Underwriting

Underwriting is the assumption and placement of new securities by a bank. Under a firm commitment, the bank guarantees the issuer the raising of capital and then sells the securities on to investors. In this form, it bears the risk of whether the offering can be placed. Two basic forms must be distinguished.

Under a firm commitment the syndicate undertakes to take the securities at a set price, so the issuer receives the proceeds regardless of placement success and the banks carry the distribution risk. Under a best efforts placement the banks merely undertake to try to place the securities, leaving the risk with the issuer. The service is remunerated through a commission usually split between a structuring portion, an underwriting portion and a selling portion, and is considerably higher for equity than for bonds. In equity offerings the firm commitment is in practice given only after bookbuilding closes, so the banks' actual risk is limited to the period until settlement. This is complemented by the over-allotment option and stabilisation in the first weeks.

The term is also used in insurance and lending for risk assessment. An over-allotment of up to 15 percent is also common. The syndicate can cover the resulting delivery obligation by purchasing additional shares under a greenshoe option or through market purchases. The latter can also stabilise the price.