicly disclosed, while the public areas such as stock analysis deal with public information. An advisor who provides investment banking services in the United States must be a licensed broker-dealer and subject to Securities & Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) regulation Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit). The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange

for a premium, would literally write their names under the risk information that was written on a Lloyd's slip created for this purpose.

Securities underwriting
Securities underwriting refers to the process by which investment banks raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt capital). The services of an underwriter are typically used during a public offering. This is a way of selling a newly issued security, such as stocks or bonds, to investors. A syndicate of banks (the lead managers) underwrite the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves. Underwriters make their income from the price difference (the "underwriting spread") between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering.

Risk, exclusivity, and reward

Once the underwriting agreement is struck, the underwriter bears the risk of being unable to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably sold. If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument. That is, even though thirdparty buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter. In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement. Also, if the securities are priced significantly below market price (as is often the custom), the underwriter also curries favor with powerful end customers by granting them an immediate profit (see flipping), perhaps in a quid pro quo. This practice, which is typically justified as the reward for the underwriter for taking on the market risk, is occasionally criticized as unethical, such as the allegations that Frank Quattrone acted improperly in doling out hot IPO stock during the dot com bubble

Bank underwriting

In banking, underwriting is the detailed credit analysis preceding the granting of a loan, based on credit information furnished by the borrower, such as employment history, salary and financial statements; publicly available information, such as the borrower's credit history, which is detailed in a credit report; and the lender's evaluation of the borrower's credit needs and ability to pay. Examples include mortgage underwriting. Underwriting can also refer to the purchase of corporate bonds, commercial paper, government securities, municipal general-obligation bonds by a commercial bank or dealer bank for its own account or for resale to investors. Bank underwriting of corporate securities is carried out through separate holding-company affiliates, called securities affiliates or Section 20 affiliates.

] Insurance underwriting
Insurance underwriters evaluate the risk and exposures of potential clients. They decide how much coverage the client should receive, how much they should pay for it, or whether even to accept the risk and insure them. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. The function of the underwriter is to protect the company's book of business from risks that they feel will make a loss and issue insurance policies at a premium that is commensurate with the exposure presented by a risk. Each insurance company has its own set of underwriting guidelines to help the underwriter determine whether or not the company should accept the risk. The information used to evaluate the risk of an applicant for insurance will depend on the type of coverage involved. For example, in underwriting automobile coverage, an individual's driving record is critical. As part of the underwriting process for life or health insurance, medical underwriting may be used to examine the applicant's health status (other factors may be considered as well, such as age & occupation). The factors that insurers use to classify risks should be objective, clearly related to the likely cost of providing coverage, practical to administer, consistent with applicable law, and designed to protect the longterm viability of the insurance program.[1] The underwriters may either decline the risk or may provide a quotation in which the premiums have been loaded or in which various exclusions have been stipulated, which restrict the circumstances under which a claim would be paid. Depending on the type of insurance product (line of business), insurance companies use automated underwriting systems to encode these rules, and reduce the amount of manual work in processing quotations and policy issuance. This is especially the case for certain simpler life or personal lines (auto, homeowners) insurance.

Other forms of underwriting

Real estate underwriting

In evaluation of a real estate loan, in addition to assessing the borrower, the property itself is scrutinized. Underwriters use the debt service coverage ratio to figure out whether the property is capable of redeeming its own value or not.

] Forensic underwriting
Forensic underwriting is the "after-the-fact" process used by lenders to determine what went wrong with a mortgage.[2] Forensic underwriting refers to a borrower's ability to work out a modification scenario with their current lien holder, not to qualify them for a new loan or a refinance. This is typically done by an underwriter staffed with a team of people who are experienced in every aspect of the real estate field.

Sponsorship underwriting
Main article: Underwriting spot Underwriting may also refer to financial sponsorship of a venture, and is also used as a term within public broadcasting (both public television and radio) to describe funding given by a company or organization for the operations of the service, in exchange for a mention of their product or service within the station's programming. [ A greenshoe option (sometimes green shoe, but must[1] legally be called an "overallotment option" in a prospectus) allows underwriters to short sell shares in a registered securities offering at the offering price. The greenshoe can vary in size and is customarily not more than 15% of the original number of shares offered. The greenshoe option is popular because it is one of a few SEC-permitted, risk-free means for an underwriter to stabilize the price of a new issue post-pricing. Issuers will sometimes not include a greenshoe option in a transaction when they have a specific objective for the offering and do not want the possibility of raising more money than planned. The term comes from the first company, Green Shoe Manufacturing (now called Stride Rite Corporation),[2] to permit underwriters to use this practice in an offering. The mechanism by which the greenshoe option works to provide stability and liquidity to a public offering is described in the following example: A company intends to sell 1 million shares of its stock in a public offering through an investment banking firm (or group of firms which are known as the syndicate) whom the company has chosen to be the offering's underwriter(s). When the stock is being offered for public trading for the first time, the offering is called an IPO (initial public offering). When the stock is already trading publicly and the company is simply selling more of their non-publicly traded stock, it is called a follow-on or secondary offering.

The underwriters function as the broker of these shares and find buyers among their clients. A price for the shares is determined by agreement between the company and the buyers. When shares begin trading in a public market, the lead underwriter is responsible for helping to ensure that the shares trade at or above the offering price. When a public offering trades below its offering price, the offering is said to have "broke issue" or "broke syndicate bid". This creates the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares. To manage this possible situation, the underwriter initially oversells ("shorts") to their clients the offering by an additional 15% of the offering size. In this example the underwriter would sell 1.15 million shares of stock to its clients. When the offering is priced and those 1.15 million shares are "effective" (become eligible for public trading), the underwriter is able to support and stabilize the offering price bid (which is also known as the "syndicate bid") by buying back the extra 15% of shares (150,000 shares in this example) in the market at or below the offer price. They can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their short position. When the offering is successful, demand for shares causes the price of the stock to go up and remain above the offering price. If the underwriter were to close their short position by purchasing shares in the open market then the underwriter would incur a loss by purchasing shares at a higher price than the price at which they sold them short. This is where the over-allotment (greenshoe) option comes into play: the company granted the underwriters the option to purchase from the company up to 15% more shares than the original offering size, at the original offering price. By exercising their greenshoe option, the underwriters are able to close their short position by purchasing shares at the same price for which they sold-short the shares, so the underwriters do not lose money. If the underwriters are able to buy back all of the oversold shares at or below the the offering price (to support the stock price), then they would not need to exercise any portion of their greenshoe option. If they are able to buy back only some of the shares at or below the offer price (because the stock eventually goes higher than the offer price), then the underwriters would exercise a portion of greenshoe option to cover their remaining short position. If the underwriters were not able to buy back any portion of the oversold shares at or below the offering price ("syndicate bid") because the stock immediately went and stayed up, then they would completely cover their 15% short position by exercising 100% of their greenshoe option.

[SEC regulations
The SEC also permits the underwriters to engage in naked short sales of the offering. The underwriter creates a naked short position either by selling short more shares than the amount stated in the greenshoe option, or by selling short shares where there is no greenshoe option. It is theoretically possible for the underwriters to naked short sell a large percentage of the offering.[3] The SEC also permits the underwriting syndicate to place stabilizing bids on the stock in the after-market.[4] However, underwriters of initial

and secondary offerings in the United States rarely use stabilizing bids to stabilize new issues, and instead engage in short selling the offering and purchasing in the after-market to stabilize new offerings. "Recently, the SEC staff has learned that in the US syndicate covering transactions have replaced (in terms of frequency of use) stabilization as a means to support post-offering market prices. Syndicate covering transactions may be preferred by managing underwriters primarily because they are not subject to the price and other conditions that apply to stabilization."[5]

[Naked short selling and syndicate covering purchases

By definition of a naked short position, the only option the underwriting syndicate has for closing a naked short position is to purchase shares in the after market. Unlike shares sold short related to the Greenshoe option, the underwriting syndicate risks losing money by engaging in naked short sales. If the offering is popular and the price rises above the original offering price, the syndicate may eventually have no choice but to close any naked short position by purchasing shares in the after-market at a price higher than for what they sold the shares. On the other hand, if the price of the offering falls below the original offer price, naked short positions gives the syndicate greater power to exert upward pressure on the issue than the Greenshoe alone, and has the added benefit of being profitable to the underwriting syndicate.[6]

Risk to investors
Underwriters' abilities to stabilize a stock's price is finite both in terms of the number of shares the underwriters sold-short, and the length of time over which they choose to close their positions. "Regulation M defines this type of share repurchase as a syndicate covering transaction and imposes the same disclosure requirements as those imposed on penalty bids. Consequently, investors need not be informed that an offering is or will be stabilized by way of a syndicate short position. Rather, investors need only be exposed to language indicating that the underwriter may effect stabilizing transactions in connection with an offering of securities and a characterization of possible stabilization practices in the plan of distribution section of the prospectus."[7] The SEC currently does not require that underwriters publicly report their short positions nor short-covering transactions. Investors who are unwary of underwriter stabilizing activity who choose to invest in what they perceive to be a stable issue can encounter volatility when the underwriters pause or complete any stabilizing activity. "Cast in the most negative light, price stabilization might be seen as a means of transferring risk to a relatively nave segment of the investor population."[8]