SEBI PROJECT 1

Merchant Banks

“MERCHANT BANKS”
SECURITIES EXCHANGE BOARD OF INDIA

RESTPECTFULLY SUBMITTED TO:

MRS. ANUSHKA CHOUDHARY
SUBMITTED BY: RANGOLI NAGENDRA
[18LLM010, LLM Batch 2018-19
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Merchant Banks

ACKNOWLEDGEMENT

I take this as an opportunity to put efforts in this project. However, it would not have been
possible without the kind support and guidance of my faculty of this subject:

MRS. ANUSHKA CHOUDHARY

I would like to extend my sincere thanks to all of them.

I am highly indebted to for their guidance and constant supervision as well as for providing
necessary information regarding the project & also for their support in completing the project.

I would like to express my gratitude towards my friends& other classmates for their kind co-
operation and encouragement which help me in completion of this project.

I would like to express my gratitude and feelings towards my faculty who has enabled me in my
better understanding to this subject and also providing me such attention and time.

My thanks and appreciations also go to my colleague in developing the project and people who
have willingly helped me out with their abilities.
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Merchant Banks

ABSTRACT

A merchant bank is a financial institution providing capital to companies in the form of share
ownership instead of loans. A merchant bank also provides advisory on corporate matters to the
firms in which they invest. In the United Kingdom, the historical term "merchant bank" refers to
an bank. A Merchant Bank can be generally described as a financial services company with a
private equity investment arm offering investment banking and ancillary services as well.
Because a merchant bank acts not only as an advisor and broker but also as a principal, a
merchant bank has a longer term approach than a typical investment bank and is highly
concerned with the viability of each investment opportunity and providing the right advice for a
strong partnership with each client company. In banking, a merchant bank is a traditional term
for an Investment Bank. It can also be used to describe the private equity activities of banking.
This article is about the history of banking as developed by merchants, from the Middle Ages
onwards. Merchant banking is an important service provided by a number of financial
institutions that helps in the growth of the corporate sector which ultimately reflects into the
overall economic development of the country. Merchant banks were expected to perform several
functions like issue management, underwriting, portfolio management, loan syndication,
consultant, advisor and host of other activities. Merchant banking is a combination of banking
and consultancy services.
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Merchant Banks

INTRODUCTION

 The merchant banking has been defined as to what a merchant banker does. A merchant
Banker has been defined by Securities Exchange Board Of India (Merchant Banker)
rules, 1992, as “Any person who is engaged in the business of issue management either
by making arrangements regarding selling, buying or subscribing to securities or acting
as manager, consultant, advisor or rendering corporate advisory services in relation to
such issue management.”A Merchant Bank is a British term for a bank providing various
financial services such as accepting bills arising out of trade, providing advice on
acquisitions, mergers, foreign exchange, underwriting new issues, and portfolio
management.1

 A Merchant Bank can be generally described as a financial services company with a

private equity investment arm offering investment banking and ancillary services as well.
Because a merchant bank acts not only as an advisor and broker but also as a principal, a
merchant bank has a longer term approach than a typical investment bank and is highly
concerned with the viability of each investment opportunity and providing the right
advice for a strong partnership with each client company.

 A merchant bank is a financial institution providing capital to companies in the form of

share ownership instead of loans. A merchant bank also provides advisory on corporate
matters to the firms in which they invest. In the United Kingdom, the historical term
"merchant bank" refers to an investment bank. In India, Merchant bankers are a body
corporate who carries on any activity of the issue management, which consist of
preparing prospectus and other information relating to the issue. Merchant banks in India
are not allowed to conduct any business other than that related to securities market.

 In banking, a merchant bank is a traditional term for an Investment Bank. It can also be
used to describe the private equity activities of banking. Merchant banks are private

1
ANVESHANA’S INTERNATIONAL JOURNAL OF RESEARCH IN REGIONAL STUDIES, LAW, SOCIAL SCIENCES,
JOURNALISM AND MANAGEMENT PRACTICES
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Merchant Banks

financial institution. Their primary sources of income are PIPE (Private Investment In
Public Entities) financings and international trade. Their secondary income sources are
consulting, Mergers & Acquisitions help and financial market speculation. Because they
do not invest against collateral, they take far greater risks than traditional banks.

 Companies raise capital by issuing securities in the market. Merchant bankers act as
intermediaries between the issuers of capital and the ultimate investors who purchase
these securities. Merchant banking is the financial intermediation that matches the entities
that need capital and those that have capital. It is a function that facilitates the low of
capital in the market.

HISTORY AND ORIGIN OF MERCHANT BANKING

 In late 17th and early 18th century Europe, the largest companies of the world was
merchant adventurers. Supported by wealthy groups of people and a network of overseas
trading posts, they collected large amounts of money to finance trade across parts of the
world. For example, The East India Trading Company secured a Royal Warrant from
England, providing the firm with official rights to lucrative trading activities in India.
This company was the forerunner in developing the crown jewel of the English Empire.2
The English colony was started by what we would today call merchant bankers, because
of the firm's involvement in financing, negotiating, and implementing trade transactions.

 The colonies of other European countries were started in the same manner. For example,
the Dutch merchant adventurers were active in what are now Indonesia; the French and
Portuguese acted similarly in their respective colonies.3 The American colonies also
represent the product of merchant banking, as evidenced by the activities of the famous
Hudson Bay Company. One does not typically look at these countries' economic

2
Braudel, Fernand (1985-01-01). La dynamique du capitalisme
3
Fitch, Thomas P. (2000 [1990]), Dictionary of Banking Terms: "Merchant Bank", 4th Edition, New York: Barron's
Business Guides,
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development as having been fueled by merchant bank adventurers. However, the colonies
and their progress stem from the business of merchant banks, according to today's
accepted sense of the word.

 Merchant banks, now so called, are in fact the original "banks". These were invented in
the middle Ages by Italian grain merchants. As the Lombardy merchants and bankers
grew in stature on the back of the Lombard plains cereal crops many of the displaced
Jews who had fled persecution after 613 entered the trade. They brought with them to the
grain trade ancient practices that had grown to normalcy in the middle and far-east, along
the Silk Road, for the finance of long distance goods trades. The Jews could not hold land
in Italy, so they entered the great trading piazzas and halls of Lombardy, along-side the
local traders, and set up their benches to trade in crops. They had one great advantage
over the locals.

 Christians were strictly forbidden the sin of usury. The Jewish newcomers, on the other
hand, could lend to farmers against crops in the field, a high-risk loan at what would have
been considered usurous rates by the Church, but did not bind the Jews. In this way they
could secure the grain sale rights against the eventual harvest. They then began to
advance against the delivery of grain shipped to distant ports.4 In both cases they made
their profit from the present discount against the future price. This two-handed trade was
time consuming and soon there arose a class of merchants, who were trading grain debt
instead of grain.

 4
Wechsberg, Joseph (1966). The Merchant Bankers. Boston: Little, Brown.
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Merchant Banks

TRADATIONAL MERCHANT BANKING

 Merchant Banking, as the term has evolved in Europe from the 18th century to today,
pertained to an individual or a banking house whose primary function was to facilitate the
business process between a product and the financial requirements for its development.
Merchant banking services span from the earliest negotiations from a transaction to its
actual consummation between buyer and seller.

 In particular, the merchant banker acted as a capital sources whose primary activity was
directed towards a commodity trader/cargo owner who was involved in the buying,
selling, and shipping of goods. The role of the merchant banker, who had the expertise to
understand a particular transaction, was to arrange the necessary capital and ensure that
the transaction would ultimately produce "collectable" profits. Often, the merchant
banker also became involved in the actual negotiations between a buyer and seller in a
transaction.

MODERN MERCHANT BANKING

 During the 20th century, however, European merchant banks expanded their services.
They became increasingly involved in the actual running of the business for which the
transaction was conducted. Today, merchant banks actually own and run businesses for
their own account, and that of others.

 Since the 18th century, the term merchant banker has, therefore, been considerably
broadened to include a composite of modern day skills. These skills include those inherent in
an entrepreneur, a management advisor, a commercial and/or investment banker plus that of
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Merchant Banks

a transaction broker. Today a merchant banker is who has the ability to merchandise – that is,
create or expands a need -- and fulfill capital requirements.5

MERCHANT BANKING IN INDIA

In India Merchant Banking activities started from the year 1967, following the footsteps of
similar activities in UK & USA. Currently Merchant Banking activity has mushroomed in the
Indian capital market with both public & private sector settings up their respective merchant
Banking divisions. Currently, the total no. of merchant bankers in India are approx. 1450 with
more than 930 registered with SEBI. The SEBI authorized Merchant Bankers Include merchant
Banking divisions of All India Financial Institutions, nationalized & foreign banks, subsidies of
the commercial banks, private merchant banks engaged in stock broking, underwriting activities
& financial consultancy & investment advisory service firms. The main service offered at that
time to the corporate enterprises by the merchant banks included the management of public
issues and some aspects of financial consultancy.6

Companies raise capital by issuing securities in the market. Merchant bankers act as
intermediaries between the issuers of capital and the ultimate investors who purchase these
securities. Merchant banking is the financial intermediation that matches the entities that need
capital and those that have capital. It is a function that facilitates the low of capital in the
market.7

Merchant banker registered with SEBI:

Public Sector: - Commercial banks (24), Financial Institutions (6), State Institutions (4)

Private sector: - International bankers (10), Banks (10), finance & investment (231)

5
Investopedia “The process by which investment bankers raise investment capital from investors on behalf of
corporations and governments that are issuing securities (both equity and debt).”Available
at http://www.investopedia.com/terms/u/underwriting.asp
6
H.R. Machiraju, Merchant Banking- Principles and Practices, 2003, p.19.
7
Sick Industrial Companies (Special Provisions) Act, 1985, § 3(o), “an industrial company (being a company
registered for not less than five years) which has at the end of any financial year accumulated losses equal to or
exceeding its entire net worth.”
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Merchant Banks

FUNCTIONS OF MERCHANT BANKS

The following comprise the main functions of a merchant banker in India:

 Management of debt and equity offerings- This forms the main function of the
merchant banker. He assists the companies in raising funds from the market. The main
areas of work in this regard include: instrument designing, pricing the issue, registration
of the offer document, underwriting support, and marketing of the issue, allotment and
refund, listing on stock exchanges.

 Placement and distribution- The merchant banker helps in distributing various

securities like equity shares, debt instruments, mutual fund products, fixed deposits,
insurance products, commercial paper to name a few. The distribution network of the
merchant banker can be classified as institutional and retail in nature. The institutional
network consists of mutual funds, foreign institutional investors, private equity funds,
pension funds, financial institutions etc. The size of such a network represents the
wholesale reach of the merchant banker. The retail network depends on networking with
investors.

 Issue Management- Management of issue involves marketing of corporate securities viz.

equity shares, preference shares and debentures or bonds by offering them to public.
Merchant banks act as an intermediary whose main job is to transfer capital from those
who own it to those who need it. After taking action as per SEBI guidelines, the merchant
banker arranges a meeting with company representatives and advertising agents to
finalize Arrangements relating to date of opening and closing of issue, registration of
prospectus, launching publicity campaign and fixing date of board meeting to approve
and sign prospectus and pass the necessary resolutions. Pricing of issues is done by the
companies in consultant with the merchant bankers.

 Underwriting of Public Issue- Underwriting is a guarantee given by the underwriter that

in the event of under subscription, the amount underwritten would be subscribed by him.
Banks/Merchant banking subsidiaries cannot underwrite more than 15% of any issue.
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 Financial structuring- It includes determining the right debt-equity ratio and gearing
ratio for the client; the appropriate capital structure theory is also framed. Merchant
bankers also explore the refinancing alternatives of the client, and evaluate cheaper
sources of funds. Another area of advice is rehabilitation and turnaround management. In
case of sick units, merchant bankers may design a revival package in coordination with
banks and financial institutions. Risk management is another area where advice from a
merchant banker is sought. He advises the client on different hedging strategies and
suggests the appropriate strategy.

 Project Counseling- Project counseling includes preparation of project reports, deciding

upon the financing pattern to finance the cost of the project and appraising the project
report with the financial institutions or banks. It also includes filling up of application
forms with relevant information for obtaining funds from financial Institutions and
obtaining government approval.

 Loan syndication- Merchant bankers arrange to tie up loans for their clients. This takes
place in a series of steps. Firstly they analyses the pattern of the client’s cash flows, based
on which the terms of borrowings can be defined. Then the merchant banker prepares a
detailed loan memorandum, which is circulated to various banks and financial institutions
and they are invited to participate in the syndicate. The banks then negotiate the terms of
lending on the basis of which the final allocation is done.8

 Providing venture capital and mezzanine financing- Merchant bankers help

companies in obtaining venture capital financing for financing their new and innovative
strategies

 Portfolio Management- Portfolio refers to investment in different kinds of securities

such as shares, debentures or bonds issued by different companies and government

8
Securities Exchange Board of India (Merchant Bankers) Regulations, 1992, Regulation 3(2)
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securities. Portfolio management refers to maintaining proper combinations of securities

in a manner that they give maximum return with minimum risk.9

 Off Shore Finance- The merchant bankers help their clients in the following areas
involving foreign currency.

 Non-resident Investment- The services of merchant banker includes investment

advisory services to NRI in terms of identification of investment opportunities, selection
of securities, investment management, and operational services like purchase and sale of
securities.

 Corporate Counseling and advisory services- Corporate counseling covers the entire
field of merchant banking activities viz. project counseling, capital restructuring, public
issue management, loan syndication, working capital, fixed deposit, lease financing
acceptance credit, etc. Merchant bankers also offer customized solutions to their client’s
financial problems like determining the right debt-equity ratio and gearing ratio for the
client.

 Capital Assistance- In providing financial assistance, merchant banks offer a full

understanding of all facets of the capital markets. This includes all types of debt and
equity financing available from both the domestic and international markets. A merchant
banker, cognizant of capital costs, looks for the best sources of capital, including its
restrictions and dollar limitations. It should be understood that interest rates are not the
only definition of capital costs .Restrictions on availability, prepayment terms, and
operating effectiveness can often outweigh what might appear to be inexpensive capital
with low interest rates. Too often, capital includes costs which force an entrepreneur or a
business to undertake undesirable actions.

9
A Grindlays Compendium, Merchant Banking, Grindlays Bank Brochure.
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ROLE OF MERCHANT BANKERS

 Fundamentally, merchant banks are financial institutions. They engage in business loans
as well as underwriting. They mostly cater to large enterprises and individuals of high net
worth. They perform a combination of consultancy and banking services. It was in 1967
that National Grind lays Bank introduced the concept of merchant banks in India. In
1972, the State Bank of India became the first Indian Commercial Bank to set up a
separate Merchant Banking Division. Till date, however, merchant banks in India have
been operating mostly as issue houses and not full- fledged merchant banks like in other
countries.10

I. Regulations governing merchant bankers

The Securities Board of India, under the SEBI Regulations, exercising its powers under Section
30, SEBI Act, 1992, has made regulations for various components of the capital market. The
merchant bankers are regulated by SEBI (Merchant Bankers) Regulations, 1992. H. R. Machiraju
has described the objectives of these regulations in the following terms: “

SEBI (Merchant Bankers) Regulations, 1992

This regulation has five chapters pertaining to definitions, compulsory registration with SEBI,
renewal of certificate and fee payable to SEBI, capital adequacy requirements, obligations and
responsibilities, code of conduct, procedure for inspection by SEBI, of documents, records and
books of accounts, procedure in case of default, i.e. the action to be taken against concerned
merchant banker (cancellation or suspension of registration by SEBI). Authorization by SEBI

II. The criteria established for obtaining the SEBI authorization are:
Professional qualifications in law, finance or business management Available infrastructure
including office space, power, equipment, etc Compliance with capital adequacy norms A record
including experience, reputation, etc.

10
Association of Merchant Bankers of India, Code of Conduct.
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III. Classification of merchant bankers

The Securities Exchange Board of India segregated merchant bankers into the following four
categories:
1. Category-I Advisor, issue manager, consultant, portfolio manager and underwriter.
2. Category-II Consultant, advisor, portfolio manager, and underwriter.
3. Category-III Advisor, underwriter, and consultant only.

IV. Advisor or consultant to issue of capital.

Given the above provisions, the role of lead managers of an issue could be fulfilled only by
merchant bankers registered under Category-I alone. From 9 December 1997, however, all other
categories were abolished, and merchant bankers can now only be registered under Category-I by
SEBI.

V. Capital Adequacy Norms

The Securities Exchange Board of India (SEBI) has prescribed capital adequacy norms for
merchant bankers to register under the various categories. The minimum ‘net worth’ set by SEBI
for Category-I of merchant bankers was initially fixed at the value of Rs. 1 crore and later raised
to the value of Rs. 5 crores through an amendment of the regulations in the year 1995.11

VI. Other guidelines in the SEBI (Merchant Bankers) Regulations, 1992

SEBI has laid down several other guidelines in that are a must to be complied with. These are as
follows:

1. Submission of the half-yearly unaudited result of financial documents to SEBI

2. Compulsory Appointment of Compliance Officer.
3. SEBI may send in an officer for inspection of records, books, etc.
4. SEBI may collect an authorization fee followed by annual or renewal fees.
5. There exists a minimum underwriting obligation upon lead managers to the extent of
5%of the size of the issue or of Rs. 25 lakh, whichever is lesser.

11
Foreign Exchange Regulation Act, 1973.
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VII. Code of conduct for merchant bankers

Since merchant banking is a profession, like all other professionals, merchant bankers must abide
by a specific and strict code of conduct. The code of conduct for merchant bankers states that a
merchant banker must: Protect the interest of the investors to the best of his capabilities.
Conduct business with a high level of dignity, integrity, and fairness.

VIII. Developments in Merchant Banking Establishment:

1. Setting up of Banks Subsidiaries

2. Re-organization of Private Firms

3. Establishment of SUA

4. Securities and Exchange Board of India (SEBI)

5. Discount and Finance House of India (DFHI)

6. Credit Rating Information Services of India Ltd. (CRISIL)

7. Stock-Holding Corporation of India Ltd. (SHC)

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FUTURE OF MERCHANT BANKING

 Time and again the merchant banking industry UN India witnessed, experienced and
underwent significant changes. The very purpose for which these firms are commencing
there services should be taken care of and they should mould there policy decision and
activities to move in tune with the main objective of investors protection and to create
healthy environment in capital markets. No doubt, merchant banking firms are subject to
a host of control measures, regulations and rules framed and guided SEBI.

DIFFERENCE BETWEEN INVESTMENT BANKS AND MERCHANT BANKS

 Merchant banks and investment banks, in their purest forms, are different kinds of
financial institutions that perform different services. In practice, the fine lines that
separate the functions of merchant banks and investment banks tend to blur. Traditional
merchant banks often expand into the field of securities underwriting, while many
investment banks participate in trade financing activities. In theory, investment banks and
merchant banks perform different functions.

 Pure investment banks raise funds for businesses and some governments by registering
and issuing debt or equity and selling it on a market. Traditionally, investment banks only
participated in underwriting and selling securities in large blocks. Investment banks
facilitate mergers and acquisitions through share sales and provide research and financial
consulting to companies. Traditionally, investment banks did not deal with the general
public.

 Traditional merchant banks primarily perform international financing activities such as

foreign corporate investing, foreign real estate investment, trade finance and international
transaction facilitation. Some of the activities that a pure merchant bank is involved in
may include issuing letters of credit, transferring funds internationally, trade consulting
and co-investment in projects involving trade of one form or another.
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 The current offerings of investment banks and merchant banks vary by the institution
offering the services, but there are a few characteristics that most companies that offer
both investment and merchant banking share. Merchant banks still offer trade financing
products to their clients. Investment banks rarely offer trade financing because most
investment banking clients have already outgrown the need for trade financing and the
various credit products linked to it.

CONCLUSION:

 Based on this paper Merchant banking in India has vast scope to develop because of lot
of domestic as well as foreign business booming here and also recent developments
helpful to booming of Indian economy. Indian economy provides an amicable
environment for these firms to setup flourish and expand here As a general rule,
investment banks focus on initial public offerings (IPOs) and large public and private
share offerings. Merchant banks tend to operate on small-scale companies and offer
creative equity financing, bridge financing, mezzanine financing and a number of
corporate credit products. While investment banks tend to focus on larger companies,
merchant banks offer their services to companies that are too big for venture capital firms
to serve properly, but are still too small to make a compelling public share offering on a
large exchange. In order to bridge the gap between venture capital and a public offering,
larger merchant banks tend to privately place equity with other financial institutions,
often taking on large portions of ownership in companies that are believed to have strong
growth potential.
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BIBLIOGRAPHY

http://articles.latimes.com/keyword/merchant-banking

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http://publications.anveshanaindia.com/wp-content/uploads/2016/12/MERCHANT-
BANKING-INDIA-RECENT-DEVLOPNMENT-IN-MERCHANT-BANKING-1.pdf

https://blog.ipleaders.in/essential-role-merchant-bankers/

http://shodhganga.inflibnet.ac.in/bitstream/10603/155244/9/09_chapter%203.pdf