INTRODUCTION Financial services are an important component of financial system. The smooth functioning of financial system depends upon the range of financial services extended by the providers. Financial services in India have witnessed remarkable changes in the recent past after the implementation of “Liberalization, privatization and globalization”. Funds are tapped from the capital market to finance various mega industrial projects. In attracting public savings, merchant bankers play a vital role as specialized agencies. The resource raising functions remains to be the primary business of a merchant banker. The primary market holds the key to rapid capital formation, growth in industrial productions and exports. There has to be accountability to the end use of funds raised from the market. The increase in the number of issues and amount raised the number of merchant bankers. Therefore, the field became highly competitive market where it requires a specialized skill in handling the situation. The merchant bankers have a social responsibility to in building an industrial structure in India. Page | 1
Merchant bankers assist corporate in raising capital. They assist in issue of Shares, syndicating loans, public issue of debentures. They do not provide funds. They only assist. They also actively arrange working capital, appraisal Projects scrutinize & persuade merger proposals. In BRITAIN merchant bankers & investment bankers are synonymous. In the U.S., Merchant bank means as investment bank which is wellequipped to handle multinational corporations. In INDIA merchant bankers is a body corporate who carries on any activity of the issue management, which consist of preparing prospectus & other information relating to the issue. Merchant banks in India are not allowed to conduct any business other than that related to securities market. There is no official category in investment banking
DEFINITION: In
banking,
a
merchant
bank is a financial institution Page | 2
primarily engaged in offering financial services and advice to corporations and wealthy individuals on how to use their money. The term can also be used to describe the private equity activities of banking. According to Cox D. merchant banking is defined as, “merchant banks are the financial institutions providing specialist services which generally include the acceptance of bills of exchange, corporate finance, portfolio management and other banking services”. The Notification of the Ministry of Finance defines a merchant banker as, “any 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”. In short, merchant bankers assist in raising capital and advice on related issues.
HISTORY AND ORIGIN OF MERCHANT BANKING
ORIGIN: Merchant banking originated through the entering of London merchants in foreign trade through acceptance of bill. Later, the Page | 3
merchants assisted the Government of under developed countries in raising long – terms through floatation of bonds in London money market. Over a period they extended their activities to domestic business of syndication of long term and short term finance, underwriting of new issues, acting as registrars and share transfer agents, debenture trustees, portfolio managers, negotiating agents for mergers, takeovers etc.
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MERCHANT BANKING IN INDIAHISTORICAL PERSPECTIVE:Till
18th
century
moneylenders,
moneychangers,
village
merchants (maharanis), & saucers performed the function of banks & merchant banks. They also issued & discounted bills of exchange (handiest) & bank draft. They gave loans on mutual trust, on mortgage of lands, ornaments & other property.
JAGAT SHETH
(1720-1773AD, BENGAL) HABIB & SONS which is now HABIB BANK (founded in 1941, now is in PAKISTAN). These were the organized merchant bankers in recent history of INDIA. Merchant Banking is an activity that includes corporate finance activities, such as advice on complex financings, merger and acquisition advice (international or domestic), and at times direct equity investments in corporations by the banks. Merchant banks are private financial institution. Their
primary sources of income are PIPE 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. Because they are private, do not take money from the public and are international in scope, they are not regulated. Anyone considering dealing with any merchant bank should investigate the bank and its managers before seeking their help.
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The reason that businesses should develop a working relationship with a merchant bank is that they have more money than venture capitalists. Their advice tends to be more pragmatic than venture capitalists. It is rare for a merchant bank to fail. The last major failure was Barings Bank (1992). It failed because of unsupervised trading of copper futures contracts and buybacks. When the Dot Com Bubble burst in 2001, scores of venture capital firms failed. The greatest merchant bank failure in history was the Knights Templar. After the Crusades, the Order became immensely wealthy controlling and funding the trade between the Middle East and Western Europe. They foolishly loaned money to the French Government. To avoid repaying the money, King Louie had the Pope declare the Order heretics. Thousands of monks lost their lives, but France balanced its budget. To understand Merchant Banks, you should know something of their history. Modern merchant banking started in Italy during the 7th Century. The banking practices evolved from the financing structure of the Silk Road Trading that predates the Roman Empire.The basic financing structure was the advance payment for goods by merchant bankers at a great discount to the delivery value of those goods. In the case of Italy and then Germany, wheat was the product. The merchant banks purchased the wheat soon after planting. They accepted the risk of crop failure. Page | 6
They profited when they sold the wheat. In most countries today,
the
national
government
accepts
the
risk
through
government crop insurance. As the British Empire expanded in the 18th and 19th Centuries, merchant banks prospered in London. For instance, merchant bankers funded Canada’s Hudson Bay Company. This period saw the rise of such merchant banks as Schroders, Warburgs or Rothschilds. Amsterdam benefited from the trade created by the Dutch East Indian Company. Since the 18th century, the role of the merchant banker has been considerably broadened to include a composite of modern day skills. Such skills are inherently entrepreneurial, managerial, financial and transactional. Today, North American merchant banks have taken the form of "boutiques"- whereby, each offers its own specialized services. The hallmarks of these merchant bank boutiques are that they typically charge fees payable in cash and/or the client's stock for each service rendered. You can find a merchant bank that meets any reasonable set of needs.
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Merchant Banking in India – Post Independence: In 1967, RBI issued its first merchant banking license to grind lays started with management of capital issues, production planning, system design and also market research. It provides management consulting services as well. Citibank setup its merchant banking division in 1970 its scope includes assisting new entrepreneur, evaluating new projects, rasing funds through borrowing and issuing equity. Indian banks started banking services as a part of multiple services they offered to clients from 1972. State bank of India started the merchant banking division in 1972. In the initial years the objective was to render corporate advice and assistance to small and medium entrepreneurs. Merchant banking activities
are
organized
and
undertaken
in
several
forms.
Commercial banks and foreign development finance institutions have organized them through formation of division; nationalized banks have formed subsidiaries companies and share brokers and consultancies constituted themselves into public ltd. Co. or registered themselves as private ltd. companies. Some of them have equity stake of foreign merchant bankers.
MERCHANT BANK Page | 8
A merchant bank deals with the commercial banking needs of international
finance,
long
term
company
loans,
and
stock
underwriting. A merchant bank does not have retail offices where one can go and open a savings or checking account. A merchant bank is sometimes said to be a wholesale bank, or in the business of wholesale banking. This is because merchant banks tend to deal primarily with other merchant banks and other large financial institutions. The most familiar role of the merchant bank is stock underwriting. A large company that wishes to raise money from investors through the stock market can hire a merchant bank to implement and underwrite the process. The merchant bank determines 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. The merchant bank files all the paperwork required with the various market authorities, and is also frequently responsible for marketing the new stock, though this may be a joint effort with the company and managed by the merchant bank. For really large stock offerings, several merchant banks may work together, with one being the lead underwriter. By limiting their scope to the needs of large companies, merchant banks can focus their knowledge and be of specific use to such clients. Some merchant banks specialize in a single area, such as underwriting or international finance. Many of the largest banks have both a retail division and a merchant bank division. The divisions are generally very separate entities, as there is very little Page | 9
similarity between retail banking and what goes on in a merchant bank. Although your life is probably affected every day in some way by decisions made in a merchant bank, most people reading this article are unlikely ever to visit or deal directly with a merchant bank. Merchant banks operate behind the scenes and away from the spotlight.
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MERCHANT BANKS AND COMMERCIAL BANKS There are differences in approach, attitude and areas of operations between commercial banks and merchant banks. The differences between merchant banks and commercial banks are summarized below: Commercial banks basically deal in debt and debt related finance and their activities are appropriately arrayed around credit proposals, credit appraisals and loan sanctions. On the other hand, the area of activity of merchant bankers is ‘equity and equity related finance’. They deal with mainly funds raised through money market and capital market. Commercial Banks are asset oriented and their lending decisions are based on detailed credit analysis of loan proposals and value of security offered against loans. They generally avoid risks. The merchant bankers are management oriented. They are willing to accept risks of business. Commercial bankers are merely financiers. The activities of merchant bankers include project counseling, corporate counseling in areas of capital restructuring ,amalgamations, mergers, takeover etc, discounting and rediscounting of short term paper in money markets, managing , underwriting and supporting public issues in Page | 11
new issue market and acting as brokers and advisers on portfolio management in stock exchange. Merchant banking activities have impact on growth, stability and liquidity of money markets.
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IMPORTANCE AND NEED OF MERCHANT BANKING Important reason for the growth of merchant banking has been developmental activity throughout the country, exerting excess demand on the sources of funds for ever expanding industry and trade, thus, leaving a widening gap under bridged between the supply and demand of inventible funds. All Indian financial institutions and experienced resources constraint to meet the ever increasing
demands
for
funds
from
the
corporate
sector
enterprises. In the circumstances corporate sector had the only alternative to avail of the capital market services for meeting their long-term financial requirements through capital issues of equity and debentures. With the growing demand for funds there was pressure on capital market that enthused the commercial banks, share brokers and financial consultant firms to enter into the field of merchant banking and share the growing capital markets. With the result, all the commercial banks in nationalized and public sector as well as in private sector including the foreign banks in India have opened their merchant banking windows and are competing in this field. There has been a mushroom growth of financial consultancy firms and broker firms doing advisory functions as well as managing public issues in syndication with other merchant bankers. Page | 13
Notwithstanding the above facts, the need of merchant banking institutions is felt in the wake of huge public savings lying still untapped. Merchant banks can play highly significant role in mobilizing
funds
of
savers
to
investible
channels
assuring
promising return on investments and thus can help in meeting the widening demand for investible funds for economic activity. With the growth of merchant banking profession corporate enterprises in both public and private sectors would be able to raise required amount of funds annually from the capital market to meet the growing requirements for funds for establishing new enterprises, undertaking expansion/modernization/diversification of the existing enterprises. This reinforces the need for a vigorous role to be played by merchant banks. Merchant banks have been procuring impressive support from capital market for the corporate sector for financing their projects. This is evidenced from the increasing amount raised form the capital market by the corporate enterprises year after year. In view of multitude of enactments, rules and regulations, guidelines and offshoot press release instructions brought out by the government from time to time imposing statutory obligations upon the corporate sector to comply with all those requirements prescribed therein, the need of skilled agency existed which could provide counseling in these matters in a package form. Merchant bankers, with their skills, updated information and knowledge, provide this service
to
the
corporate
units
and
advise
them
on
such Page | 14
requirements to be complied with for raising funds from the capital market under different enactments viz. Companies Act, Income-tax Act,
Foreign
Exchange
Regulation
Act,
Securities
Contracts
(Regulation) Act and various other corporate laws and regulations. Merchant bankers advise the investors of the incentives available in the form of tax relief’s, other statutory relaxations, good return on investment and capital appreciation in such investment to motivate them to invest their savings in securities of the corporate sector.
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ROLE OF MERCHANT BANKER The role of merchant banker is dynamic in the wake of diverse nature of merchant banking services. Merchant banker’s dynamism lies in promptly attending to the corporate problems and suggest ways and means to solve it. The nature of merchant banking services is development oriented and promotional to help the industry and trade to grow and survive. Merchant banker is, therefore,
dedicated
to
achieve
this
objective
through
his
dynamism. He is always awake to renew his skills, develop expertise in new areas so as to equip himself with the knowledge and techniques to deal with emerging new problems of corporate business
world.
He
has
to
keep
pace
with
the
changing
environment where government rules, regulations and politics affecting business conditions frequently change; where science and technology create new innovations in production processes of industries
envisaging
immediate
renovations,
diversifications,
modernizations or replacements of existing plant and machinery or other
equipments
putting
new
demands
for
finances
and
necessitating overhauling of the capital structure of the firms. Merchant banker has to think and devise new instruments of financing
industrial
projects.
He
has
to
assume
wider
responsibilities of saving industrial units from going sick and guiding industries to be setup in industrially backward areas to
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eliminate regional imbalances in industrial development of the country.
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He has to guide the wider section of the community possessing surplus money to invest in corporate securities and other productive investment channels. He has to help the industry in different forms to ensure that it runs risk free and devoid of uncertainty by assisting the promoters with his knowledge and skills to resolve the problems being faced by them. He has to watch the interest and win over the confidence of the government, its agencies, along with the entrepreneurs, the investors and the whole community. He must bridge the communication gap between different sections and resolve the problem being faced in different areas concerned with the business world. To discharge the above role, a merchant banker has to be dynamic. In the days ahead, merchant bankers have very significant role to play tuning their activities to the requirements of the growth pattern of the corporate sector, the industry and the economy as a whole which is, in it, a challenging task and to meet these challenges merchant bankers will have to be more vigorous and strategic in playing their role. They will have also to adopt new ways and means in discharging their role.
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THE GROWTH OF MERCHANT BANKING IN INDIA Formal merchant activity in India was originated in 1969 with the merchant banking division setup by the Grindlays Bank, the largest
foreign
bank
in
The
main
service
country. offered
at
corporate
that
time
enterprises
the
to
the
by
the
merchant banks included the management of public issues and some aspects of financial consultancy. Following Grindlays Bank,
Citibank
merchant
set
banking
up
its
division
in
1970.The division took up the task
of
assisting
new
entrepreneurs and existing units in the evaluation of new projects and
raising
funds
through
borrowing and equity issues. Management consultancy services were also offered. Merchant bankers are permitted to carry on activities of primary dealers in government securities. Consequent to the recommendations of Banking Commission in 1972, that Page | 19
Indian banks should offer merchant banking services as part of the multiple services they could provide their clients, State Bank of India started the Merchant Banking Division in 1972. In the initial years the SBI’s objective was to render corporate advice and assistance to small and medium entrepreneurs. The commercial banks that followed State Bank of India were Central Bank of India, Bank of India and Syndicate Bank in 1977.Bank of Baroda, Standard Chartered Bank and Mercantile Bank in 1978 and United Bank of India, United Commercial Bank, Punjab National Bank, Canara Bank and Indian Overseas Bank in late ‘70s and early ‘80s. Among the development banks, ICICI started merchant banking activities in 1973 followed by IFCI (1986) and IDBI (1991).
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ORGANIZATIONAL SETUP OF MERCHANT BANKERS IN INDIA In India a common organizational setup of merchant bankers to operate is in the form of divisions of Indian and foreign banks and financial institutions, subsidiary companies established by bankers like SBI, Canara Bank, Punjab National Bank, Bank of India, etc. Some firms are also organized by financial and technical consultants and professionals. Securities and Exchange Board of India has divided the merchant bankers into four categories based on their capital adequacy. Each category is authorized to perform certain functions. From the point of organizational setup India’s merchant banking organizations can be categorized into four groups on the basis of their linkage with parent activity. They are: A) Institutional Base Where merchant banks function as an independent wing or as subsidiary
of
various
private/Central
Governments/State
Governments financial institutions. Most of the financial institutions in India are in public sector and therefore such setup plays a role on the lines of government priorities and policies. Page | 21
B) Banker Base These merchant bankers function as division/subsidiary of banking organization. The parent banks are either nationalized commercial bank or the foreign banks operating in India. These organizations have brought professionalism in merchant banking sector and they help their parent organization to make a presence in capital market. C) Broker Base In the recent past there has been an inflow of qualified and professionally skilled brokers in various stock exchanges of India. These brokers undertake merchant banking related operations also like providing investment and portfolio management services. D) Private Base These merchant banking firms are originated in private sector. These organizations are the outcome of opportunities and scope in merchant banking business and they are providing skill-oriented specialized services to their clients. Some foreign merchant bankers are also entering either independently or through some collaboration
with
their
Indian
counterparts.
Private
sector
merchant banking firms have come up either as the sole proprietorship or public limited companies. Many of these firms were in existence for quite some times before they added a new activity in the form of merchant banking services by opening new Page | 22
divisions on the lines of commercial banks and All India Financial Institutions.
Page | 23
QUALITIES
OF
MERCHANT
BANKERS:1. Knowledge:
Thorough
understanding
of
technical
issues
related
to
business, understanding of legal and statutory requirements, appreciation of business acumen; financial expertise is a key thing a merchant banker must know. Delivery of his services depends on his basic understanding of these issues. 2. Capital market familiarity: Merchant banker should be well versed with stock markets, their movements. He should track imp happenings in the market on ongoing basis. 3. Liasioning ability: Merchant bankers are required to liaison with SEBI, RBI, the stock exchanges, depositories and other government authorities for public issue related duties. It is imperative that a merchant bank maintains excellent rapport with all of them and also close relations even at informal levels. This only can see speedy and favorable clearances by the authorities.
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4. Innovation: Corporate may approach with unique requirements. Standard solutions and products may not solve problems sometimes. Merchant bankers should do out of box thinking and be able to do financial engineering. They can device new financial instruments and get approved from the authorities. Innovation is required even to address stringent legal requirements. 5. Integrity: Merchant banker has valuable and confidential information of its customers. Merchants bankers should take utmost care that the information is not leaked and also not consumed for the purpose other than for which it was disclosed to the merchant banker.
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Requirements for setting up a merchant banking outfit : 1. Formation of the Business Organization: SEBI act, 1992 does not prescribe any specific form of business organization to carry on the activities as merchant banker. However, the types of organizations are listed below: a. Sole proprietorship b. Partnership firm c. Hindu Undivided Family (HUF) d. Corporate Enterprises e. Co-operative Society Generally it is preferred that the Merchant Banking outfit be a registered company. Merchant Banks are generally setup as subsidiary companies of banks (Public or Private). For example, SBI caps, ICICI Securities etc.
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2. Adoption of a viable business plan: All the basic tests required to find out whether the business to be
undertaken
is
viable
or
not
are
also
applicable
to
a
MerchantBanking setup. Capital adequacy, profitability, growth opportunities and current market size are some of the factors which need to be looked into.
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MAIN OBJECTS OF MERCHANT BANKER Merchant bankers render their specialized assistance in achieving the main objectives which are presented below: 1. To carry on the business of merchant banking, assist in the capital formation, manage advice, underwrite, provide standby assistance, securities and all kinds of investments issued, to be issued or guaranteed by any company, corporation, society, firm, trust person, government, municipality, civil body, public authority established in India. 2. The main object of merchant banker is to create secondary market for bills and discount or re-discount bills and acts as an acceptance house. 3. Merchant banker’s another objective is to set up and provide services for the venture capital technology funds. 4. They also provide services to the finance housing schemes for the construction of houses and buying of land. 5. They render the services like foreign exchange dealer, money exchange, and authorized dealer and to buy and sell foreign exchange in all lawful ways in compliance with the relevant laws of India.
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6. They will invest in buying and selling of transfers, hypothecate and deal with dispose of shares, stocks, debentures, securities and properties of any other company.
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SERVICES PROVIDED BY MERCHANT BANKS: (in detail) The
development
activity
through the country had exerted excess demand on the sources of funds
by
the
ever
expanding
industry and trade which could not be met by the All India Financial Institutions. In these circumstances, the corporate sector enterprises had the
only
alternative
to
avail
themselves of the capital market services for meeting the long-term fund requirements through capital issues of equity and debentures. The growing demand for funds from capital market has enthused many organizations to enter into the field of merchant banking for managing the public issues. The need of merchant banker is also felt in the wake of huge untapped public savings as merchant bankers can play a highly significant role in mobilizing funds from savers to invest in channels assuring promising return on investments and thus narrow down the gap between demand for and supply of investible funds.
Page | 30
Merchant bankers not only provide advisory services to corporate enterprises but also advise the investors of the incentives available in the form of tax relief and other statutory obligations. Thus, the merchant bankers help industry and trade to raise funds, and the investors to invest their saved money in sound and healthy concerns with confidence, safety and expectation of higher yields Broadly a merchant banker can provide the following services: • Corporate Counseling • Project Counseling And Pre-Investment Studies • Credit Syndication And Project Finance • Issue Management •Underwriting •Bankers •Portfolio Management •Venture Capital Financing •Leasing •Non-Resident Investment Counseling And Management •Acceptance Credit And Bill Discounting Page | 31
•Advising On Mergers, Amalgamations And Take-Over •Arranging Offshore Finance •Fixed Deposit Broking •Relief to Sick Industries
Let’s take a brief look at each of these functions:
Corporate Counseling: It includes a whole range of financial services provided by a merchant banker to a corporate unit a view to ensure better performance, maintain steady growth and create a better image among investors. It covers the entire field of merchant banking activities i.e., project counseling, capital restructuring, portfolio management and the full range of financial engineering including venture capital, public issue management, loan syndication, working capital, fixed deposits, lease financing, acceptance credit, etc. However, the scope of corporate counseling is limited to suggestions and Page | 32
opinions leaving to the client to take corrective actions for solving its corporate problems. A merchant banker finds out the problems of enterprise, which shall include organizational goals for the enterprise, size of the organization and operational scales, choice of a product, pricing, etc, and suggests ways and means to solve those problems. Project Counseling: Project counseling is an important merchant banking service which include preparation of project reports, deciding upon the financing pattern to finance the cost of the project, appraising the project report with the financial institutions/banks. Project reports are prepared to obtain government approval of the project, for procuring financial assistance from financial institutions and banks, for ensuring market for the proposed product, for planning public issues, etc. Financing the project cost is an important aspect of project counseling. The two sources of funds available to finance the project cost are internal sources of funds (or owners' funds) which includes promoter's contribution and retained earnings; and external sources of funds which refers to the borrowed funds in the form
of
loans
from
banks,
private
investors
and
financial
institutions and in the form of debentures from the public.
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Merchant banker has to decide the financing mix of the internal and external sources of funds keeping in view the rules, regulations and norms prescribed by the government or followed by the term lending financial institutions. While rendering project counseling services, the merchant banker has to ensure that the application forms for obtaining the funds from financial institutions are filled in with relevant and appropriate information and before submitting the application, the merchant banker has to appraise the project considering the various aspects as to the type of the project, location, technical, commercial and financial viability of the project. Credit Syndication: Once the client company has decided about the project proposed to be undertaken, the next step is looking for the sources wherefrom the funds could be procured to implement the project. Merchant banker has to locate the sources of funds and comply the formalities required to procure the funds. This service rendered by the merchant banker in arranging and procuring credit from financial institutions, banks and other lending and investment organizations for financing the clients' project cost or meeting working capital requirement is referred to as loan syndication or credit syndication. Credit syndication in case of domestic borrowings is with the institutional lenders and banks. Long and medium term funds are Page | 34
obtained from the All India Financial Institutions like IFCI, IDBI etc., state level financial bodies like SFC, SIDC etc., commercial banks, mutual funds etc. Short-term funds are also required by the firm for purchase of raw materials, payment of wages, salaries etc. Sources of financing these short term requirements or working capital needs can be from internal sources like internal accruals from working or operations and short term loans from friends and relatives; or from external sources like short term borrowings from banks etc. Issue Management and Underwriting: A fully underwritten public issue spells confidence to the investing public, which ensures a good response to the issue. Keeping this in view companies, which float a public issue usually, desire a full underwriting of the issue. Underwriting is only the guarantee given by the underwriter that in the event of under subscription, the amount underwritten would be subscribed in proportion by the underwriter. An underwriter of the issue gets the following benefits: • It earns a commission of the commitment given. • It earns the right to be appointed as bankers of that issue. • It expands its clientele by underwriting more and more issues.
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Bankers to the Issue The merchant banker can automatically become the banker to the issue in the following cases: • The bank is a broker to the company • It has given underwriting commitments. • It acts as a manger to the issue • The function of a banker to the issue is to accept application forms from the public together with subscription money and transfer them to the account of the controlling branch. Portfolio Management Portfolio refers to investment in different types of marketable securities or investment papers like shared, debentures and debenture
stocks,
bonds
etc.
from
different
companies
or
institutions held by individuals firm or corporate units. Portfolio management refers to managing efficiently the investment in the securities held by professionals to others. Merchant bankers take up management of a portfolio of securities on behalf of their clients, providing special services with a view to ensure maximum return by such investments with a minimum risk of loss of return on the money invested in securities.
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A merchant banker while performing the services of portfolio management has to enquire of the investment needs of the client, the tax bracket, ability to bare risk, liquidity requirements, etc. they should study the economic environment affecting the capital market, study the securities market and identify blue chip companies in which money can be invested. They should keep record of latest amendment in government guidelines, stock exchange regulations, RBI regulations, etc. Advisory Services Relating To Mergers and Takeovers A merger is defined as a combination of two or more companies into a single company where one services and other looses their corporate existence. A merger is also defied as an amalgamation
wherein
the
shareholders
of
the
combining
companies become substantially the shareholders of the company formed. A takeover is referred to as an acquisition, which is the purchase, by one company of a controlling interest in the share capital of another existing company. Merchant bankers are the middlemen settling negotiations between the offered and the offeror. Their role is specific and specialized in handling the mergers and taker over assignments. Being a professional expert, the merchant banker is apt to safeguard the interest of the shareholders in both the companies and as such his assistance is
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useful for both the companies, i.e. the acquirer as well as the acquired company. Based on the purpose of business objective, the search of the acquirer company will start for a merger partner company. If the objective of merger is growth oriented i.e. seeking expansion in production and market segments, utilization of existing companies or optimum utilization of resources, then the acquirer company will select a business related company as a merger partner. If the objective is diversification in production line or business activities, then it will select a non-related company as a merger partner. Once the merger partner is proposed the merchant banker has to appraise the merger/takeover proposal with respect to financial viability and technical feasibility. He has to negotiate with the parties and decide the purchase consideration and mode of payment. He has to comply with the legal formalities like getting approval from the Government/ RBI; drafting the scheme of amalgamation; getting approval of company Board, financial institution, high court if required; arranging for the meeting etc. Venture Capital Financing Financing an emerging high-risk project is called venture capital financing. Many merchant bankers are entering into this area by also financing viable upcoming projects. The financing is by subscription to the equity capital, while repayment is by selling the equity through stock market when the shares are listed. Page | 38
Leasing Is there another lucrative area of financing where merchant bankers are turning? Leasing is a viable source of financing while acquiring capital assets. The services include arrangement for lease finance facilities for leasing companies, legal; documents and tax consultancy. Non Resident Investment To attract NRI investments in the primary and secondary markets, the merchant bankers provide investment advisory services to the NRIs in terms of identification of investment opportunities, selection of securities, portfolio management, etc. they also take care of operational details like purchase and sale of securities securing the necessary clearance from RBI under FERA for repatriation of dividends and interest, etc. Acceptance Credit and Bill Discounting Though merchant bankers world over specialize in acceptance credit and bill discounting, these services are not currently provided by merchant bankers in India the principal reasoning being the lack of an active market for commercial bills. Arranging Offshore Finance The merchant bankers also help their clients in the following areas involving foreign currency financing: Page | 39
1. Financing Of Exports And Imports 2. Long Term Foreign Currency Loans 3. Joint Ventures Abroad 4. Foreign Collaboration Arrangements The assistance rendered as in the case of financial services covers appraisals, negotiations, compliance with procedural and legal aspects etc. Management of Fixed Deposits of Companies Recently, merchant’s bankers have begun to structure and mobilize fixed deposits for their corporate clients. They take care of the procedural and legal aspects, and also mange the collection and subsequent servicing of the deposits. Advice with regard to the amount to be raised, interest charges, terms of deposits and other related issues are also offered to the client. Relief to Sick Industries The services offered by merchant bankers to sick industries can be summarized as follows: 1. Assessment of capital requirements and counseling on capital restructuring;
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2. Appraisal of technological, environmental, financial and other factors causing sickness; 3. Preparations of programs and packages for rehabilitation of sick units; 4. Providing necessary assistance where the rehabilitation package involves mergers or amalgamation; 5. Obtaining necessary approval for implementation the rehabilitation package from the statutory authorities; 6.
Monitoring
the
implementation
of
the
scheme
of
rehabilitation.
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EXAMPLES FOR MERCHANT BANKING SERVICES MERCHANT BANKING SERVICES OF CANARA BANK
INTRODUCTION Canara
Bank
is also one of the leading
Merchant
Bankers in India, offering specialized services to Banks, PSUs, State owned Corporations, Local Statutory and sector.
bodies corporate
Its
SEBI
registered
Category
I
Merchant
Banker
/
Underwriter to carry on Issue Management (Public / Rights / Private Placement
Issues),
Underwriting,
Consultancy
and
Corporate
Advisory Services etc.
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They also hold SEBI registration Certificate to act as "Bankers to an Issue" with network of exclusive Capital Market Service Branches to handle “Capital Market" related assignments. They undertake "project appraisals" with resource raising plans from Capital Market/ Debt Markets and facilitate tie-ups with Banks / Financial Institutions and Potential Investors. Their uniqueness is extending services under single window concept covering the following areas: 1. Merchant Banking 2. Commercial Banking 3. Investments 4. Bankers to Issue - Escrow Bankers 5. Underwriting 6. Loan Syndication As leading Merchant Bankers in India, they have associated with issues ranging from Rs.1crore to Rs.1500 crores, involving various types of industries, banks, statutory Bodies etc. and have an edge in handling Private Placement issues –both retail & HNIs.
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SPECTRUM OF SERVICES:1. Issue (Public/Rights) Management 2. Debt Issue Management 3. Private Placements 4. Project Appraisals 5. Monitoring Agency Assignments 6. IPO Funding 7. Security Trustee Services 8. Agriculture Consultancy Services 9. Corporate Advisory Services 10. Mergers and Acquisitions 11. Buy Back Assignments 12. Share Valuations 13. Syndication
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Investment Criteria:A wide range of later stage opportunities are considered. Targeted companies include the following characteristics: 1. Having weathered the start-up process and established a core business model that is sustainable; 2. Proven management team; 3. If not already profitable, visibility to profitability within a 12month period; 4. Having established business partnerships that give it a major position in a market space; 5. Significant barriers to entry; and 6. Technology or business that is scalable with global applications. They look for opportunities for synergistic consolidation and/or companies that are on the verge of extraordinary growth.
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GUIDELINES OF SEBI After the obligations of the
CCI,
the
place
was
occupied by a legal organ called
as
“Securities
and
Exchange Board of India”. The
issue
pricing
of
of
capital issues
and by
companies has become free of prior approval. The SEBI has issued guidelines for the issue
of
capital
by
companies.
The
broadly
covers
the
guidelines the
requirement of the first issue by a new or the first issue of a new company set up by the existing company, the first issue by the existing private companies and public issues by the existing listing companies. The SEBI is the most powerful organization to control and lead both the primary market and secondary market. Page | 47
The
SEBI
has
announced
the
new
guidelines
for
the
disclosures by the Companies leading to the investor protection. They are presented below: a) If any Company’s other income exceeds 10 per cent of the total income, the details should be disclosed. b)The Company should disclose any adverse situation which affects the operations of the Company and occurs within one year prior to the date filing of the offer document with the Registrar of Companies or Stock Exchange. c)
The
Company
should
also
disclose
the
information
regarding the capacity utilization of the plant for the last 3 years. d) The Promoters of the Company must maintain their holding at least at 20 per cent of the expanded capital. e) The minimum application money payable should not be less than 25 per cent of the issue price. f) The company should disclose the time normally taken for the disposal of various types of investor’s grievances. g) The Company can make firm allotments in public issues as follows: Indian mutual funds (20%), FIIS (24%), Page | 48
Regular employees of the company (10%), Financial institution (20%). h) The Company should disclose the safety net scheme or buy back arrangements of the shares proposed in public issue. This scheme is applicable to a limited number of 500 shares per allottee and the offer should be valid for a period of at least 6 months from the date of dispatch of securities.
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CODE OF CONDUCT According to the 13 Regulation of the SEBI of 1992 (Merchant bankers), every merchant banker should comply with following codes of conduct. They are: a) The merchant banker must observe high integrity and fairness in all his dealings. b)He shall render at all times high standard of services, exercise
due
diligence,
exercise
independent
professional
judgment. c) If necessary, he must disclose to his clients the possible source of conflict of duties and interests. d) The merchant banker should not indulge in unfair practice or unfair competition with other merchant bankers. e) He should not make any exaggerated statement about his capacity or achievement. f) He should always Endeavour to give the best possible advice and prompt efficient and cost effective service. g) He should maintain the secrecy of all the confidential information received during the course of service to his client.
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h) He should not engage in the creation of a false market or price rigging or manipulation.
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MERCHANT BANKERS COMMISSION SEBI and ministry of finance, ceiling rates on merchant bankers’ commission: Discretion
Project appraisal fee Public
negotiable(no ceiling)
issue
0.5% of total issue
management fees Lead managers
0.5% up to Rs.25 crores
commission
On
Underwriting commission Equity shares Pref. Shares debentures Up to Rs.5lakh In excess of Rs.5lakh
and
On
amt
devolving
subscribed by
amt 2.5%
the public 2.5%
2.5% 2%
1.5% 1%
and
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Registration of Merchant Bankers : A. Application for grant of certificate An application for grant of a certificate needs to be made to SEBI . The application can be made for any one of the following categories of the merchant banker namely:• Category I (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. • Category II To act as adviser, consultant, co- manager, underwriter, portfolio manager; • Category III To act as underwriter, adviser, consultant to an issue;
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• Category IV To act only as adviser or consultant to an issue. To carry on the activity as underwriter or portfolio manager a separate certificate of registration needs to be obtained from SEBI. B. Application to conform to the requirements The application should conform to all the requirements under the SEBI guidelines, otherwise it may be rejected. C. Furnishing of information, clarification and personal
representation The Board may require the applicant to furnish further information or clarification regarding matters relevant to the activity of a merchant banker for the purpose of disposal of the application. The applicant or its principal officer may appear before the Board for personal representation.
Consideration of application The Board shall take into account for considering the grant of a certificate, all matters, which are relevant to the activities relating to merchant banker and in particular the applicant complies with the following requirements, namely: -
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• The applicant shall be a body corporate other than a nonbanking financial company • The merchant banker who has been granted registration by the Reserve Bank of India to act as a Primary or Satellite dealer may carry on such activity subject to the condition that it shall not accept or hold public deposit . • The applicant has the necessary infrastructure like adequate office space, equipments, and manpower to effectively discharge his activities • The applicant has in his employment minimum of two persons who have the experience to conduct the business of the merchant banker • A person directly or indirectly connected with the applicant has not been granted registration by the Board; • The applicant fulfils the capital adequacy requirement is as follows: The capital adequacy requirement should not be less than the net worth of the person making the application for grant of registration. The networth shall be as follows,
Category Category I
Minimum Amount Rs. 5, 00, 00, 000 Page | 55
Category II Category III Category IV
Rs. 50, 00, 000 Rs. 20, 00, 000 Nil
The applicant, his partner, director or principal officer is not involved in any litigation connected with the securities market which has an adverse bearing on the business of the applicant and have not at any time been convicted for any offence involving moral turpitude or has been found guilty of any economic offence The applicant has the professional qualification from an institution recognised by the Government in finance, law or business management •
Grant of certificate to the applicant is in the interest of
investors. D.Procedure for Registration The Board on being satisfied that the applicant is eligible shall grant a certificate. On the grant of a certificate the applicant shall be liable to pay the fees as prescribed. E. Payment of fees and the consequences of failure to pay fees Every applicant eligible for grant of a certificate shall pay such fees in such manner and within the period specified. Where a Page | 56
merchant banker fails to pay the Annual fees as provided in Schedule II, the Board may suspend the registration certificate, whereupon the merchant banker shall cease to carry on any activity as a merchant banker for the period during which the suspension subsists. The Merchant Bank can commence business on acquisition of a Certificate of Registration from the SEBI after completion of the above mentioned formalities.
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MERCHANT BANKERS AS LEAD MANAGERS As SEBI guidelines it is mandatory that all public issues should be managed by merchant bankers in the capacity of lead managers. Only in the case of right issues not exceeding Rs. 50lakhs such an obligation is not necessary. The number of lead managers to be appointed by a company depends upon the size of the issue as shown below:
Size of the issue Less than Rs. 50 crores Rs. 50 crores to Rs. 100 crores Rs. 100 crores to Rs. 200 crores Rs. 200 crores to Rs. 400 crores Above Rs. 400 crores
Maximum number of lead managers 2 3 4 5 5 or more as prescribed by SEBI
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DUTIES AND RESPONSIBILITIES OF LEAD MANAGERS The most important aspect of merchant
banking
business
is
to
function as lead managers to the issues
management.
managers,
they
have
As to
lead
exercise
reasonable care and diligence in issue management by paying attention to the following: 1. AGREEMENTIt is the duty of every lead manager to enter into an agreement with the issuing companies stating the details regarding their
responsibilities,
liabilities,
mutual
rights,
functions,
disclosures, refund, allotment etc. A copy of this at least one month before the opening of the issue for subscription. 2. REGISTRATIONOne merchant banker cannot have association with another merchant banker who does not hold a certificate of registration with the SEBI.
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3. ISSUE MAGNAGEMENTSimilarly a lead manager cannot undertake the work of issue management if the issuing company is its associate. 4. RESPONSIBILITIESIn case there is more than one lead manager to an issue, the responsibilities of each of them should be clearly defined in the agreement. 5.MINIMUM UNDERWRITINGA lead manager is under an obligation to accept a minimum underwriting obligation of 5 per cent of the total underwriting commission or Rs. 25 lakhs whichever is less. If he is not able to comply
with
the
above
provision
it
is
his
duty
to
make
managements with another merchant banker associated with that issue to underwrite the said amount. Of course it must be duly intimated to the SEBI. 6.CARE & DILIGENCEA lead manager has to exercise due care and diligence in the verification of prospectus or letter of offer. 7.SUBMISSION OF RATING CERTIFICATEPage | 60
He has to submit due diligence certificate rating that the prospectus or letter of offer is in conformity with the documents relevant to the issue, the disclosures are true, fair and adequate and all legal requirements connected with the issue have been duly complied with. 8.SUBMISSION OF DRAFT PROSPECTUS OR LETTER OF OFFEREvery lead manager has to submit all the particular of an issue, draft prospectus or letter of offer etc. to the SEBI at least two weeks before the date of filing with the Registrar of Companies or regional stock exchanges or both. 9.ACCEPTANCE OF MODIFICATIONIn case of any suggestions or modifications given by the SEBI, he has to ensure that they are properly incorporated in the appropriate areas. 10.COLLECTION OF AMOUNT FROM UNDERWRITERSIn the case of development, the lead manager has to ensure the collection of the specification amount from the underwriters.
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OBLIGATIONS AND RESPONSIBILITES Merchant
bankers
have
the
following
obligations
and
responsibilities: 1. Merchant banker should maintain proper books of accounts, records and submit half yearly/annual financial statements to the SEBI within stipulated period of time. 2. No merchant banker should associate with another merchant banker who is not registered in SEBI. 3. Merchant bankers should not enter into any transactions on the basis of unpublished information available to them in the course of their professional assignment. 4. Every merchant banker must submit himself to the inspection by SEBI when required for and submit all the records. 5. Every merchant banker must disclose information to the SEBI when it requires any information from them. 6. All merchant bankers must abide by the code of conduct prescribed for them. 7.Every merchant banker who acts as lead manager must enter into an agreement with the issuer setting out mutual rights,
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liabilities, obligations, relating to such issues with particular reference to disclosures allotment, refund etc.
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SCOPE FOR MERCHANT BANKING IN INDIA Scope
for
merchant
banking depends upon size of the
market,
liberation, corporate
restriction-
banking
policies,
culture,
and
corporate dynamics. 1.Size and dynamics of the market : Indian market is growing. In fact India is one of the largest emerging markets. Obviously, public issues, FDI, debt raising are on rise. Lots of new and green fried projects are happening. Merchant bankers have lots space to contribute. 2. Restrictions - liberalization: more liberal the market is, more the things left to be decided by the corporate. Merchant bankers assist in decision making and hence their scope increases. With significant market freedom, merchant bankers work has increased many folds. 3. Banking policies: RBI prefers that commercial banks do not indulge in merchant banking business directly. They should setup a Page | 64
subsidiary for the purpose. This limits scope of commercial banks and gives space to merchant bankers. This policy also results in fair business practices. Some countries allow commercial bankers to get involved in IPO’s, placement of debentures, etc. Indian scenario is favorable to merchant bankers. 4. Corporate culture: corporate can do project appraisal, strategic restructuring in house as well. If the corporate prefer third-party independent assessment, then only they will engage merchant bankers. Otherwise merchant banker’s role is only statutory as in issue management. India inc. apparently prefers and is happy with merchant bankers work. 5. Corporate dynamics: more happening in business gives more opportunities to merchant bankers. Mergers, takeover acquisition, new Greenfield projects, fund raising for government institutions, active money market are all providing better business prospectus to merchant bankers.
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Problems of Merchant Bankers: 1.ISSUE RELATED ACTIVITIES SEBI
guidelines
has
authorized
merchant
bankers
to
undertake issue related activities only with an exception of portfolio management.
2.SCOPE OF ACTIVITIESThese guidelines have made the merchant bankers either to restrict their activities or think of separating their activities from the present ones and float new subsidiary and enlarge the scope of its activities.
3.NET WORTHSEBI guidelines stipulate a minimum net worth of Rs.1 crore for authorization of Merchant bankers.
4.ELIGIBLITYSmall but professional and specialized merchant bankers who do not have a net worth of Rs.1 crore may have to close down their business. The entry is denied to young, specialized professionals into merchant banking business. Page | 66
5.RESPONSIBILITIESNon- co- operation of the issuing companies in timely allotment of securities and refund of application money is another problem of merchant bankers. The guidelines have put the responsibility on the merchant bankers. They have to seek the cooperation of the issuing company to shoulder the responsibility.
PROGRESS OF MERCHANT BANKING IN INDIA
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Merchant banker’s main activity is of management of public issue of shares. As stock markets in the country progress or move, merchant banker’s business activity grows. Earlier, stock markets in India nascent stage. Controller of capital issues was the controlling authority. Issue pricing was also dictated by CCI. Later,
it
was replaced with SEBI. Physical shares were replaced with demat. BSE got a strong companion as NSE. Both are highly automated and sophisticated now. Merchant banker’s role in CCI era and in restricted freedom was of course not so significant. As the size of capital market increased, pricing became a critical issue. Book building and book running is an imp exercise. With India liberalizing its policies, its presence in Page | 68
international markets has increased. Number of merchant bankers is on rise since liberation. Virtually every PSU bank has merchant banking subsidiary. Indian finance companies dominated merchant banking in early years. Now giant multinational merchant bankers are showing presence in India. Market and its scope are growing.
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CONCLUSION The merchant banker plays a vital role in channelizing the financial surplus of the society into productive investment avenues. Hence before selecting a merchant banker, one must decide, the services for which he is being approached. Selecting the right intermediary
who
has
the
necessary
skills
to
meet
the
requirements of the client will ensure success. It can be said that this project helped me to understand every details about Merchant Banking and in future how it’s going to get emerged in the Indian economy. Hence, Merchant Banking can be considered as essential financial body in Indian financial system. Market development is predicted on a sound, fair and transparent regulatory framework. To sustain the growth of the market and crystallize growing awareness and interest into a committed, discerning and the growing awareness and interest into an essential to remove the trading malpractice and structural inadequacies prevailing in the market, and provide the investors an organized, well regulated market.
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