Why is SEBI Rewriting SME IPO Rules After Trying to Rein In the Retail Frenzy?

SEBI tried to make SME IPOs harder for casual retail investors to enter. It increased the minimum application size and trading lot, hoping larger commitments would discourage speculative bets.

The investors came anyway. What followed was an unintended squeeze. Some shareholders were left with odd lots they could not easily sell. Mandatory market makers failed to produce sufficient liquidity while charging companies more. Underwriting added another layer of expense. In some cases, listing on the platform created for smaller companies reportedly became costlier than accessing the mainboard.

The Securities and Exchange Board of India now plans to rewrite the framework again. Chairman Tuhin Kanta Pandey has announced a “comprehensive reform proposal” covering trading lots, market making, underwriting, listing costs and migration from the SME platform. A consultation paper will place the possible changes before investors, exchanges, intermediaries and companies. Why is SEBI changing course, and will easier rules revive the same risks that forced it to tighten the market?

What exactly has SEBI announced?

SEBI will undertake a comprehensive review of the rules governing companies listed on the SME platforms of the BSE and NSE. Pandey said some provisions designed to regulate the segment were instead restricting companies, impairing trading and possibly curbing business growth. Reuters reported that the review will examine rules governing IPOs by smaller companies, with the chairman specifically identifying market-making costs as a problem. The regulator will publish a consultation paper detailing its proposed reforms. That means no rule has changed yet. SEBI will first seek feedback before placing final proposals before its board.

Why were SME IPO platforms created?

The SME exchanges were designed to give smaller businesses access to public capital without forcing them to meet every financial, disclosure and compliance requirement applicable to larger mainboard companies. A growing manufacturer, retailer or technology company may require equity capital but remain too small to mount a conventional IPO. An SME listing allows it to raise money from public investors, create a visible market valuation and potentially migrate to the mainboard after expanding. The structure deliberately offers regulatory concessions because smaller companies possess fewer managerial and financial resources. That relaxation creates the central tension SEBI must manage. If the entry barriers become too high, genuine SMEs lose access to capital. If the rules become too loose, weak companies, inflated valuations and unscrupulous promoters can exploit retail investors.

Why did SEBI tighten SME IPO rules in the first place?

The SME market exploded as Indian investors chased IPO listing gains. Applications sometimes ran into extraordinary oversubscription levels even for obscure companies with limited operations. SEBI grew concerned that some promoters were presenting an unrealistically optimistic picture of their businesses, using corporate announcements, bonus issues, stock splits and other actions to generate excitement after listing. The resulting price rise could allow promoters or connected parties to sell shares at inflated valuations. In August 2024, the regulator warned investors against relying on unverified social-media posts, rumours and tips while buying SME shares. It said some companies and promoters were making announcements that projected an “unrealistic picture” of their operations. SEBI subsequently proposed tighter eligibility, disclosure and governance rules. Reuters reported in November 2024 that the proposals included a minimum ₹10-crore issue size and restrictions on how much of an IPO could be used by existing shareholders to sell their holdings. The regulator also increased the minimum application size, seeking to keep small and potentially inexperienced investors away from a high-risk segment.

Why did a bigger application size fail to deter retail investors?

SEBI assumed that forcing investors to commit more money would cool speculative participation. Pandey has now acknowledged that the expected result did not materialise. “The thought was that if we increase the trading lot and increase the application size, we would be able to control retail participation, but that is not happening,” he said. The problem is behavioural. Raising the entry ticket does not necessarily remove the appetite for quick profits. Investors convinced that a heavily subscribed IPO will deliver a large listing gain may pool capital, borrow money or simply make a bigger bet. A high minimum application can therefore concentrate risk instead of eliminating it. The investor still enters, but commits more money to a relatively small and potentially illiquid company. It can also shut out informed investors with smaller portfolios while failing to deter wealthier speculators.

What are odd lots and how can they trap investors?

SME shares generally trade in fixed lots rather than single shares. If the prescribed market lot is 1,000 shares, for example, an investor may normally have to buy or sell in multiples of 1,000. An “odd lot” emerges when an investor holds fewer shares than the standard market lot or a quantity that does not divide cleanly into it. This can happen following corporate actions, changes in lot size or the sale of part of a holding under permitted arrangements. Finding a buyer for that residual quantity can become difficult. An investor may own shares that have a quoted market price but cannot readily convert them into cash. Pandey said odd lots created under the existing framework have left some investors unable to trade. That turns a rule intended to manage retail risk into a fresh investor-protection problem: forced illiquidity. SEBI may therefore have to redesign lot sizes or create a smoother mechanism for trading odd-lot holdings.

What is a market maker and why is that system under scrutiny?

A market maker is an intermediary expected to continuously provide buy and sell quotations in a stock. Small-company shares may have few natural buyers and sellers. Without a market maker, an investor looking to exit might find no counterparty. The system is supposed to ensure basic liquidity and reduce sharp price distortions caused by thin trading. The trouble is that providing liquidity in an infrequently traded or volatile SME stock is risky. Market makers must hold inventory, deploy capital and absorb price movements. Those costs are ultimately built into the fee charged to the issuer. SEBI’s review reportedly follows concerns that the market-making structure has failed to deliver adequate liquidity even as it increases the cost borne by companies. Pandey was reportedly blunt: “The market-making framework is not working properly.” The regulator must now determine whether the obligation needs to be redesigned, shortened, made more competitive or linked to the actual liquidity of each company. Removing it altogether could reduce issuer costs but worsen trading in thinly held shares. Retaining it unchanged could preserve a system that companies pay for without receiving meaningful liquidity.

Why is underwriting also a problem?

An underwriter agrees to subscribe to shares that investors do not buy, reducing the danger that an IPO will fail because of insufficient demand. That backstop is particularly important for smaller companies with limited brand recognition. But it carries a price. Underwriters charge for accepting the risk that they may have to purchase unsold stock. Pandey said the existing underwriting arrangement is not functioning effectively and imposes significant costs on issuers. If an SME must pay merchant bankers, market makers, underwriters, exchanges, lawyers, auditors and other intermediaries, the total expense can consume a substantial portion of a relatively small fundraising exercise. That defeats the purpose of a simplified platform. A company seeking modest growth capital should not have to surrender a disproportionately large share of its proceeds merely to enter the market.

How can an SME listing cost more than a mainboard IPO?

The absolute cost of a mainboard IPO will generally be much higher. The issue arises when costs are measured relative to the amount raised. A ₹30-crore SME issue and a ₹3,000-crore mainboard issue both require professional intermediaries, documentation and regulatory compliance. But the smaller company has far fewer proceeds over which to spread those fixed expenses. Mandatory market making and underwriting can add further SME-specific costs. As a percentage of funds raised, the smaller issue may therefore become significantly more expensive. Pandey said SEBI does not want companies on the SME platform to face costs “significantly higher compared with the mainboard”. That comment reveals the regulator’s larger concern: the framework may be protecting the market so aggressively that it is undermining the platform’s economic purpose.

Why is migration from the SME platform being reviewed?

An SME company that grows beyond a certain scale can migrate to the mainboard, where its shares may gain better liquidity, wider institutional participation and greater visibility. Existing eligibility requirements have often been linked to paid-up capital. Pandey said those linkages need to be reconsidered and possibly removed. Paid-up capital alone does not necessarily capture the size, quality or maturity of a company. Two businesses with identical paid-up capital can have radically different revenues, profitability, market capitalisation, governance standards and shareholder bases. SEBI may therefore consider a broader test involving market value, operating record, public shareholding, compliance and financial performance. A better migration system would allow successful SMEs to graduate without being trapped by an outdated capital threshold. But SEBI will also have to prevent companies from using the SME route merely as an easier back door to the mainboard.

Has the SME IPO market become large enough to require another overhaul?

Yes. What began as a niche fundraising route has expanded rapidly. According to figures reported by Mint, SME IPOs raised a record ₹10,955.1 crore in FY26, up from ₹9,119.9 crore in FY25. The scale of activity means defects in the framework now affect thousands of investors and a growing pool of corporate capital. Rapid expansion also increases the incentive for manipulation. In May 2026, SEBI barred seven people from the securities market over allegations that they used Telegram, WhatsApp and X to manipulate the shares of as many as 82 small companies, Reuters reported. Separately, an analysis published by the National Institute of Securities Markets found that nearly 65% of SME companies listed in 2024 and about 57% of those listed in 2025 were subsequently trading below their issue prices. Listing-day excitement, therefore, has not always translated into durable returns.

Is SEBI now relaxing investor protection?

That would be an oversimplification. The proposed overhaul is not necessarily a retreat from tougher oversight. It is an acknowledgement that some blunt safeguards have produced unwanted consequences without stopping speculation. SEBI can simultaneously make SME shares easier to trade and strengthen scrutiny of promoters, merchant bankers, valuations, use of IPO proceeds and post-listing announcements. The likely regulatory shift is from barriers based primarily on lot size and paid-up capital towards more targeted supervision of conduct, disclosures, liquidity and governance. In other words, the regulator may try to stop manipulating the entry ticket and focus more sharply on what issuers and intermediaries do before and after listing.

What could change for investors and companies?

The consultation paper could propose smaller or redesigned trading lots, a mechanism for disposing of odd-lot holdings and a revised market-making model. Underwriting obligations and migration criteria may also be altered, while eligibility could be delinked from paid-up capital. For companies, the goal will be lower and more proportionate fundraising costs. For investors, the immediate benefit could be improved liquidity and a clearer exit route. But easier trading should not be mistaken for lower risk. SME companies generally have shorter operating histories, smaller balance sheets, concentrated management and more volatile shares than established mainboard businesses. The real test of SEBI’s reform will be whether it can make the market easier to use without making it easier to abuse.

(With inputs from ANI)