L. S.

RAHEJA COLLEGE OF ARTS & COMMERCE

JUHU ROAD, SANTACRUZ (WEST), MUMBAI 400 054

TITLE OF THE REPORT

INVESTMENT BANKING
PRESENTED BY
PRIYANK M. SANDHEL
T.Y. B. COM
(BANKING & INSURANCE)
Semester V

PROJECT GUIDE
PROF. GOVIND SOVANI.

UNIVERSITY OF MUMBAI.
ACADEMIC YEAR
2008-2009

L.S. RAHEJA COLLEGE OF ARTS & COMMERCE

JUHU ROAD, SANTACRUZ (WEST), MUMBAI 400 054

B.Com in (Banking and Insurance)

INVESTMENT BANKING

Name of Student: Priyank M. Sandhel

Seat No: ____________
Date: _____________

DECLARATION
I, Priyank M. Sandhel , of L. S. Raheja College of Arts &
Commerce of T.Y.BBI. , (Semester V) hereby declare that I
have completed this project on Investment Banking in the
Academic Year 2008-2009. The information submitted is
true and original to the best of my knowledge.

Signature of Student

CERTIFICATE
I, Govind Sowani here by certify that SANDHEL PRIYANK of
L. S. Raheja College of T.Y.BBI (Semester V) has completed
the project on Investment Banking in the Academic Year
2008-2009. The information submitted is true & original.

Co-ordinator

Project Guide

Internal Examiner

Principal

External Examiner

College Seal

ACKNOWLEDGEMNT

It is my proud privilege to express my sincere gratitude to all

those who helped me directly or indirectly in completion of this
project report.
I am greatly indebted to Mr. Govind Sowani my project guide
for his support, guidance and valuable suggestions by which this work
has been completed effectively and efficiently . These all
contributions are of immense value.
I owe thanks to Mr. Kashyap Ganatra my co-ordinator for
providing the required data to complete this project.

INDEX
Sr. No Topic

Page No.

1.
2.
3.

Executive Summary
Introduction
Investment Banking and Merchant Banking

1
2
4

4.
5.
6.
7.
8.
9.

Distinguished
Evolution of American Investment Banks
European Investment Banks
Global Industry Structure
Business Portfolio of Investment Banks
The Indian Scenario
Characteristics and Structure of Indian Investment

6
10
12
13
15
19

10.
11.

Banking Industry
Service Portfolio of Indian Investment Banks
Interdependence between Different Verticals in

23
29

12.
13.
14.
15.
16.
17.

Investment Banking
Regulatory Framework for Investment Banking
Regulatory Framework for Merchant Banking
Anatomy of Some Leading Indian Investment Banks
Recent Trends in Investment Banking
The Conflict of Interest Issue
Conclusion

31
35
38
51
56
60

EXECUTIVE SUMMARY

Introduction
At a very macro level, Investment Banking as the term suggests, is
concerned with the primary function of assisting the capital market in its
functions of capital intermediation, i.e. the movement of financial resources
from those who have them (the Investors), to those who need to make us of
them for generating GDP (the Issuers). As already discussed banking and
financial institutions on the one hand and the capital market on the other are
the two broad platforms of institutional intermediation for capital flows in
the economy. Therefore, it could be inferred that investment banks are those
institutions that are the counterparts of banks in the function of
intermediation in resource allocation. Nevertheless, it would be unfair to
conclude so, as that would confine investment banking to a very narrow
sphere of its activities in the modern world of high finance. Over the
decades, backed by evolution and also fuelled by recent technological
developments, investment banking has transformed repeatedly to suit the
needs of the finance community and thus become one of the most vibrant
and exciting segment of financial services. Investment bankers have always
enjoyed celebrity status, but at times they have paid the price for excessive
flamboyance as well.
To continue from the above, in the words of John F. Marshall and M.E. Ellis,
investment banking is what investment banks do. This definition can be
explained in the context of how investment banks have evolved in their
functionality and how history and regulatory intervention have shaped such
as evolution. Much of investment banking in its present form thus owes its

origin to the financial market in USA, due to which, American investment

banks have been leaders in the American and Euro markets as well.
Therefore, the term investment banking can arguably be said to be of
American origin. Their counterparts in UK were termed as merchant banks
since they had confined themselves to capital market intermediation until the
US investment banks entered the UK and European markets and extended
the scope of such businesses.

Investment Banking and Merchant Banking Distinguished

At this stage, it would be relevant therefore, to draw a fine line of distinction
between the terms Investment Banking and Merchant Banking as both
these terms are extensively used in this project. Merchant Banking as the
term suggests, is the function of intermediation in the capital market. It
consists of assisting issuers to raise capital by placement of securities issued
by them with investors. However, merchant banking is not merely about
marketing securities in an agency capacity. The Merchant Banker has an
onerous responsibility towards the investors who invest in such securities.
The regulatory authorities require the merchant banking firms to promote
quality issues, maintain integrity an ensure compliance with the law on own
account and on behalf of the issuers as well. Therefore, merchant banking is
a fee based service management of public offers; popularly know as issue
management and for private placement of securities in the capital market. In
India, the Merchant Banker leading a public offer is also called as the Lead
Manager.
On the other hand, the term, Investment Banking has a much wider
connotation and is gradually becoming more of an inclusive term to refer to
all types of capital market activity, both fund-based and non-fund based.
This development has been driven more by the way the American
investment banks have evolved over the past century. Given this situation,
investment banking encompasses not merely merchant banking but other
related capital market activities such as stock trading, market making,
underwriting, broking and asset management as well. Besides the above,

investment banks also provide a host of specialized corporate advisory

services in the areas of project advisory, business and financial advisory and
mergers and acquisitions. The activity profile of investment banks is
discussed in more in detail later in this chapter.

Evolution of American Investment Banks

The earliest events that are relevant for this discussion can be traced to the
end of World War I, by which time, commercial banks in the USA were
already preparing for an economic recovery and consequently, to the
significant demand for corporate finance. It was expected that American
companies would shift their dependence from commercial banks to stock
and bond markets wherein funds were available at a lower cost and for
longer periods of time. In preparation for a boom in the capital markets in
the 1920s, commercial banks started to acquire stock broking businesses in a
bid to have their presence made in such markets. The first of such
acquisitions happened when the National City Bank of New York acquired
Halsey Stuart and Company in 1916. As in the past, in the entire 1920s,
investment banking meant underwriting and distribution of securities.
The stock and bond market boom in 1920s was as opportunity that banks
could not miss. But since they could not underwrite and sell securities
directly, they owned security affiliates through holding companies. However,
they were not maintained like water tight compartments. The affiliates were
sparsely capitalized as were financed by the parent banks for their
underwriting and other business obligations. While the boom lasted,
investment banking affiliates made huge profits as underwriting fees,
specially in the segment called Yankee Bonds issued by overseas issuers in
US market. In the stock market, the banks mainly conducted broking
operations through their subsidiaries and lent margin money to customers.
But with the passage of the McFadden Act in 1927, bank subsidiaries began

underwriting stock issues as well. National City Bank, Chase Bank, Morgan
and Bank of America were the most aggressive banks present at that time.
The stock market got over-heated with investment banks borrowing money
from the parent bank in order to speculate in the banks stock, mostly for
short selling. Once the general public joined the frenzy, the price-earning
ratios reached absurd limits and the bubble eventually burst in October 1929
wiping out millions of dollars of bank depositors funds and bringing down
with it banks such as Bank of United States/
In order to restore confidence in the banking and financial system, several
legislation measure were proposed, which eventually led to the passing of
the Banking Act 1933 (popularly know as Glass-Steagall Act) that restricted
commercial banks from engaging in securities underwriting and taking
positions or acting as agents for others in securities transactions. These
activities were segregated as the exclusive domain of investment banks. On
the other hand, investment banks were barred from deposit taking and
corporate lending, which were considered the exclusive business of
commercial bank. The Act thus provided the water tight compartments that
were needed before. Since the passing of this Act, investment banking
became narrowly defined as the basket of financial services associated with
the floatation of corporate securities, i.e. the creation of primary market for
securities. It was also extended to mean at a secondary level, secondary
market making through securities dealing.
By 1935, investment banking became one of the most heavily regulated
industries in USA. The Securities Act, 1933 provided for the first time the
7

preparation of offer documents and registration of new securities with the

federal government. The Securities Exchange Act, 1934 led to the
establishment of the Securities Exchange Commission. The Maloney Act of
1938 led to the formation of the NASDAQ, the Investment Company Act,
1940, which brought mutual funds within the regulatory ambit and the
Investment Advisers Act, 1940 which also regulated the business of
investment advisers and wealth managers.
After the passing of the Glass-Streagall Act of the 1930s, until the beginning
of the 21st century, investment banking had been through several phases of
transformation which had broken down the water tight compartments to a
great extent. Due to the 1973 Arab oil embargo, world economies were
under pressure and inflation and interest rate volatility became disturbing. It
was at this time that institutional investors madder their advent into
securities markets. It was also the time when the industrial and financial
service sectors were beginning to expand and globalize. Due to these
developments, investment banking and commercial banking once again
became constrained by the very legislation that was meant to clean up the
system in the 1930s. This led to several relaxations over the years such as
the Securities Acts Amendments, 1975 which had permitted commercial
banks to have subsidiaries (called section 20 subsidiaries) that were allowed
to underwrite and trade in securities. In 1990, J.P. Morgan was the first bank
to open a section 20 subsidiary. Since the Glass-Streagall Act did not apply
to foreign subsidiaries of US banks, they continued to underwrite in the
Eurobond market and by 1984, they had a 52% market share in that
business. But there was stiff competition from Japanese banks in this market
and by 1987, they underwrote only 25% of the Eurobond issuances.
8

During the economic growth and globalization of the 1980s, investment

banking expanded to several new areas and services which had included
currency trading, real estate, financial futures, bridge loans, mortgagebacked securities and several others. But the stock market crash of 1987
once again brought the focus back to core areas of specialization. Similarly,
the ambitious expansion that took place on a global scale was also halted to
some extent. However due to technological advancements in the 1990s and
the availability of global access through the revolution in communication
technologies fuelled the global growth again. But this time though,
investment banking is no more restricted to underwriting new issuances and
security dealing. The shift is more towards providing expertise in new
products and risks. Apart from these activities, investment banking also
encompasses a considerable spectrum of advisory services in the areas of
corporate restructuring, mergers and acquisitions and LBOs, fund raising
and private equity. On the dealing and trading side, investment banks
participate in derivatives market, arbitrage and speculation. In the area of
structured finance, investment banks also provide financial engineering
through securitization deals and derivative instruments.

European Investment Banks

In continental Europe (excluding UK), the concept of a Universal Bank
had been the undercurrent since the late nineteenth century, when most of
these banks were set up. The term universal banking meant the coexistence of commercial banking (lending activity) along with investment
banking (investment and distribution activity). Their universality was in the
sense of harnessing the vast retail customer base that these banks enjoyed to
market security issuances by their investment banking arms. These issues
were mostly in the local markets designated in the local currencies. Frances
Banques daffiars and Germanys Universalbanken are good examples.
The United Kingdom, which is considered as Europes largest investment
banking market, had its own structure evolved from history. The oldest
merchant bank in London was Barings Brothers which had played a
prominent role in the nineteenth century. Securities distribution was the
function of stock brokers, secondary market trading was held by jobbers and
advisory services were provided by merchant bank. The term merchant
bank was evolved so as to distinguish between commercial banks and those
that provided capital market advice. However, the breaking down of such
barriers in 1986 by allowing banks to own broking outfits led to a
consolidation and most of the broking firms got absorbed by larger and
diversified entities. Around the same time, the US too was witnessing the
disappearance of distinction between pure broking entities restricted to the
secondary markets and investment banking entities involved with the
primary markets. The US investment banks with their integrated global
business model entered UK and Europe and later into Japan. The
10

introduction of the Euro currency in 1999, helped the US invasion further by

neutralizing the local currency advantages enjoyed by European universal
banks. By 2001, the US bulge group garnered 29.7% of the investment
banking fee generated in Europe as compared to 16.3% by the European
universal banks.
Post-1986, the merchant banks and commercial banks in UK could not
match up to the US onslaught which ultimately led to the sale of SG
Warburg, the merchant bank to Swiss Bank Corporation (which was
acquired by UBS later) in 1995. In 1997, Natwest Bank and Barclays Bank
exited investment banking business. Morgan Grenfell, a merchant bank was
sold to Deutsche Bank in 1990. In this upheaval, niche players such as
Drexel Burnham and Barings Bank also collapsed with internal deficiencies.
This led to cross border M&A between European banks inter-se and their
American counterparts to create bigger investment banks. UBS Warburg was
born out of merger of UBS and Swiss Bank Corporation which had earlier
acquired SG Warburg. Deutsche Bank acquired Bankers Trust.

11

Global Industry Structure

The investment banking industry on a global scale is oligopolistic in nature
ranging from the global leaders (known as the Global Bulge Group) to
Pure investment banks and Boutique investment banks. The bulge group
consisting of eight investment banks has a global presence and these firms
dominate the league tables in key business segments. The top ten global
firms in terms of their fee billing as in 2001 are listed in Table
Within the listing given in the table referred to above are the top pure
investment banks, i.e. which do not have commercial banking connections,
which are Merrill Lynch, Goldman Sachs and Morgan Stanley Dean Witter.
Listed therein are also the leading European Universal Banks that are called
so due to their role in both commercial and investment banking. The five
leading universal banks in the world and their important group affiliates are
given in Table
Therefore, the global investment banking industry ranges form the
acknowledged global leaders to a larger number of mid-sized competitors at
a national or regional level and the rear end is supported by boutique firms
or advisory and sectoral specialists.

12

Business Portfolio of Investment Banks

Globally, investment banks handle significant fund-based business of their
own in the capital market along with their non-fund service portfolio which
is offered to clients. However, these distinct segments are handled either on
the same balance sheet or through subsidiaries and affiliates depending upon
the regulatory requirements in the operating environment of each country.
All these activities are segmented across three broad platforms equity
market activity, debt market activity and merger and acquisition (M&A)
activity. In addition, given the structure of the market, there is also a
segmentation based on whether a particular investment bank belongs to a
banking parent or is a stand-alone pure investment bank. Figure represents
the broad spectrum of global investment acitivity.
From this diagram, it may be appreciated that investment banking
encompasses a wide area of capital market based businesses and services
and has a significant financial exposure to the capital market. Though
investment banks also earn a significant component of their income from
non-fund based activity, it is their capacity to support clients with fundbased services, which distinguishes them from pure merchant banks. In the
US capital market, investment banks underwrite issues or buy them outright
and sell them later to retail investors thereby taking upon themselves
significant financial exposure to client companies. Besides, being such large
financial power houses themselves, the global investment banks play a
major role as institutional investors in trading and having large holdings of
capital market securities. As dealers they take positions and make a market
for many securities both in equity and derivative segments. They hold large
13

inventories and therefore influence the direction of the market. Goldman

Sachs, Salomon Brothers, Merrill Lynch, Schroeders, Rothschild and other
significant Market Investors both on their own account and on behalf of the
billions dollars of funds under their management.
The global mergers and acquisitions business is very large and measures up
to trillions of dollars annually. Investment banks play a lead advisory role in
this booming segment of financial advisory business. Besides, they come in
as investors in management buy-outs and management buy-in transactions.
On other occasions, wherein investment banks manage private equity funds,
they also represent their investors in such buy-out deals.
In the case of universal banks such as the Citigroup or UBS Warburg, loan
products form a significant part of the debt market business portfolio. Pure
investment banks such as Goldman Sachs, Merrill Lynch and Morgan
Stanley Dean Witter do not have commercial banking in their portfolio and
therefore, do not offer loan products. Besides the larger firms, there are a
host of other domestic players present in each country and mid-sized
investment banks, which either specialize in local markets or in certain
product segments.
Some investment banks in the overseas markets also specialize in niche
segments such as management of hedge funds, bullion trade, commodity
hedges, real estate and other exotic markets.

14

The Indian Scenario

Origin
In India, though the existence of this branch of financial services can be
traced to over three decades, investment banking was largely confined to
merchant banking services. The forerunners of merchant banking in India
were the foreign banks. Grindlays Bank (now merged with Standard
Chartered Bank in India) began merchant banking operations in 1967 with a
license obtained from the RBI followed by the Citibank in 1970. These two
banks were providing services for syndication of loans and raising of equity
apart from other advisory services.
It was in 1972, that the Banking Commission Report asserted the need for
merchant banking services in India by the public sector banks. Based on the
American experience which led to the passing of the Glass-Streagall Act, the
Commission recommended a separate structure for merchant banks so as to
distinct them from commercial banks and financial institutions. Merchant
banks were meant to manage investments and provide advisory services.
Following the above recommendations, the SBI set up its merchant banking
division in 1972. Other banks such as the Bank of India, Central Bank of
India, Bank of Baroda, Syndicate Bank, Punjab National Bank, Canara Bank
also followed suit to set up their merchant banking outfits. ICICI was the
first financial institution to set up its merchant banking division in 1973. The
later entrants were IFCI and IDBI with the latter setting up its merchant

15

banking division in 1992. However, by the mid eighties and early nineties,
most of the merchant banking divisions of public sector banks were spun off
as separate subsidiaries. SBI set up SBI Capital Markets Ltd. in 1986. Other
such banks such as Canara Bank, BOB, PNB, Indian Bank and ICICI
created separate merchant banking entities.

16

Growth
Merchant banking in India was given a shot in the arm with the advent of
SEBI in 1988 and the subsequent introduction of free pricing of primary
market equity issues in 1992. However, post 1992, the merchant banking
industry was largely driven by issue management activity which fluctuated
with the trends in the primary market. These have been phases of hectic
activity followed by a severe setback in business. SEBI started to regulate
the merchant banking activity in 1992 and a majority of the merchant
bankers who registered with SEBI were either in issue management or
associated activity such as underwriting or advisorship. SEBI had four
categories of merchant bankers with varying eligibility criteria based on
their networth. The highest number of registered merchant bankers with
SEBI was seen in the mid-nineties, but the numbers have dwindled since,
due to the inactivity in the primary market. The number of registered
merchant bankers with SEBI as at the end of March 2003 was 124, from a
peak of almost a thousand in the nineties. In the financial year 2002-03
itself, the number decreased by 21.

17

Constraints in Investment Banking

Due to the over dependence on issue management activity in the initial
years, most merchant banks perished in the primary market downturn that
followed later. In order to stabilize their businesses, several merchant banks
diversified to offer a broader spectrum of capital market services. However,
other than a few industry leaders, the other merchant banks have not been
able to transform themselves into full service investment banks. Going by
the service portfolio of the leading full service investment banks in India, it
may be said that the industry in India has seen more or less similar
development as its western counterparts, though the breadth available in the
overseas capital market is still not present in the Indian capital market.
Secondly, due to the lack of institutional financing in a big way to fund
capital market activity, it is only the bigger industry players who are in
investment banking. The third major deterrent has also been the lack of
depth in the secondary market, especially in the corporate debt segment.

18

Characteristics and Structure of Indian Investment Banking

Industry
Investment banking in India has evolved in its own characteristics structure
over the years both due to business realities and the regulatory regime.
On the regulatory front, the Indian regulatory regime does not allow all
investment banking functions to be performed under one entity for two
reasons(a) to prevent excessive exposure to business risk under one entity
and (b) to prescribe and monitor capital adequacy and risk mitigation
mechanisms. Therefore bankruptcy remoteness is a key feature in structuring
the business lines of an investment bank so that the risks and rewards are
defined for the investors who provide resources to the investment banks. In
addition, the capital adequacy requirements and leveraging capability for
each business line have been prescribed differently under relevant provisions
of law. On the same analogy, commercial banks in India have to follow the
provisions of the Banking Regulation Act and the RBI regulations, which
prohibit them from exposing themselves to stock market investments and
lending against stocks beyond certain specified limits.
Therefore, Indian investment banks structure their business segments in
different corporate entities to be able to meet regulatory norms. For e.g. it is
desirable to have merchant banking is a separate company as it requires a
separate merchant banking license from the SEBI. Merchant bankers other
than banks and financial institutions are also prohibited from undertaking
any other business other than that in the securities market. However, since

19

banks are subject to the Banking Regulation Act, they cannot perform
investment banking to a large extent on the same balance sheet. Asset
management business in the form of a mutual fund requires a three-tier
structure under the SEBI regulations. Equity research should be independent
of the merchant banking business so as to avoid the kind of conflict of
interest as faced by American investment banks. Stock broking has to be
separated into a different company as it requires a stock exchange
membership apart from SEBI registration. A complete overview of the
regulatory framework for investment banking is furnished later.
Investment banking in India has also been influenced by business realities to
a large extent. The financial services industry in India till the early 1980s
was driven largely by debt services in the form of term financing from
financial institutions and working capital financing by commercial banks
and non-banking financial companies (NBFCs). Capital market services
were mostly restricted to stock broking activity which was driven by a noncorporate unorganized body industry. Merchant banking and asset
management services came up in a big way only with the opening up of the
capital markets in the early nineties. Due to the primary market boom during
that period, many financial business houses such as financial institutions,
banks and NBFCs entered the merchant banking, underwriting and advisory
business. While most institutions and commercial banks floated merchant
banking divisions and subsidiaries, NBFCs combined their existing business
with that of merchant banking.
Over the subsequent years, two developments have taken place. Firstly, with
the downturn in the capital markets, the merchant banking industry has seen
20

a tremendous shake out and only about a 10% of them remain in serious
business as pointed out earlier. The other development is that due to the
gradual regulatory developments in the capital markets, investment banking
activities have come under regulations which require separate registration,
licensing and capital controls.
Due to the above reasons, the Indian investment banking industry has a
heterogeneous structure. The bigger investment banks have several group
entities in which the core and non-core business segments are distributed.
Others have either one or more entities depending upon the activity profile.
The heterogeneous and fragmented structure is evident even if Indian
investment banks are classified on the basis of their activity profile. Some of
them such as SBI, IDBI, ICICI, IL & FS, Kotak Mahindra, Citibank and
others offer almost the entire gamut of investment banking services
permitted in India. Among these, the long term financial institutions are
gradually transforming themselves into full service commercial banks
(called universal banking in the Indian context). They also have full service
investment banking under their fold. Other entities such as NBFCs or
subsidiaries of public sector banks mainly offer merchant banking and other
capital market services. There are also several others who are providing only
corporate advisory services but prefer to hold merchant banking or
underwriting registrations.
Presently, there are no global Indian investment banks although there is a
bulge bracket of investment banks in India that have some overseas presence
to serve Indian issuers and their investors. At the middle level are several
21

niche players including the merchant banking subsidiaries of some public

sector banks. Some of these subsidiaries have been either shut down or sold
off in the wake of two securities scam seen in 1993 and in 2000. However,
certain banks such as Canara Bank and Punjab National Bank have had
successful merchant banking activities. Among the middle level players are
also merchant banks structured as non-banking financial services companies
such as Rabo India Finance Ltd, Alpic Finance etc. There are also in the
middle level, some pure advisory firms such as Lazard Capital, Ernst &
Young, KPMG, Price Waterhouse Coopers etc. At the lower end are several
niche players and boutique firms, which focus on one or more segments of
the investment banking spectrum.

22

Service Portfolio of Indian Investment Banks

Core Services
Merchant Banking, Underwriting and Book Running
The primary market which was quite small in India, was revitalized with the
abolition of the Capital Issues (Control) Act 1947 and the passing of the
Securities and Exchange Board of India Act, 1992. The SEBI functions as
the regulator for the capital markets similar to its counterpart, the SEC in
USA. SEBI vide its guidelines dated June 11, 1992 introduced free pricing
of securities in public offers for the first time in India. Over the last ten
years, there have been two distinct phases of primary market boom the first
between 1992-1996 and the second between 1998-2001. The third wave of
primary market issues could shape up in the near future. This market is very
closely regulated by SEBI. In the days when the public offers market is very
vibrant, this area of service forms the main activity for most Indian
investment banks. In the past few years, though public offers have been very
few, the private placement market especially in the debt segment has been
very active and has served as an important source of funds for prime-rated
corporates. Notable among such offerings are related privately placed
debentures issued by public sector corporations and leading private
companies. Financial institutions have been raising funds via the public
offers and hand holding them in the private placements as well. Once the
private placement markets also come under regulatory stipulations,
investment banks would have a wider role to play in such issuances.

23

Mergers and Acquisitions Advisory

The mergers and acquisitions industry was pretty nascent in India prior to
1994 and continues to be tiny compared to the global scale of such
transactions. However, two main features that have given a big push to this
industry are:
The forces of liberation and globalization that have forced the Indian
industry to consolidate.
The institutionalization of corporate acquisitions by SEBI through its
guidelines, popularly known as the Takeover Code.
One of the cream activities of investment banks has always been M&A
advisory. The larger investment banks specialize in M&A as a core activity.
While some of them provide pure advisory services in relation to M&A,
others holding valid merchant banking licenses from SEBI also manage the
open offers arising out of such corporate events.

24

Corporate Advisory
Investment banks in India also have a large practice in corporate advisory
services relating to project financing, corporate restructuring, capital
restructuring through equity repurchases (including management of buyback
offers under section 77A of the Companies Act, 1956), raising private equity,
structuring joint-ventures and strategic partnerships and other such value
added specialized areas.

25

Support services and Businesses

Secondary Market Activities
Most of the universal banks such as ICICI, IDBI and Kotak Mahindra have
their broking and distribution firms in both the equity and debt segments of
the secondary market. In addition several other investment banks such as the
IL & FS and pure investment banks such as DSP Merrill Lynch and JM
Morgan Stanley have a strong presence in this area of activity. In the past
few years, the derivatives segment has been introduced in Indian capital
market and this provides an additional avenue of specialization for
investment banks. Derivatives trading, risk management and structured
products offerings are the new segments that are fast becoming the areas of
future potential for Indian investment banks. The securities business also
provides extensive research offerings and guidance to investors. The
secondary market services cater to both the institutional and noninstitutional investors.

Asset Management Services

Most of the top financial groups in India which have investment banking
businesses such as the ICICI, the IDBI, Kotak Mahindra, DSP Merrill
Lynch, JM Morgan Stanley, SBI and IL & FS also have their presence in the
asset management business through separate entities. As per the three layer
structure propounded by SEBI, the parent organization acts as the sponsor of
the fund and the fund itself is constituted as a trust. The trust is managed by

26

an asset management company and a separate trustee company which

oversees the interests of the unit holders in the Mutual Fund. The whole
structure has as arms length distance from the sponsors other businesses
and entities.

Wealth Management Services (Private Banking)

Many reputed investment banks nurture a separate service segment to
manage the portfolio of high networth individuals, households, trusts and
other types of non-institutional investors. This can be structured either as a
pure advisory service wherein the investment manager does not have any
access to the funds or as a fund management service wherein the investment
manager is given charge of the funds. In the former case, it becomes a nondiscretionary portfolio and in the latter case, it becomes a discretionary
portfolio. Such activity is regulated under the SEBI guidelines as already
discussed. In other cases, wealth management may be restricted to a research
based activity wherein the investor is provided good investment
recommendations from time to time.

Institutional Banking
Institutional investors have been a recent phenomenon in the Indian capital
market, which till then had the presence of a handful of public financial
institutions such as the UTI and the insurance companies. The term lending
institutions such as the IDBI and IFCI did not participate in secondary
market dealing as a matter of policy. With the advent of liberalization, there

27

are presently a large number of domestic institutional investors in the

secondary market apart from approved foreign institutional investors. In
addition, institutional investments have risen significantly in the primary
markets through venture capital and private equity investments by investors
in both the domestic and non-domestic categories. Several of the leading
investment banks either have dedicated venture funds or private equity funds
that invest in primary market. In addition they make proprietary investments
in the secondary market through their dealing and market activities. The
business portfolio of Indian Investment Banks has been briefly discussed in
Fig.

28

Interdependence between Different Verticals in Investment

Banking
As is evident from Figure

, there are different verticals in investment

banking and they do enjoy synergies with one another. While some of the
service or business segments form the core of investment banking, others
provide invaluable support. This inter-dependence and complementary
existence has been explained below.
While merchant banking largely relates to management of public floatations
of securities or reverse floatations such as buy backs and open offers,
underwriting is an inherent part of merchant banking for public issues.
Similarly, bought out deals and market making are a part of the process of
floating issues on the OTC Exchange of India. The concept of market
making has now been introduced for listing of certain scrips in the main
stock exchanges as well. Advisory and transaction service have a close
linkage with merchant banking as more often than not, such services
culminate in a merchant banking assignment for a public issue or a reverse
floatation. Such services also help in maintaining an enduring relationship
with clients during those times when merchant banking is not a hot activity
due to depressed market conditions. The other segment of primary market
activity, i.e. venture capital and private equity has equal synergies with
merchant banking. Being in venture capital business which enables
identification of potential IPO candidates quite early, which helps not only in
generating good fee income from merchant banking services, but also good
in capital gains for the venture capital invested at earlier rounds of financing

29

in such companies. Similarly, being in private equity business helps in

harnessing the potential offered by later stage and listed companies, which
may approach an investment bank primarily for merchant banking services.
The support business vertical in the secondary market operations also have
synergies with those in the primary equity and debt market segment as far as
investment banking is concerned. Stock broking and primary dealership in
debt markets nurture institutional, corporate and retail clients who can be
tapped effectively for asset management, portfolio management, and private
equity business. In addition, presence in the equity derivative and foreign
exchange derivatives segments can help in offering solutions in treasury
management to clients. In addition, the advisory and transaction services
vertical can draw expertise from such segments in providing structured
financing solutions to its clients. All these verticals are driven by support
services such as sales and distribution and also equity research and analysis.
Lastly but more importantly, the capability in sales and distribution also
determines the success of the merchant banking vertical.
Thus, it may be seen that the growth and success of an investment bank
depends on its strengths in each vertical and how well it combines them for
synergies. To sum up, investment banking is a business that is very sensitive
to the economic and capital market scenario and therefore, the broader the
platform of its operations, the more is likelihood of an investment bank
surviving business cycles and sudden shocks from the market.

30

Regulatory Framework for Investment Banking

As discussed above, investment banking in India is regulated in its various
facets under separate legislations or guidelines issued under statute. The
regulatory powers are also distributed between different regulators
depending upon the constitution and status of the investment bank. Pure
investment banks which do not have presence in the lending or banking
business are governed primarily by the capital market regulator (SEBI).
However, universal banks and NBFC investment banks are also regulated
primarily by the RBI in their core business of banking or lending and so far
as the investment banking segment is concerned, they are also regulated by
SEBI. An overview of the regulatory framework is furnished below:
1. At the constitutional level, all investment banking companies
incorporated under the Companies Act, 1956 are governed by the
provisions of that Act.
2. Investment banks that are incorporated under a separate statute such
as the SBI or the IDBI are regulated by their respective statute. IDBI
is in the process of being converted into a company under the
Companies Act.
3. Universal Banks are regulated by the Reserve Bank of India under the
RBI Act 1934 and the Banking Regulation Act which put restrictions
on the investment banking exposures to be taken by banks. The RBI
has relaxed the exposure limits for merchant banking subsidiaries of
commercial banks. Till now, such companies were restricting their
31

exposure to a single entity through the underwriting business and

other fund based commitments such as standby facilities etc to 25% of
their net owned funds (NOF). Therefore these companies are now on
par with other investment banks which can do so up to 20 times their
NOF.
4. Investment banking companies that are constituted as non-banking
financial companies are regulated operationally by the RBI under
Chapter IIIB (sections 45H to 45QB) of the Reserve Bank of India
Act, 1934. Under these sections RBI is empowered to issue directions
in the area of resource mobilization, accounts and administrative
controls. The following directions have been issued by the RBI so far:
Non-Banking Financial Companies Acceptance of Deposits
(Reserve Bank) Directions, 1998.
NBFCs Prudential Norms (Reserve Bank) Directions, 1998.
5. Functionally, different aspects of investment banking are regulated
under the Securities Exchange Board of India Act, 1992 and the
guidelines and regulations issued there under. These are listed below:
Merchant banking business consisting of management of public
offers is a licensed and regulated activity under the Securities
and Exchange Board of India (Merchant Bankers) Rules 1992
and Securities Exchange Board of India (Merchant Bankers)
Regulations 1992.

32

 Underwriting business is regulated under the SEBI

(Underwriters) Rules 1993 and the SEBI (Underwriters)
Regulations 1993.
The activity of the secondary market operations including stock
broking are regulated under the relevant by-laws of the stock
exchange and the SEBI (Stock Brokers and Sub Brokers) Rules
1992 and the (Stock Brokers and Sub Brokers) Regulations
1992. Besides, for curbing unethical trading practices, SEBI has
promulgated the SEBI (Prohibition of Insider Trading)
Regulations 1992 and the SEBI (Prohibition of Fraudulent and
Unfair Trade Practices Relating to Securities Markets)
Regulations 1995.
The business of asset management as mutual funds is regulated
under the SEBI (Mutual Funds) Regulations 1996.
The business of portfolio management is regulated under the
SEBI (Portfolio Managers) Rules, 1993 and the SEBI (Portfolio
Managers) Regulations, 1993.
The business of venture capital and private equity by such
funds that are incorporated in India is regulated by the SEBI
(Venture Capital Funds) Regulations, 1996 and by those that are
incorporated outside India is regulated under the SEBI (Foreign
Venture Capital Funds) Regulations 2000.
The business of institutional investing by foreign investment
banks and other investors in Indian secondary markets is
governed by the SEBI (Foreign Institutional Investors)
Regulations 1995.

33

34

6. Investments banks that are set up in India with foreign direct

investment either as joint ventures with Indian partners or as fully
owned subsidiaries of the foreign entities are governed in respect of
the foreign investment by the Foreign Exchange Management Act,
1999 and the Foreign Exchange Management (Transfer or issue of
Security by a Person Resident Outside India) Regulations 2000 issued
there under as amended from time to time through circulars issued by
the RBI.
7. Apart from the above specific regulations relating to investment
banking, investment banks are also governed by other laws applicable
to all other businesses such as the tax law, property law, state laws,
arbitration law and other general laws that are applicable in India.

35

Regulatory Framework for Merchant Banking

Merchant Bankers are governed by the SEBI (Merchant Bankers) Rules
1992 and SEBI (Merchant Bankers) Regulations 1992. According to the
SEBI (Merchant Bankers) Rules 1992 a Merchant Banker means a person
who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as
manager, consultant, advisor or rendering corporate advisory service in
relation to such issue management.
Given the fact that Merchant Bankers are entrusted with the responsibility of
issue management by law, the regulatory framework is designed to ensure
that they sufficient competence and exercise diligence in their work such
that the issuers comply with all statutory requirements concerning the issue.
At the same time, the merchant banker shall have high levels of integrity so
that quality issues alone are brought to the primary market. Keeping these
objectives in mind and investor protection as the paramount objective, the
SEBI has laid emphasis on ensuring that merchant bankers fulfil the
eligibility criteria on an on-going basis and has therefore provided for
compulsory registration every three years. All Merchant Bankers need to
have a valid registration certificate under the said rules to perform the role of
Merchant Bankers to issues. In considering the application for registration,
SEBI shall pay regard to the professional qualification in finance, law or
business management, adequate office space, manpower, office equipment
and other infrastructure, at least two support staff members who have the
competence to be in the field of merchant banking business, existence of

36

minimum stipulated capital and previous experience to investor grievance

redressal.
The activities that a Merchant Banker is authorized to do are issue
management and associated activities such as advising or providing
consultancy or marketing services for the issue, underwriting of issues and
portfolio management, though portfolio management alone requires
additional registration under the relevant regulations. Merchant Bankers are
precluded from carrying on any business or fund-based activity other than
that associated with the securities market. Merchant Bankers are also bound
by the Code of Conduct prescribed under the Regulations. In addition,
Merchant Bankers have to comply with general obligations and
responsibilities under the Regulations.
Presently there is only one category of Merchant Bankers prescribed by
SEBI (Category I) and the minimum stipulated networth for such Merchant
Bankers is Rs.five crore. Such Merchant Bankers holding valid certificates
of registration are alone qualified to manage public offers. SEBI levies a
one-time authorization fee, an annual fee and a renewal fee from each
Merchant Banker.
Under the regulations, Merchant Bankers have also to submit periodical
returns and any other additional information that SEBI might seek from time
to time. SEBI also has a right of inspection of the books of account, records
and documents of the merchant banker at any time if required. SEBI may
suo moto conduct an enquiry or launch an investigation into the working of
a Merchant Banker or on receipt of a complaint against such Merchant
37

Banker. SEBI may even appoint an external auditor to inspect the books and
report to SEBI. Based on the findings, SEBI is empowered to take
appropriate action to award penalty points to the erring Merchant Banker
based on the degree of the default or contravention in accordance with the
SEBI (Procedure for Holding Enquiry by Enquiry Officer and Imposing
Penalty) Regulations 2002. The aggrieved Merchant Banker may prefer to
appeal the Central Government under the SEBI (Appeal to Central
Government) Rules 2003. It may also be mentioned here that a Merchant
Banker is deemed to be a connected person to the issuer under the SEBI
(Prohibition of Insider Trading) Regulations, 1992.

38

Anatomy of Some Leading Indian Investment Banks.

ICICI Securities Ltd. (I-Sec).
I-Sec is a part of the ICICI group whose parent company is the ICICI Bankm
which till recently was a financial institution that converted itself into a
universal bank by it merger with its own commercial bank, the ICICI Bank
in 2003. I-Sec, which was initially a joint venture with J.P. Morgan of the
US, became fully owned by ICICI after J.P. Morgan exited from the
business.
I-Sec is a full service investment bank that provides services across all the
segments spanning debt market, equity market, derivatives and corporate
advisory services. It has support services in research and broking. The
advisory business focuses on merger and acquisitions, cross border
acquisitions, equity and bidding for a number of reputed companies. The
equity business offers research, sales and execution services to institutional
investors in the secondary market and capital market related services such as
execution of public offerings, structuring and regulatory and legal
documentation services.
In order to assist/provide corporate clients and institutional investors with
investment banking services in the USA. I-Sec set up two US based
subsidiaries namely ICICI Securities Holding Inc and ICICI Securities Inc.
ICICI Securities Inc registered itself with the National Association of

39

Security Dealers Inc as a broker-dealer, empowering it to engage in a variety

of securities transactions in the US market.
ICICI Brokerage Services Limited, a member of the National Stock
Exchange of India Limited, is the domestic broking subsidiary of I-Secs
distribution and secondary market services are handled by the broking
company.

DSP Merrill Lynch Ltd.

Originally incorporated as DSP Financial Consultants Ltd, its name was
changed to DSP Merrill Lynch (DSP-ML) in 1996 following its conversion
into a joint venture with Merrill Lynch of USA, a leading international
capital raising financial management and advisory company. Merrill Lynch
has a 40% equity stake in DSP-ML. DSP-ML is a part of the DSP group
which has been in the securities and brokerage business for 130 years in the
Indian market, thus pre-dating even the Bombay Stock Exchange.
DSP-ML is a leading full service Investment Bank that provides services
across debt market, equity market and corporate advisory segments. It also
provides services to private customers on equity and debt products and
wealth management. It has a full fledged research team serving the needs of
both its institutional and retail clients. The company is among the major
players on proprietary account in the debt and equity markets and is also a
registered primary dealer in government securities.

40

The functional divisions at DSP-ML consist of the Investment Banking

Group, the Equity Sales Group, the Equity Trading and Dealing Group, Debt
Sales Group, the Mergers and Acquisitions Group, the Research Group and
the Private Client Group. The investment banking group generates equity
and debt products emerging from IPOs, secondary issues and debt market
issues as well as private placements. It is also a leading underwriter in both
equity and debt products. These products are distributed through the equity
sales group and the debt sales group. Both the marketing groups serve a
cross section of institutional clients, other non-institutional clients such as
trusts and investment companies, retail clients and overseas investors. The
sales groups also distribute apart from their own products, the products
emerging from other entities such as DSP Merrill Lynch Mutual Fund and
other mutual funds. The sales groups are supported by a national distribution
networking comprising of approximately 8000 sub-brokers and alliance
partners.
The trading and dealing groups support the broking activity in equities and
the primary dealership activities in the debt market. DSP-ML, is one of the
largest institutional broking firms in India. It is a founding member of The
Stock Exchange, Mumbai (BSE) and is an active member of the National
Stock Exchange (NSE) of India in both the equity segment and the
wholesale debt market segment. It is an accredited primary dealer with the
RBI and an active participant in the Government Securities/Treasury bill
markets. As a primary dealer, it makes a market for debt securities by
offering to buy and sell quotes. These quotes are also available on wire
services like Reuters, Crisil Market wire, Bloomberg and Dow Jones
Newswires.
41

The mergers and acquisitions advisory has been structured as a separate

specialist group that offers their clients financial advice and assistance in
restructuring, divestures, acquisitions, de-mergers, spin-offs, joint ventures,
privatization and takeover defense mechanisms. The research group offers
products such as sectoral reports, company reports and special theme
analyses, daily, weekly and monthly market views as well as specific policy
forecasts. The private client group offers depository, broking and investment
advisory services to high net worth individuals, professionals and promoters
of business groups, corporate executives, trusts and private companies.
In 1996, the DSP group floated a separate equity broking company called
DSP Securities Ltd. which is a member of the BSE.

42

JM Morgan Stanley Pvt. Ltd.

JM Morgan Stanley (JMMS) is a joint venture between the JM Financial
Group and Morgan Stanley Dean Witter of the USA. In 1997, Morgan
Stanley which was established in New York in 1935, had acquired Dean
Witter, an investment bank founded in 1924 in San Francisco. JM Morgan
Stanley commenced operations in April 1999. However, the association of
the two partners is limited only to the investment banking area. Both of them
have separate asset management companies in India which run independent
of mutual fund businesses.
Unlike DSP-ML and I-Sec which have an integrated structure, the JM Group
has separate companies handling various components of the capital market
business. The core functions of investment banking are performed by
JMMS. This company focuses on capital raising, mergers and acquisitions,
private equity and advisory work for Indian corporations in both the
international and domestic capital markets. The function of distribution and
marketing securities is handled by two of its wholly owned subsidiaries JM
Morgan Stanley Retail Services Pvt. Ltd. (JMRS) and JM Morgan Stanley
Fixed Income Securities Pvt. Ltd. (JMFI). JMRS provides equity distribution
services for primary market products, mutual funds, equity sales and
marketing support for the group broking activity and wealth management
and portfolio management services to high net worth individuals. JMFI
offers similar services in fixed income (debt) securities. A third company,
JM Morgan Stanley Securities Pvt. Ltd. handles all the broking operations
for the group and provides services to institutional clients and others. It also
provides research support for both FII and Indian institutional clients.
43

SBI Capital Markets Ltd

Founded in 1986 as a hive-off of the SBI Merchant Banking division, SBI
Capital Markets Ltd. (SBI Caps) is amongst the oldest players in the Indian
capital market. It is a full service investment bank that provides investment,
advisory and financial services. In 2001, SBI Caps started its sales and
distribution activity along with equity and debt broking services.
SBI Caps provides services across the following spectrum:
Mergers and Acquisitions: This group provides advisory services
with regard to disinvestment of the government, valuations, mergers
and acquisitions in the corporate sector, financial and business
restructuring and other areas.
Project advisory and structure finance: It is arguably one of the
leading groups in the company that provides services such as
restructuring and privatization advisory for public utilities, policy
advisory to Central and State Governments, regulatory bodies and
government departments and organizations, project structuring and
advisory to the private sector and arranging finance for such projects.
SBI Caps has been a major player in governmental work and in the
infrastructure sector. The project advisory services consist of handholding from the concept to commissioning stage involving project
structuring, contract structuring, financial modeling, preparation of
information memorandum, syndication of debt and equity and
assistance in documentation and financial closure. Other services
include appraisals for green-field and brown-field projects, techno-

44

economic appraisal from banks and financial institutions for

establishing the viability of corporate restructuring plans, and vetting
of contracts, loan documents, project documentation etc.
Capital market: This group provides merchant banking services in
connection with public issues, rights issues and public offers for buybacks and open offers. It also advises clients on the private
placements, ADR and GDR issues and overseas bond issues by the
SBI.
Treasury and Investments: This group deals with the proprietary
investment of the company in the equity, debt and money markets.
Resource mobilization and management is also undertaken by this
group.
Broking of Equity and Debt: SBI Caps is a registered broker and a
member of the NSE in the equity and wholesale debt segments and is
also a member in the equity segment. The broking group caters to the
secondary market needs of financial institutions, FIIs, mutual funds,
banks, other corporates, high net worth individuals, non-resident
investors and retail investors. The company commenced wholesale
debt market broking in 2001. The company expects to have a strong
presence in institutional broking. The company plans to open a
derivative trading desk soon.
Sales and Distribution of equity and mutual fund products: SBI
Caps has been a leading mobilizer of funds both for public offers and
private placements.
Research: This group provides the research support for in-house
departments and for institutional clients. Besides regular updates on

45

companies and industries, the research group brings out India

Strategy, Debt Market Review and Daily Debt Market review which
are circulated to SBI Caps investment banking and broking clients.
In its annual report for the year ending March 31, 2002, SBI Caps
reported that is has two business segments (a) Fee based segment
providing merchant banking and advisory services like issue
management, underwriting, arranger, project advisory and structured
finance. (b) Fund based segment which undertakes deployment of funds
in leasing, hire purchase and securities dealing. However, as a result of
SEBI directives, fresh lending under leasing and hire-purchase was
stopped from 1st July 1998. For the period 2001-02, SBI Caps was ranked
first among issue managers by PRIME database.

46

Kotak Mahindra Capital Company

Born in 1995 as part of a corporate re-organization as an unlimited
company. The Kotak Mahindra Capital Company (KMCC), is the
investment banking entity belonging to the Kotak Mahindra Group. It is a
strategic joint venture between Kotak Mahindra Bank Limited (KMBL)
and the Goldman Sachs Group LLP of USA. KMCC is a full service
investment bank whose core business centers on equity issuances and
fixed income securities, mergers and acquisitions and advisory services.
As an investment bank, KMCC is registered with SEBI and is also
registered as a non-banking financial company with RBI. It is also an
active member of the association of Merchant Bankers of India (AMBI).
KMCC has two wholly owned subsidiaries (a) Kotak Mahindra (UK)
Limited, which is registered with the Securities and Futures Association,
UK and regulated by the Financial Services Authority, UK and (b) Kotak
Mahindra Inc based in USA, which is registered with the Securities and
Exchange Commission, USA. KMCC is the first Indian investment bank
to have sought such regulations in USA and UK. A third company called
Kotak Mahindra (International) Limited., based in Mauritius provides
distribution and other client services to non-resident investors.
In KMCC, the Equity Capital Markets group focuses on structuring and
executing diverse equity financing transactions in the public and private
markets for corporates, banks, financial institutions and the Government.
Products include initial public offerings (IPOs), rights offerings,
convertible offerings, private placements and private equity for unlisted
and listed companies. In the advisory business, the Structured Finance
47

(Project Finance & Advisory Business) Group provides expertise in

various vertical segments in the infrastructure sector including power, oil,
gas, ports, automobiles, steel & metals and hotels by offering structured
finance solutions to clients. The Fixed Income Securities Group at
KMCC advises PSUs, Government companies, financial institutions,
banks and corporates on raising capital by way of public or private
placement of debt. KMCC is credited with innovating on some bond
structures in the Indian market. The advisory group on mergers and
acquisitions provides complete solutions on strategy formulation
identification of targets or buyers, valuation, negotiations and bidding,
capital structuring, transaction structuring, assistance in legal
documentation and acquisition financing strategies and implementation.
KMCC is supported in its functions by Kotak Securities Ltd, a broking
firm incorporated in 1995 that is also a joint venture with Goldman Sachs
which handles all the broking, distribution and research business of the
group. Kotak Securities is a member of the debt segment of the NSE and
is also a member of the National Stock Exchange Members Association.
Kotak Securities offers services to investors, financial institutions, mutual
funds, religious and charitable trusts, insurance companies, etc. The
institutional business division has a comprehensive research cell with
sectoral analysts covering all the major areas of the Indian economy. In
the international arena, it provides brokerage services on the Indian
securities to institutional and other investors who are based outside India.
Due to its overseas presence, the company has marketing interests in
Indian GDR and ADR issues as well.

48

The research products brought out by Kotak Securities include:

For the institutional clients, a product called AKSESS, which
primarily covers secondary market broking. It caters to the needs
of foreign and Indian institutional investors in Indian equities (both
local shares and GDRs).
The Daily Forex Monitor which tracks the Indian and international
foreign exchange markets and opines on currency strategies on a
daily basis.
The Weekly Money Market Update which gives the details of the
developments in markets and provides a short-term interest rate
view along with indicative pricing for Triple A credits.
The CURRENCY WATCH captures the monthly developments in
the Indian foreign exchange markets, analyses the key influencing
issues, assess future outlook and also recommends hedging
strategies.
Monthly FINSEC and FINSEC Focus.
Kotak Securities is also a registered primary dealer with the RBI in the
government securities market. As a primary dealer, the company acts as a
market maker and also provides two way quotes, acts as retailer and
marketing agent, provides underwriting support on government securities
issues and participates in auctions held by the RBI.
Besides, the above companies, the Kotak Group includes the Kotak
Mahindra Bank which was formerly a non-banking finance company that
has recently been converted into a bank, the Kotak Mahindra Mutual Fund

49

which is managed by the Kotak Mahindra Asset Management Co. Ltd and
the OM Kotak Life Insurance, which is a joint venture with Old Mutual Plc
of UK and the Kotak Mahindra Venture Capital Co. which manages the
private equity fund of the group.

50

Recent Trends in Investment Banking

One of the trends that has been developing in the past few years in the
global and Indian investment banking arena, is the strong emergence of
universal banks ahead of pure investment banks as market leaders. These
universal banks have the additional financial muscle of their banking
arms that add to their investment banking strengths. Pure investment
banks have found it unmanageable to maintain leadership positions due
to difficult market conditions and the economic downturn. The year 2002
has been dubbed as the watershed year in investment banking for over a
decade. Globally, universal banks such as the Citigroup, JP Morgan
Chase and Deutsche Bank are emerging strongly against pure investment
banks such as Goldman Sachs and Morgan Stanley. This trend could
probably reappear in India as well with the emergence of SBI, ICICI,
IDBI and Kotak Mahindra Bank as strong universal banks. However, in
2002, pure investment banks such as JM Morgan Stanley and DSP
Merrill Lynch still occupied top positions in the investment banking
league tables.
Some recent developments in the investment banking industry as
reported in some financial dailies and other press clippings are listed
below:
International
The Wall Street IPO market has seen the fewest number of issues
since 1978 in the calendar year 2003, with just five in the first

51

quarter. These have mostly been from insurance and financial

services firms and four of them were IPOs.
In 2002, there was a drop of 28% in global equity and equity
related issuances according to Thomson Financial. IPOs were the
main causality with a drop of 34% to $60.6 billion. European
market saw a drop of 53% drop in IPOs and 54% drop in
convertible bond issuances. In Europe, the market focus shifted
from fund raising through IPOs and public issues to more
restructuring deals. These are termed as rescue finance deals such
as rights issue and fully convertible bond issues by troubled
companies. Ericsson, Sonera and Zurich Financial Services are
some companies that made rights issues in 2002. According to
Dealogic, the volume of rights issues in Europe rose from $20.7
billion to $21.5 billion in 2002. The most popular instrument in
USA and Europe has been the mandatory convertible (fully
convertible) bond which is considered as a forward share sales
which is superior in nature to a rights issue.
The Citigroup was Wall Streets top stock and bond underwriter in
2002. Citigroup affiliates Salomon Smith Barney arranged $414
billion of offerings with a 10.6% market share according to
Thomson Financial. Merrill Lynch and CSFB were ranked second
and third respectively. However, the total underwriting pie fell by
5% during the same year.
The top IPO investment bank in 2002 was Salomon Smith Barney
followed by Goldman Sachs. Goldman arranged the largest IPO of
2002, the $4.6 billion CIT Group Inc. (Tyco International Ltd) unit.

52

 The reported fee of American Investment banks fell by 21% in

2002 to $14.1 billion. Salomon took the highest fee of around $2
billion followed by the other two with around $1.2 billion each.
Since April 2001, 78000 jobs were slashed in this industry in USA
accounting for about 10% of the total strength.
Global M&A market was also dull in 2002 witnessing a sharp fall
of 47% to stand at $996 billion from $1887 billion in the previous
year. The biggest deals in 2002 were HP-Compaq, AmgenImmunex Corp, AOL Time Warner-AOL Europe, Bayer-Aventis
Crop Science, Comcast Corp-AT&T Broadband, Philips
Petroleum-Conoco and Siemens Robert Bosch-Atccs
Mannesmann.
Some of the big universal banks such as JP Morgan Chase took
major hits in their private equity businesses due to the technology
meltdown. Incidentally, JP Morgan, which is one of Wall Streets
largest private equity operators with a fund base of $28 billion,
generated $130 million in revenues in private equity in 2001
fuelled mainly by the IPO market boom in technology stocks. Due
to the meltdown, many investment banks have felt it necessary to
spin off their private equity operations into separate entities. BNP
Paribas, Deutsche Bank, HSBC and Zurich Financial Services are
some of these banks.
American investors poured more money into debt mutual funds in
2002 accounting to $133 billion and there were few takers for
public issues of equity junk bonds and convertible bonds.

53

National
During the year 2001, JM Morgan Stanley which acted as adviser to
M&A deals worth Rs.16022 crore was rated the top investment bank
in India. The other players in the big league were ABN-Amro
(Rs.10460 crore), DSP Merrill Lynch (Rs.7130 crore), Arthur
Andersen (now part of E&Y, Rs.3532 crore), Kotak Mahindra
(Rs.1719 crore), Rabo India Finance (Rs.833 crore) and Lazard
Capital (Rs.536 crore) (as reported in the Economic Times 21st
November 2001).
In 2002, there was only one GDR/ADR issue as compared to 6 in
2001 and 9 in 2000. This was made by Mascon Global which raised
$10 million through issue of 2.5 million GDRs which are listed at
Luxembourg Stock Exchange. In this market, Citibank was the
leading depository banks according to Instanex Capital Consultants.
This was followed by Bank of New York, Deutsche Bank and JP
Morgan.
In the M&A market, the year 2002 saw an increase of around 5% in
the value of M&A deals in Inda. Among these, more than 50% were
cross-border deals according to a survey conducted by KPMG
Corporate Finance. The deals were mostly in the SME segment with
average size not exceeding $25 million. The banking, finance and
insurance sectors contributed almost one-third of the total volume.
Privatization deals also played a significant part.
DSP-ML de-listed from the stock exchange since its promoters,
Hemendra Kothari and Merrill Lynch together held more than 90% of

54

the shares. DSP was rated the The Best Domestic Investment Bank
in India for 2000 by Finance Asia. Euromoney voted it Best
Domestic M&A House in India as well as Best Domestic Equity
House in India in 2000. This distinction has returned for three years
in a row with DSP-ML being named as the Best Domestic Securities
House and Best Domestic Investment Bank for 2002-2003 by
Asiamoney (May 2003 issue) and The Asset (January 2003 issue)
magazine respectively.

55

The Conflict of Interest Issue

The most burning global issue in the investment banking industry is that of
conflict of interest between investment bankers and their research analysis
divisions. In the wake of the Enron, Worldcom and other corporate disasters,
the issue has gained some significance. The Securities and Exchange
Commission in the USA (SEC) have initiated investigations into instances of
investment banks issuing over-optimistic research and steering shares in hot
IPOs to important clients for vested interests. In such investigations some of
the banks have been imposed fines. Merrill Lynch paid up fines to the extent
of $100 million in regulatory proceedings in 2002 brought against its
misleading research reports. Citigroups Salomon Smith Barney is also in
the dock and may find itself paying the heaviest fines. CSFB also finds itself
in trouble with the regulators. Most of the other top investment banks such
as Goldman Sachs, Lehman Brothers, Bear Sterns, Deutsche Bank, JP
Morgan Chase and others also found their names in the fines list in 2002.
CSFB was fined for misleading investors on offerings in technology shares.
JP Morgan on the other hand, has been under a cloud for its role in the
infamous off-balance sheet partnership it had crafted for Enron.
Besides, investment banks have also been the target of several lawsuits filed
by aggrieved investors. In late 2002, the French luxury goods leader LVMH
filed a 100 million euro lawsuit against Morgan Stanley alleging that its
research report on LVMH was biased because of the investment banks close
advisory relationship with LVMHs arch rival Gucci Group NV. Morgan
Stanley was also the underwriter of Guccis IPO in 1995.

56

Both the NYSE and NASDAQ came out with research analysts conflict of
interest rules in May 2002 which was subsequently approved by SEC.
Market observers have felt that this is a good development from the point of
view of addressing conflict of interest, currently a burning issue in the
industry. While an investment bank may be advising a client on a buy out, its
private equity arm may be in the fray for its purchase. An example of this
was the sale of the power storage business of Invensys in 2001 wherein
Morgan Stanley was the advisor in the $505 million sale to EnerSys a
company owned by Morgan Stanley Capital Partners (Morgan Stanleys
private equity firm).
So how does the conflict of interest really arise? Most investment banks
have in-house research divisions which act as a support function as
discussed earlier. The research divisions perform vital function of tracking
corporates and making recommendations to their clients in the secondary
market operations or to their own dealing rooms. They also issue reviews
and ratings to new issuances hitting the market. The conflict could arise if
the research analyst promotes a share, the public offering for which is being
handled by the merchant bank. Alternatively, it could also be that the analyst
is privy to insider information being provided by their merchant banking
division and there upon issue recommendations that could amount to
fraudulent deceit of investors or gains for select few. Over the years, the
ethical wall between merchant bankers and research analysts melted
especially in the heat of the IPO and the internet boom. The compensation
patterns of the investment bankers and research analyst were also getting
complementary to an extent thus undermining their independence.

57

A study was conducted by the SEC in 2001on full service investment

banks in Wall Street focusing on these conflicting relationships. The study
disclosed two main areas of conflict(a) research recommendations tending
to become marketing tools for merchant banking assignments by the same
bank and analysts getting paid share of such investment banking gains, (b)
ownership of stocks by research analysts in the companies that they
recommend or research. The study disclosed that analysts leveraged their
position in pumping up recommendations in companies that they are
interested in when they went public.
In the revised dispensation, one of the main provisions is that analysts have
to disclose their interests in their recommendations. In addition, there is
sought to be a water tight compartment in the working of the merchant
banking departments and research divisions. The third area has been the
regulation of compensatory structures for research analysts based on the
profits of the merchant banking divisions. The developments in the USA
have also resulted in precautionary amendments to regulations made in India
by SEBI though such instances of conflict of interest have not surfaced so
far. SEBI has amended the regulations that have been in place for Merchant
Bankers, Underwriters and for the prohibition of insider trading. As a result,
analysts are barred from private trading in shares they analyze. There is still
room for more regulation in future in this area of importance for the survival
of the investment banking industry.
In conclusion, it can be said that the investment banking industry has been
through difficult times. On one hand, the economic slow down and the crash
of the markets that were propelled to dizzy heights by the new economy
58

stocks have battered their bottom lines and led to a large scale cut back in
staff and operations. On the other hand, role of investment banks in
corporate scandals and their questionable business practices and ethics have
taken a toll on their reputation and image. A large scale cleaning up has to
take place in their methods of working and service offerings. Similarly, a
major resurrection of their confidence is required through resurgence of the
markets, whenever that happens. In the meantime, the industry has to live up
to the challenge through appropriate restructuring and consolidation.

59

Conclusion
Given the scope for investment banking in India, the future looks bright for
the industry as a whole in India. Many more pure investment banks and
advisory firms could convert themselves into full service investment banks
that would broaden the market and make the service delivery much more
efficient. In addition, the technological and market developments shaping
the capital market as discussed would also provide an added impetus to
growth of investment banking. Better regulatory supervision and stricter
enforcement of the code of conduct of market intermediaries would ensure
that better quality issuers come to the market and existing issuers would
follow enhanced standards of corporate governance. In the long run, all these
developments would ensure fair return to investors, and bring back investor
support to the market. This would augur well for the capital market in
general and investment banking in particular.

60