What is 'Devolvement'

Devolvement refers to a situation when the undersubscription of a security issue, such as an initial public offering (IPO), forces the underwriting investment bank to purchase unsold shares during an offering.

During the underwriting process, investment banks raise capital for companies that are issuing equity or debt securities,and if those securities aren't snapped up by investors, the responsibility for the unsold shares devolves to the underwriters.

Devolvement is often an indication that the market currently has negative sentiments toward the issue. This negative sentiment can have a significant impact on subsequent demand for the company's shares, and can cause losses for the banks.

BREAKING DOWN 'Devolvement'

Devolvement poses substantial risk for the underwriting investment bank. When it is required to purchase unsubscribed shares of an issue, it will often purchase the stock at a higher-than-market-value price. Because demand is lower than anticipated, there are few buyers for the security at its issued value.

Typically, the investment bank will not hold onto the floundering issue in its own account for too long; it  will usually liquidate the shares in the secondary market, often incurring a financial loss.

Devolvement in the U.S. and abroad

For all the appealing reasons to do an IPO, such as vastly enhanced capital and media attention associated with a company, an undersubscribed offering has big risks for companies and underwriting banks.

"In your consideration on whether to take that leap of faith, it is pertinent to properly evaluate and consider the requirements, processes and pros and cons involved in filing an IPO to determine the best course for your company," according to Deloitte, which offers a checklist for pre-IPO prep, to help companies make sure they're ready for an IPO and avoid an undersubscribed offering.

Most of the time in the U.S., the company that hopes to go public and the investment bank underwriting the IPO have done the necessary homework to ensure the initial shares are all purchased and devolvement isn't necessary.

Other emerging economies in recent years have gotten better at taking similar steps to ensure that IPOs are well-considered and fully-subscribed.

For example, Reuters reported in 2015 that China’s securities regulator would "devolve some of its authority over approving initial public offerings to the Shanghai and Shenzhen Stock Exchanges," which it called another step toward a U.S.-style "registration" system for IPOs.

The China Securities Regulatory Commission aimed to "dissolve its Issuance Examination Committee, which approves IPOs and secondary offerings," according to Reuters. "The CSRC would then allow the Shanghai Stock Exchange and the Shenzhen Stock Exchange to create 'hearing committees' similar to those used in Hong Kong to vet new listings."

According to the news report, China is "working to shift from an approval-based system to a registration-based one in a bid to let market players play a bigger role in determining the timing and pricing of IPOs."

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