Merchant Banking in India

Investment Banking in India

Learning Objective

Nature and Scope of Merchant BankingRegulation of Merchant Banking ActivityOverview of Current Indian Merchant

Banking SceneStructure of Merchant Banking IndustryProfessional Ethics and Code of ConductCurrent Development

1. Nature and Scope of Merchant Banking

Merchant banking (MB) is a non-banking financial activity,

resembles banking function. The word ‘Merchant

Banking’ originated by the Dutch and the Scottish traders

and was later developed and professionalized in Britain.

Functions of MB were enriched by Americans and now

being provided throughout the world.

The MB functions in UK and Europe are the same as

functions of investment banking in US. In India, the term

MB is more often used due to the inheritance of the

financial system from UK and the mention in SEBI

(Merchant Bankers) Rule 1992. 5 / 38


According to SEBI (Merchant Bankers) Rule 1992, a

merchant banker is defined as any person who is engaged

in the business of issue management either by making

arrangements regarding selling, buying or subscribing to

securities or acting as manager, consultant, advisor or

rendering corporate advisory services in relation to such

issue management.

6 / 38


Merchant banks are generally engaged in providing

specialized services such as issue underwriting, credit

syndication, M&A advisory, portfolio management,

acceptance of bills of exchange, corporate finance and

other services. It is not necessary for a merchant banker

to carry out all these activities. A merchant banker may

specialize in one activity and take up other activities,

which may be complimentary or supportive to the

specialized activity.

MBs also arrange funds or negotiate financial deals for their

clients for a fee as arrangers, brokers or intermediaries. 7 / 38

Scope of Merchant Banking

MB being a service-oriented industry, renders following

services to its customers.

Management of Debt and Equity

Corporate Counseling

Project Counseling

Credit Syndication and Project Finance

Mergers, Acquisitions and Corporate Restructuring

Venture Capital

Financial Engineering

Private Equity 8 / 38

Management of Debt and Equity

Instrument Designing

Pricing the Issue

Registration of the offer document

Underwriting support

Marketing of the issue

Allotment and refund

Listing on the stock exchange

Corporate Advisory Services

IB offer customized solutions to financial problems of their clients.

Financial restructuring: D/E

Asset turnover ratio: whether over / under trading

Working capital policy: suggestions (Financing)

Refinancing of high cost funds by low cost funds

Turnaround management

Revival of sick units

Management of risk advisory, hedging strategies

Project Advisory Services

Early stages of projects advisory

Project ideas

Initial feasibility studies and viability

Detailed project report

Project appraisal service

Loan Syndication

IBs arrange to tie-up loans for their clients.

Cash flow analysis and requirements

Important loan parameters include amount, currency, tenure,

amortization.

Prepares loan memorandum, circulated to various banks and invited

for syndication.

Banks decide the amounts and interest rates.

Loan documentation process.

Venture Financing

VC business evolved from individuals to institutionalized

sector.

Number and size of deals increasing.

Returns are expected more.

Private Equity

Stages of VC, then PE

Company becomes profitable, establishes track record.

Exit with IPO

M&A

Increased M&A activities.

Pre-liberalization era, M&As in unrelated areas

Post liberalization era, M&As growth, consolidation in core

competence.

Advisory on acquisitions

Financial; Tax shields like carried forward losses or unclaimed

depreciation

Marketing: Growth in market share, eliminating competition

Production: Horizontal or vertical integration

Financial Engineering

Design new financial products, develop superior processes and

implement structured solutions to complex financial problems.

The factors accelerated the financial innovations

Interest rate volatility

Exchange rate volatility

Asset price volatility

Regulatory and Tax changes

Globalization of the markets

Increased competition

Merchant Banking

Other Functions of Merchant Banks

• Accepting Credit and Bill Discounting

• Lease Financing

• Foreign Currency Finance

• Pre-investment Studies

• Capital Restructuring

• Portfolio Management

2. Regulation of Merchant Banking Activity

RegulationsMBs are governed by the SEBI (Merchant Bankers) Rules

and Regulations, 1992. MB must register with SEBI to carry out MB activities,

even if MB is bank sponsored it need to register with SEBI. MB has to be incorporated under the Companies Act 1956.

As a company it comes under the jurisdiction of the Registration of Companies and the formalities of the Companies Act have to be approved including Memorandum and Articles of Association, authorized and the paid up capital.

MB undertaking fund based activities need to register with RBI as a NBFC. 10 / 38


Underwriter business is regulated by SEBI (Underwriters)

Rules and Regulations, 1993. Activities of secondary market operations including stock

broking are regulated by stock exchange and SEBI (Stock

Brokers and Sub Brokers) Rules and Regulations, 1992. Business of portfolio management is regulated under SEBI

(Portfolio Managers) Rules and Regulations, 1993. Business of venture capital and private equity funds are

regulated by SEBI (Venture Capital Funds) Regulations,

1996. MBs should fulfill the eligibility criteria on an on-going

basis and requires registration every three years. 11 / 38


Initially, SEBI classified the MBs into four categories. Later modified the rules to have only Category I merchant banker with minimum net worth Rs. 5 Crore and initial registration fee Rs. 5 Lakh. MB shall pay a renewal fee of Rs. 2.5 Lakh every three years from fourth year of the registration.

MBs cannot accept deposits from public.

12 / 38


MB not to associate with any business other than that of

the securities market.

MB shall keep and maintain the books of account, records

and documents.

While registration as MB, SEBI ensures the professional

qualification in finance, law or business management,

adequate office space, manpower, office equipment, other

infrastructure, office staff having competency in MB

business, minimum stipulated capital and previous

experience as MB. 13 / 38


Lead MBs: All issues should be managed by at least one MB functioning as a lead MB, except in case of a rights issue and the issue size not exceeding Rs. 50 Lakh. Every lead MB should enter into an agreement with corporate setting their rights, liabilities and obligations relating to such issues on disclosures, allotment and refund. Number of lead MBs should not exceed than stated below.

14 / 38

Size of Issue Number of lead MBs

Less than Rs. 50 Crore 2

Above Rs. 50 Crore but less than Rs. 100 Crore 3



Above Rs. 400 Crore 5 or more as agreed by SEBI


Remuneration of MBs: MBs generate income, classified

based on their activities as fund based and fee based

income. Fund based activities generate a spread being the

difference between the cost of funds and the yield from the

funds.

15 / 38

3. Overview of Current Indian Merchant Banking Scene

In India, first MB division was set up in 1967 by Grindlays Bank (merged with Standard Chartered Bank), followed by Citibank in 1970.

In 1972, SBI set up a MB division namely SBI Capital Markets Ltd (SBICAP). Other banks followed to set up MB divisions such as Bank of India, Central Bank of India, Canara Bank, Bank of Baroda, Punjab National Bank and Syndicate Bank.

16 / 38


In 1974, ICICI set up a MB division, later IFCI and IDBI

also entered this field. Private firms such as DSP financial

consultants Ltd., J M Financial Services Ltd. and Credit

Capital Finance Corporation Ltd. have also started MB

activities.

During economic reforms period, post 1991, number of MBs

increased drastically. The number of MBs rose to about

thousand in 1990s. Later due to SEBI restrictions, many

MBs have closed down and the number reduced to 124 in

2003.17 / 38


Currently, major MBs in India are

SBI Capital Markets Ltd.

Kotak Mahindra Capital Company

ICICI Securities Ltd.

IDBI Capital Markets Ltd.

Enam Financial Consultants Ltd.

JM Morgan Stanley Ltd.

DSP Merrill Lynch Ltd.19 / 38

4. Structure of Merchant Banking Industry

Indian MBs follow a conglomerate structure by keeping their business segments in different corporate entities. For example, MB business has to be in a separate company as it requires a separate MB licensing from the SEBI. MBs are prohibited from undertaking any business other than the securities market.

Asset management business in the form of mutual fund requires a three-tier structure under the SEBI regulations.

Equity research should be independent of the MB business to avoid the conflict of interest faced by American investment banks.

Securities business has to be separated into a different company as it requires a stock exchange membership and SEBI registration. 21 / 38

4. Structure of Merchant Banking Industry

Post 1991, due to financial liberalization & primary market boom, many banks, FIs, financial business houses and NBFCs entered the MB, underwriting and advisory business. Due to the gradual regulatory developments in the capital markets, MB activities came under regulations which required separate registration, licensing and capital requirements.

Due to the above reason, Indian MB industry has a heterogeneous structure. Bigger MBs have several group entities in which the core and non-core business segments are distributed. Other MBs have one or more entities depending activities.

22 / 38

Structural Analysis of Investment Banking Industry

Given the industry structure, competition in the industry has its

basis in the economic structure.

Reviewing the competition, the framework is developed by

Michael Porter to examine the competitive advantage to IBs.

Five forces which determine profit potential in the industry

Threat of entry

Competition

Pressure from substitute products

Bargaining power of buyers

Bargaining power of suppliers*****

7. Current Development

Business of MB is undergoing rapid transformation in

response to the growing sophistication in the financial

markets and the needs of clients. Consolidation and

globalization is the key for success and growth. Financial

conglomerates with equal presence in commercial

banking, investment banking, insurance and financial

advisory are the way to go for one-stop shopping for all

financial needs. Most US universal banks are shaping up

to be financial conglomerates that would eventually

threaten the supremacy of pure investment banks on Wall

Street.35 / 38


Future therefore lies in ‘full service investment banking’

comprising of core investment banking (managing and

underwriting security issues of all types, M&A advisory),

asset management (mutual funds, portfolio management,

private banking), private equity and venture capital,

brokerage, sales and distribution, research and analysis,

proprietary trading and investment, primary dealing in

fixed income securities, structured financing and

corporate advisory services. Universal banks can add all

their banking products in both corporate and retail

banking segments to the long list of services offered as full

service investment banks. 37 / 38


A step forward would be the financial conglomerates of the

future that can even add on insurance and pension

products to make them one-stop financial shops. Large

financial conglomerates such as the Citigroup or ING

would be the models of growth in the years to come.

*****

38 / 38

Merchant Banking in India

Documents

Transcript of Merchant Banking in India