COURSE: REGULATION OF BANKING & INSURANCE

PROJECT ON MERCHANT BANKING UNDER THE GUIDANCE OF PROF. O.V.NANDIMATH

SUBMITTED BYRAUT SONALI PRITHVIRAJ ID NO. 443 & JYOTI BHARAT RANGARI ID NO.421 LLM IInd Year NLSIU, BANGALORE

TABLE OF CONTENTS Sr. no. CONTENTS CHAPTER-I 1.

1.1 Introduction 3

Page no.

CHAPTER II 2.
2.1 Conceptual Overview Of Merchant Banking 4

CHAPTER III 3.
3.1 Evolution Of Merchant Banking 9

CHAPTER IV 4.
4.1 Commercial Banking V. Merchant Banking.. 12

CHAPTER-V 5.
5.1 Services Rendered By Merchant Bankers. 13

CHAPTER VI 6.
6.1 Regulatory Framework of Merchant Banking In India.. 6.2 SEBI (Merchant Banking) Regulation, 1992 Types Of Merchant Banker Registration Of Merchant Bankers. General Obligations & Responsibilities 20 16 18 18 18

of Merchant Bankers.

7.

Conclusion

24

8.

Bibliography.

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CHAPTER I INTRODUCTION
Merchant bankers operate in a financial markets existing within financial system of the country. In India the, merchant bankers operate in the following forms 1. Divisions of Indian Banks 2. Divisions of Foreign Banks 3. Subsidiary companies established by various banks like, SBI Capital Markets Ltd, Bank of India Finance Ltd. Etc. 4. Firms organized by stock brokers, CA etc Merchant banking is highly competitive business activity. To get the business they have to stand on their heels and run to grab the business opportunity. Due to this high competition it is very much necessary to regulate this institution in order to promote healthy competition and to protect the other interests involved like companies, consumers etc.1 Merchant bankers are one of the intermediaries rendering non-banking services. They are fee based businesses assuming market risk. With the growth of the primary market their significance is also growing.2

1 2

Dr.J.C.Verma, Manual of Merchant Banking, 3rd (Edn) Bharat law House New Delhi, 1993 http://www.slideshare.net

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CHAPTER II CONCEPTUAL OVERVIEW OF MERCHANT BANKING

General Understanding In simple terms we can understand the term merchant banking as the set of functions performed and services rendered by the merchant bankers. Who is merchant banker? They are financial institutions, providing specialist services, like corporate finance, portfolio management, corporate counseling, project counseling. A merchant banker may carry out any one or more of these activities.3 Merchant bankers are neither merchants nor necessarily banks. 4Though the name merchant banking includes the term banking, it is a non-banking financial activity which is similar to banking. They deal with the long-term company loans, and stock underwriting. They do not have retail offices where a customer can go and open a savings or checking account. Sometimes it is called as wholesale bank because they deal primarily with other merchant banks and other large financial institutions. The primary role of the merchant banker is stock underwriting. A corporation wishing to raise money from investors through the stock market hires a merchant banker which implements and underwrite the process. It determines the important factors like; the number of stocks to be issued, the price at which the stock will be issued, and the timing of the release of this new stock. It also carries out the work of filling all required paperwork with the various market authorities.5

Gurusamy, Merchant banking and financial services Tata McGraw-Hill Education, 2009 available at Limited available at http://books.google.co.in 4 Tripathy, Financial Instruments and Services, Prentice Hall India Pvt., Limited available at http://books.google.co.in 5 Retrieved from http://www.wisegeek.com

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Dictionary meaning The dictionary of Banking and Finance defines the term Merchant Banking as a bank which arranges loans to companies, deals in international finance, buys and sells shares and launches new companies on the stock exchange, but does not provide normal banking services to the general public. This definition indicates that merchant banks do not include commercial banks i.e. they do not accept demand deposits and do not advance loans to public. The word merchant bank does not have a fixed definition as it is used differently in different countries. In United States these are called as Investment Banks and in UK they are called as accepting and issuing houses.6 Definitions The word Merchant Banking is originated among the Scottish and Dutch traders.7 US origin definitions In US, the term merchant banking is defined neither under banking law nor under securities law. It is generally understood to mean negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies. Both commercial and investment banks can carry out the functions of the merchant banking.8 It is understood as an activity of making direct investment of the investment banks own fund in some assets not directly related to the investment banks traditional business. It shows that merchant banking is about investing own funds in outside businesses and monitoring and sale of such investments. But it is different from proprietary trading. In US merchant banking is understood as a fund based, risk oriented business which is a part of wider term investment banking.

6 7 8

Retrieved from http://www.indianmoney.com Supra, note 1 Merchant Banking :Past and Present by Valentine V. Craig available at http://www.fdic.gov

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UK origin definitions The merchant banking refers to those who are members of British Merchant Banking and Securities House Association, and carry out consultation, leasing, portfolio services, assets management, euro credit, loan syndication etc.9 It is a financial institution that specializes in services such as acceptance of bill of exchange, hire purchase or installment buying, international trade financing, long-term loans, and management of investment portfolios. It also advise on and invest own funds in acquisitions, mergers, and takeovers.10 The term refers to an organization that underwrites corporate securities and advises such clients on issues like corporate mergers etc. Some other definitions M.J.Rosenberg: An organization that underwrites securities for corporations, advices such clients on mergers, and involved in the ownership of commercial ventures. This is an effort to define merchant banker with the help of activities carried out by him. But it does not include all the activities carried out by merchant banker and hence fails to define its actual scope. J.A.P Herbert He defines it as Merchant banking is what merchant bankers do. This cannot be called as definition in real sense as it does not give any idea regarding the nature or scope of the term merchant banking. In fact it is possible to define anything in this manner.

10

Retrieved from http://dspace.vidyanidhi.org.in Retrieved from http://www.businessdictionary.com

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Indian Definition Ministry of Finance and SEBI Ministry of Finance provides the following definition of merchant banking, Any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to the securities as manager, consultant, adviser, or one rendering corporate advisory services in relation to such activities in the management. SEBI The same definition given by Ministry of Finance was inserted in SEBI (Merchant Banking) Regulation, 1992 by way of regulation 2 (cb).11 Any person Even though the term used is any person, and it includes both natural and artificial person, it is important to note that according to SEBI (Merchant Banking) Regulation, 1992 the person must be an incorporated body other than non banking financial institution. This definition is descriptive in nature. It describes the activities carried out or services rendered by the merchant bankers. Activities According to this definition merchant banker should be engaged in A. i. ii. iii. Making arrangements for: Selling of securities Buying of securities Subscribing to securities or

11

Inserted by the Securities and Exchange Board of India (Merchant Bankers) (Third Amendment) Regulation, 2006., w.e.f., 7-9-2006

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B. i. ii. iii. iv.

Acting as: Manager Consultant Adviser Rendering corporate advisory service in issue management

Characteristics of merchant banking From the definitions discussed above we can highlight following characteristics of merchant banking. a. It is a skill based activity b. Merchant bankers attend the corporate problems and suggest ways and means to solve it. c. Merchant banking activities are promotional and developmental in nature as they help the industry and trade to survive and grow.12

12

Supra, note 1

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CHAPTER III EVOLUTION OF MERCHANT BANKING

Family owned and managed Italian firms In 13th century there were few Italian firms owned and managed by families in European Continent e.g. Ricardo of Lucca, Medici and Fogger. These firms were mainly engaged in coastal trade i.e. sale and purchase of commodities, but beside this they were also engaged in banking business. They used to act as bankers to the kings, monarchs and state government engaged in continental wars. The object behind this activity was profit maximization, but no doubt that it was a highly risky business. Many times they had to suffer heavy losses due to denied repayment by debtors, confiscation of their property by kings financed by them. The examples of Ricardo of Lucca can be cited here where the property of this firm was confiscated by the English King when the firm refused to finance the war. Commission Agents in Amsterdam The main center for world trade, during earlier period was Amsterdam, where the Dutch traders mainly relied upon the financing by merchant bankers. They were known as commission agents. The services rendered by them included handling of costal trade for their principals on commission basis, financing the owners or suppliers of goods, shipping agencies. They were also engaged in investing in manufacturing of goods. These commission agents also used to finance the continental war. Industrial Revolution in Europe The period of 18th and 19th century was marked by industrial revolution in England. The growth industry of home made goods gave a further boost to the business of merchant banking. The international trade was expanded to the colonies of the new world including North America and other continents. This has attracted many firms to enter in to the merchant banking mainly

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bringing the raw material to Europe from other nations and transshipment of finished goods from Europe to other countries.13 Indian Scenario 1. Merchant Banking division of Grind lays bank-1967 The activities of merchant banking were commercially started in India when the Grind lays bank was first set up its merchant banking division after receiving the license from RBI in 1967. It was the largest foreign bank in India at that time. 2. Citybank-1970 In 1970 Citibank entered into business of merchant banking. 3. Banking Commission Report 1972 In this report the need for merchant banking services in the background of industrial and economic development was indicated by the Banking Commission. The Commission suggested having separate institution which should be distinct from commercial banks and term lending institutions to provide merchant banking services. It was also recommended that they should be able to manage provident funds, pension funds and trusts of various kinds. 4. SBI-1972 In the light of recommendations of Banking Commission, Indian banks started the merchant banking in 1972. SBI was first Indian bank to set up its merchant banking division with the initial objective of rendering corporate advice and assistance to small and medium entrepreneurs.14

13 14

Executive summary on merchant banking retrieved from http://www.scribd.com H. R. Machiraju Merchant Banking, Principles And Practice available at Google books.com

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5. Other banks rendering merchant banking services Followed by SBI other commercial banks started rendering merchant banking services. They are enlisted below. Name 1. Central Bank of India 2. Bank of India 3. Syndicate Bank 1. Bank of Baroda 2. Standard Chartered Bank 3. Mercantile Bank 1. United Bank of India 2. United Commercial Bank 3. Canara Bank 4. Indian Overseas Bank Late 70s and early 80s 1978 Year 1977

Development banks providing merchant banking services in India Bank Name ICICI IFCI IDBI Year 1973 1986 1991

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CHAPTER IV COMMERCIAL BANKING V. MERCHANT BANKING

It is necessary to draw a distinction between commercial banking and merchant banking. 1. Raising capital and Granting loan The main function of Merchant banks is to assist in raising capital in the form of equity, preference shares, and syndicated loan working capital instruments, whereas Commercial banks provide funds in the form of term loan. Term lending and bank deposits are the main function of commercial banking. 2. Advising and financing Merchant banks acts as Advisor, they do not provide finance. On the other hand financing is the main business of Commercial banks. 3. Demand Deposits Merchant banks do not accept cheques whereas accepting and issuing cheques is the key feature of Commercial banks. 4. Fees based and fund based Merchant banking is fees based business whereas Commercial banking is fund based business.15 5. Regulation Merchant bankers are primarily regulated by SEBI (Merchant Banking) Regulation, 1992 Whereas commercial banks are regulated by Banking Regulation Act and RBI Act, 1934

15

http://www.scribd.com

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CHAPTER-V SERVICES RENDERED BY MERCHANT BANKERS

Merchant bankers provide a number of services, some of the important are discussed below. 1. Issue Management: This is the core activity of merchant banker. In this he acts as an intermediary between the issuer and investor. He plays the role of assistant of the company who assists it to raise fund from the market. Issue management involves, a. Pre issue management which commences from structuring of issue and continues up to opening of subscription list. It includes obtaining of approval from SEBI, drafting of prospectus, arranging underwriting for the issue proposed, drafting other documents like application, newspaper advertisement, deciding the opening and closing dates for issue b. Post issue management continues up to listing of securities on the stock exchange. It includes daily report of the money collected at various branches, obtaining consent from stock exchange for deciding basis of allotment after the closing date, sending compliance report to SEBI, obtaining letter of approval from regional stock exchange for basis of allotment, confirming compliance of all the listing formalities. 2. Loan syndication: It is also known as credit procurement or project finance services. It includes a series of acts like estimating the total cost of the project, preparing the loan application, selecting institutions for participation, circulating the detailed loan memorandum to selected banks, negotiating the terms of lending, assisting in completion of other formalities like documentation.16

16

See http://www.mbaknol.com visited on 28-11-11

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3. Underwriting: A company issuing shares is always exposed to the risk of the issue not being fully subscribed. In such a case underwriting is a guarantee given that in the event of under subscription the amount underwritten would be subscribed by the person underwriting it i.e. underwriter. The merchant banker, in order to carry out the activity of underwriting has to obtain separate certificate of registration under the Securities and Exchange Board of India (Underwriters) Regulations, 1993.17 4. Corporate counseling This term is of wide import. It is the starting point of merchant banking services. It covers all the activities like, project counseling, loan syndication, capital restructuring, public issue management.18

5. Project counseling It includes the study of project, advice on the project viability, advice on the procedural steps for its implementation including the technical feasibility review, selecting technical consultancy organizations. Merchant bankers also prepared project report from financial angle, they review the reports made by TCO, and further obtain the government consent for project implementation.

6. Advisory services to mergers and acquisition In these transactions they act as middlemen between two companies. They are charged with the duties of protecting the interest of the parties. They owe fiduciary duties to the parties. The Takeover Code provides for the various functions and duties to be carried out by merchant bankers in such transactions.

7. Consultancy to sick industries They guide such industries for growth and diversification. Their main responsibility is to obtain the approval from Board of Industrial and Financial Reconstruction and Sick

17 18

Regulation 2A of SEBI (Merchant Banking) Regulation, 1992 Supra, note 3

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Industrial Companies Act, 1985 for their financial restructuring and technical rehabilitation.

8. Portfolio management The term portfolio management refers to minimizing the risk and maximizing the returns. Merchant bankers render advice as to investment in government securities. The merchant banker, for carrying out the activity as portfolio manager has to obtain separate certificate of registration under Securities and Exchange Board of India (Portfolio Manager) Regulations, 1993.19 Role of Merchant Bankers

From the services enlisted above one can conclude that merchant bankers play significant role in financial sector as follows 1. Channelizing A merchant banker arranges necessary capital and ensures the implementation of transaction. In this he channelizes the flow of capital among the concerned parties. 2. Coordinating activities He coordinates the activities of corporation and creditors. 3. Ensuring compliance As seen above he plays a significant role in ensuring the legal compliances such as documentation work, obtaining permission, submission of documents.

19

Supra, note 17

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CHAPTER -VI REGULATORY FRAMEWORK OF MERCHANT BANKING IN INDIA

The law regulating merchant banking in India has gone through three substantial stages as follows 1. Law before 1990 2. Law during 1990-1992 3. Law after 1992

1. Before 1990 As discussed earlier the activities of merchant banking have started in India in 1967. At that time there was no special law governing these activities. Following legislations were applicable to merchant bankers, The Companies Act, 1956 The Securities Contracts (Regulation) Act, 1956 FERA, 1973 2. During 1990-1992 Before the establishment of SEBI in 1992 the merchant banking activities were governed by the guidelines issued by the Central Government vide its circular letter no. F. NO. 1 (44) SE/86-II, III, dated 9.4.1990. This circular was addressed to all stock exchanges and all merchant bankers. 3. After 1992 SEBI Act, 1992 The above mentioned guidelines were issued before Parliament resulting in to enactment of SEBI Act, 1992.

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Exercising the power given under section 30 of the SEBI Act, 1992; the SEBI (Merchant Bankers) Rules, 1992 and SEBI (Merchant Banking) Regulation, 1992 were notified. These two replaced the earlier guidelines. SEBI (Merchant Bankers) Rules, 1992 Mandatory registration Rule 3 makes it mandatory to hold certificate granted by SEBI on registration in order to act as a merchant banker. It also provides that, those who were carrying the merchant banking activities before establishment of SEBI, may continue to do so provided they have made an application to SEBI for such registration. Till the disposition of that application such person can continue his activities. Conditions of grant or renewal of certificate Rule 4 lays down the conditions subject to which SEBI can grant or renew the certificate to merchant banker Prior permission of Board In case of any change in status or constitution the merchant banker shall obtain a prior permission of Board to carry out the merchant banking activities. Payment of Fees It is obligatory to pay the required registration or renewal fees in the manner provided in the regulations. Redressal of grievances of the investors There is further obligation on the part of merchant bankers to take adequate steps for redressal of grievances of the investors within the period of one month from the date of receipt of the complaint. He should keep the Board informed regarding the nature, number and other particulars of the complaint received.

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 Compliance with the rules and regulations Merchant banker should abide by the rules and regulations governing their activities. Validity of Certificate According to Rule 5 the validity period of certificate or its renewal shall be three years starting from the date of issue to the applicant.

SEBI (Merchant Banking) Regulation, 1992 1. Types of Merchant Banker: There are four categories of merchant bankers in India. Regulation 3(2) of the Merchant Banker Regulation 1992 enlists them as follows:20 a. Category I, that is (i) to carry on any activity of the issue management, which will inter-alia consist of preparation of prospectus and other information relating to the issue, determining financial structure, tie-up of financiers and final allotment and refund of the subscription; and (ii) to act as adviser, consultant, manager, underwriter, portfolio manager. b. Category II, that is, to act as adviser, consultant, co-manager, underwriter, portfolio manager; c. Category III, that is to act as underwriter, adviser, and consultant to an issue; d. Category IV, that is to act only as adviser or consultant to an issue.

2. Registration of Merchant Bankers As seen earlier Rule 3 of SEBI (Merchant Banker) Rules, 1992 states that No person shall carry on any activities as a merchant banker unless he holds a certificate granted by the Board under the regulations

20

Regulation 3(2) of the Merchant Banker Regulation 1992

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Procedure for registration: a. Norms for Application The applicant must be incorporated under companies Act, 1956 other than non banking financial institution21 It should not carry on any business other than those connected with the securities market It should have necessary infrastructure like office space, equipment, manpower etc. It must have at least two employees with prior experience in merchant banking The applicant should not have been involved in any securities scam or proved guilt for any offence. The applicant has the professional qualification from an institution recognised by the Government in finance, law or business management; The applicant should fulfill the capital adequacy requirement as follows22:

Category of Merchant Banker Category I Category II Category III Category IV

Minimum Amount Rs. 5, 00, 00, 000 Rs. 50, 00, 000 Rs. 20, 00, 000 Nil

b. Apply to whom An application is to be made to the Board for grant of certificate under Form A specifying the category of Merchant Banker accompanied by non refundable application fees 23 c. Form of Application Application should be complete and conform to all requirements stated in the Form 24 d. Further information Further information to be furnished if required 25
21 22

Regulation 6 Regulation7 23 Regulation 3 24 Regulation 4 25 Regulation 5

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e. Grant of certificate Board if satisfied as to the eligibility of applicant will grant the certificate 26

3. REJECTION OF APPLICATION

If the application does not satisfy the criteria set out in regulation 6, the Board may reject the application, but an opportunity of being heard must be given to the applicant.

The refusal shall be communicated by the Board within thirty days of such refusal to the applicant stating the grounds on which the application has been rejected. Aggrieved applicant may apply within a period of thirty days from the date of receipt of such intimation to the Board for reconsideration of its decision. In such case Board has to reconsider the application and communicate its decision as soon as possible to applicant. This communication must be in writing.27

Effect of Refusal of certificate

On refusal to grant of certificate, merchant banker whose application for a certificate has been refused by the Board shall, on and from the date of the receipt of the communication cease to carry on any activity as merchant banker.

4. GENERAL OBLIGATIONS & RESPONSIBILITIES OF MERCHANT BANKERS: Chapter III of SEBI (Merchant Banker) Regulation, 1992 deals with General obligations & Responsibilities of Merchant Bankers. They can be summarized as follows, They are required to abide by the code of conduct Merchant banker have to maintain proper books of accounts, records and submit half yearly/annual financial statements to the Board within stipulated period of time.
26 27

Regulation 8 Regulation 10

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No merchant banker should associate with another merchant banker who is not registered with the Board. No Merchant bankers should enter into any transactions on the basis of unpublished information available to them in the course of their professional assignment. It is the duty of every merchant banker to submit himself to the inspection by Board when required for and to submit all the records. Every merchant banker has to disclose information to the Board whenever required. Every merchant banker acting as a lead manager must enter into an agreement with the issuer setting out mutual rights, liabilities, obligations, relating to such issues with particular reference to disclosures allotment, refund etc.

RBI AND MERCHANT BANKING Master Circular- Exemptions from the provisions of RBI Act, 1934

The RBI has exempted the Merchant Banking Companies from the following provisions of The RBI Act, 1934 S. 45-IA: This section provides for the registration of non banking financial company with the Reserve Bank and requires such companies to have the net owned fund of twenty five lakhs rupees or such other amount, not exceeding two hundred lakhs, as the bank may, be notification in the Official Gazette, specify. S. 45-IB: According to this section it is mandatory for every non banking financial company to maintain liquid assets of the value of five percent or such higher percentage not exceeding 25 percent as notified by the Reserve Bank of the deposits outstanding at the close of business on the last working day of the second preceding quarter.

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S.45-IC: Every non banking financial company is under an obligation to create a reserve fund and transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared.28 Again the section puts restriction on every non banking financial company to appropriate such fund for the purposes other than specified by the Reserve Bank and to report the Bank every such appropriation. Conditions Precedent In order to get exemption from above mentioned sections a merchant banking company has to satisfy following conditions 1. It should be registered with SEBI and carry out the business of merchant banking according to SEBI(Merchant Banking) Rules, 1992 and Regulation, 1992 2. It should acquire the securities only as a part of its merchant banking business 3. It does not carry out any other financial activity as specified under S.45I(c ) of RBI Act, 1934 Section 45I(c) defines the term financial institution as any banking institution which carries on its business or part of its business any of the following activities, (i) Financing by way of making loans or advances or otherwise, of any activity other than its own;

(ii) Acquiring of shares, stock, bonds, debentures or securities issued by a government or local authority or other marketable securities of a like nature

(iii) Letting or delivering of any goods to a hirer under a hire-purchase agreement as defined in section 2 (c) of the Hire-Purchase Act, 1972

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2(ii) of Master Circular- Exemptions from the provisions of RBI Act, 1934

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(iv) To carry on of any class of insurance business (v) To manage, conduct or supervise, as foreman, agent or in any other capacity, of chits or kuries as defined in any law which is for the time being in force in any State, or any business, which is similar thereto (vi) To collect for any purpose or under any scheme, or arrangement monies in lump sum or otherwise, by way of subscriptions or by sale of units, or other instruments or in any other manner and awarding prizes or gifts, whether in cash or kind, or disbursing monies in any other way, to persons from whom monies are collected or to any other person. Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 This regulation contains s detail procedure of issue of capital. It provides for the duties and functions of merchant banker in issue of capital. In this process merchant banker acts as book runner, stabilizing agent. The regulation makes it obligatory for issuer to appoint the merchant banker29. They are further entrusted with the task of submission of the offer documents before opening of the issue30, allotment refund and payment of interest31, consultation as to pricing of securities32

29 30

Regulation 5 Regulation 8 31 Regulation 18 32 Regulation 28

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CONCLUSION
The term merchant banking is understood differently in different countries. But the core function of merchant bankers remains the same as management of issues. In US and UK no statutory definition of merchant banking is available. Whereas in India Ministry of Finance defined the same which was adopted by the SEBI (Merchant Banking) Regulation, 1992. The systematic regulation of merchant banking in India started in 1992 with the formation of SEBI (Merchant Banker) Rules, 1992 and SEBI (Merchant Banker) Regulation, 1992. Prior to the establishment of SEBI there was no special law regulating merchant banking activities rather it was regulated by FERA, Companies Act, 1956, SCRA, and guidelines issued by the Government of India. The 1992 Regulation brought significant change in prevailing situation. Now the registration of Merchant Banker is with the SEBI. Previously Reserve Bank of India used to issue certificate of registration. By the virtue of Master Circular - Exemptions from the provisions of RBI Act, 1934, the merchant bankers registered with SEBI are exempted from the various requirements like creation of reserve fund, maintenance of liquid assets etc.

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