Unregulated waters: The perils faced by grey market investors

Risks of investing in unlisted markets, also known as grey markets, can be significant in the context of the Indian markets

Reliance Retail recently made a decision to decrease its equity share capital by eliminating the shares held by shareholders other than its promoter and holding company, Reliance Retail Ventures Ltd (RRVL). As per the proposal, the minority shareholder’s holdings will be terminated and invalidated following the share buyback.

This move came as a surprise to retail investors of Reliance Retail, especially considering that the offered price for the share buyout was Rs 1362 per share. Interestingly, reports suggest that the price in the grey market reached approximately Rs 3,000 per share, and at one point, it even reached Rs 4,000.

Risks of investing in unlisted markets, also known as grey markets, can be significant in the context of the Indian markets. These markets involve trading in securities that are not listed on recognized stock exchanges. While they may offer opportunities for investors to gain exposure to promising companies, they also come with certain risks that investors should carefully consider.

Lack of Regulation and Oversight: One of the primary risks of investing in unlisted markets is the absence of regulatory oversight. Unlike listed companies that are subject to strict disclosure requirements, unlisted companies often operate with minimal regulatory scrutiny. This lack of transparency can make it difficult for investors to evaluate the financial health, governance practices, and potential risks associated with these companies.

Liquidity Risk: Investing in unlisted markets can expose investors to significant liquidity risk. Unlike listed stocks, which are traded on stock exchanges with active buyers and sellers, unlisted securities often have limited liquidity. It can be challenging to find buyers or sellers for these securities, and investors may face difficulties in exiting their positions or converting their investments into cash when needed.

Valuation Uncertainty: Determining the true value of unlisted securities can be challenging due to the absence of transparent market prices. The valuation of these securities is often based on assumptions and estimates, making it prone to biases and errors. Investors may find it difficult to accurately assess the fair value of their investments, which can lead to potential overvaluation or undervaluation.

Counterparty Risk: In unlisted markets, investors are exposed to counterparty risk. These markets often involve transactions between private individuals or entities, and the financial strength and credibility of the counterparty can be uncertain. There is a risk of default or non-performance by the counterparty, which can result in financial losses for investors.

Limited Exit Options: Exiting investments in unlisted markets can be challenging. Unlike listed stocks, where investors can easily sell their shares on stock exchanges, unlisted securities may have limited exit options. Investors may have to rely on secondary market platforms or negotiate private transactions to find potential buyers, which can be time-consuming and may not guarantee optimal prices.

Operational and Business Risks: Unlisted companies may be at different stages of their business lifecycle, including start-ups and early-stage ventures. Such companies often face higher operational and business risks compared to established listed companies. Factors like lack of track record, uncertain business models, and limited financial resources can increase the probability of failure or underperformance, leading to potential losses for investors.

In conclusion, while investing in unlisted markets in the Indian context may offer potential opportunities, it is crucial for investors to be aware of the associated risks. Lack of regulation, liquidity risk, valuation uncertainty, counterparty risk, limited exit options, and operational/business risks are some of the key factors that investors should carefully consider before venturing into these markets. Conducting thorough due diligence, seeking professional advice, and diversifying investments can help mitigate some of these risks, but investing in unlisted markets should be approached with caution and a thorough understanding of the specific risks involved.