HIDAYATULLAH NATIONAL LAW UNIVERSITY

RAIPUR (C.G)

Banking Law
MERCHANT BANKING, ITS FUNCTIONING AND SCOPE
IN INDIA
Submitted To-
Ms. Kiran Kori
Faculty, Law of Insurance
Submitted by-
Muktesh Swamy
Sem IX Sec C
Roll no 94

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 ACKNOWLEDGEMENTS

I feel highly elated to work on the topic MERCHANT BANKING, ITS FUNCTIONING AND
SCOPE IN INDIA

The practical realization of this project has obligated the assistance of many persons. I express
my deepest regard and gratitude for Ms. Kiran Kori Maam, Faculty of Law of Insurance, Her
consistent supervision, inspiration and invaluable guidance have been of immense help in
understanding and carrying out the nuances of the project.

I take this opportunity to also thank the University and the Vice Chancellor for providing
extensive database resources in the library and through the internet.

Some printing errors might have crept in, which are deeply regretted. I would be grateful to
receive comments and suggestions to further improve the project.

Muktesh Swamy

Sem IX

R.No. 94

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 CONTENTS

1. Objectives and Research Methodology

2. Introduction

3. Registration Of Merchant Bankers With SEBI

4. Major Difference Between Merchant Banking And Investment

Banking

5. Services Of Merchant Banks In Detail

6. Role Of Merchant Banker In A Primary Market Issue Management

7. Code Of Conduct For Merchant Bankers

8. SEBI Regulations For Merchant Bankers

9. Conclusion

10.

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 OBJECTIVE

To bring out instances where film makers have decided to use insurance as a dominant
theme in the plot for their movies
To speculate that if the scenario would have panned out in India, then what the
circumstances would have been.

RESEARCH METHODOLOGY

The research work is Doctrinal in nature. It is of analytical descriptive type. No empirical

approach has been used. Secondary sources such as books, articles/ journals are referred while
making this project.

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 INTRODUCTION

The merchant bankers are those financial intermediaries involved with the activity of transferring
capital funds to those borrowers who are interested in borrowing. They guarantee the success of
issues by underwriting them. Merchant Banks are popularly known as issuing and accepting
houses.

Unlike in the past, their activities are now primarily non-fund based (Fee based). They offer a
package of financial services. The basic function of merchant banks is marketing corporate and
other securities that are guaranteeing sales and distribution of securities and also other activities
such as management of customer services, portfolio management, credit syndication, acceptance
credit, counseling, insurance, etc.

Merchant banking activity was formally initiated into the Indian capital Markets when Grindlays
bank received the license from reserve bank in 1967. Grindlays started with management of
capital issues, recognized the needs of emerging class of Entrepreneurs for diverse financial
services ranging from production planning and system design to market research. Even it
provides management consulting services to meet the Requirements of small and medium sector
rather than large sector. Citibank Setup its merchant banking division in 1970. The various tasks
performed by this divisions namely assisting new entrepreneur, evaluating new projects, raising
funds through borrowing and issuing equity. Indian banks Started banking Services as a part of
multiple services they offer to their clients from 1972. 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. Merchant banking activities is of course
organized and undertaken in several forms. Commercial banks and foreign development finance
institutions have organized them through formation divisions, nationalized banks have formed
subsidiaries companies and share brokers and consultancies constituted themselves into public
limited companies or registered themselves as private limited Companies. Some merchant
banking outfits have entered into collaboration with merchant bankers abroad with several
branches.

REGISTRATION OF MERCHANT BANKERS WITH SEBI

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It is mandatory for a merchant banker to register with the SEBI. Without holding a certificate of
registration granted by the Securities and Exchange Board of India, no person can act as a
merchant banker in India.

1. Only a body corporate other than a non-banking financial company shall be eligible to get
registration as merchant banker.
2. The applicant should not carry on any business other than those connected with the
Securities market.
3. All applicants for Merchant Bankers should have qualification in Finance, law or
Business Management.
4. The applicant should have infrastructure like office space, equipment, manpower etc.
5. The applicant must have at least two employees with prior experience in merchant
banking.
6. Any associate company, group company, subsidiary or interconnected company of the
applicant should not have been a registered merchant banker.
7. The applicant should not have been involved in any securities scam or proved guilt for
any offence.
8. The applicant should have a minimum net worth of Rs.5 Crores.

The various categories for which registration can be obtained are:

1. Category I to carry on the activity of issue management and to act as adviser,

consultant, manager, underwriter, portfolio manager.
2. Category II - to act as adviser, consultant, co-manager, underwriter, portfolio manager.
3. Category III - to act as underwriter, adviser or consultant to an issue
4. Category IV to act only as adviser or consultant to an issue

The capital requirement for carrying on activity as merchant banker:

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The capital requirement depends upon the category. The minimum net worth requirement for
acting as merchant banker is given below:

Category I Rs. 5 crores

Category II Rs, 50 lakhs

Category III Rs. 20 lakhs

Category IV Nil

Procedure for getting registration:

An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers)

Regulations, 1992. SEBI shall consider the application and on being satisfied, issues a certificate
of registration in Form B of the SEBI (Merchant Bankers) Regulations, 1992.

Registration fee payable to SEBI:

Rs. 5 lakhs which should be paid within 15 days of date of receipt of intimation regarding grant
of certificate. Validity period of certificate of registration is three years from the date of issue.
Three months before the expiry period, an application along with renewal fee of 2.5 lakhs should
be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall
consider the application and on being satisfied renew certificate of registration for a further
period of 3 years.

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 MAJOR DIFFERENCE BETWEEN MERCHANT BANKING AND INVESTMENT
BANKING

Sources of revenue could be [a] Fund based source & [b] Fee based source The fund based
income is that revenue gained from interest, lease rental, and as well as income from capital
market investments. The fee-based income is that source gained from banking, advisory services,
custodial services etc. The major difference between the Merchant bankers and Investment
Bankers is:

Merchant Banking is purely fee based.

Investment banking is both fee based and fund based.

A merchant banker can undertake only those activities, which are relating to securities market
and which do not require registration / have been granted exemption from registration as an
NBFC from RBI.

In particular a merchant Banker can undertake the following activities:

Managing of public issue of securities

Underwriting connected with the public issue Management Services acting like as Book
Running Lead Manager/Lead Manager for the IPOs/FPOs/Right issues/Debt issues
Managing advising on international offerings of dept / equity i.e. GDR, ADR, bonds and
other instruments
Private placements of securities
Primary or satellite dealership of GOVT securities
Corporate advisory services relate to securities market eg: takeovers acquisitions and
disinvestments
Stocking broking
Advisory services for projects and Project appraisals.
Syndication of rupee term loans
International financial advisory services.
Project counseling and pre investment activities
Undertaking Feasibility studies

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 SERVICES OF MERCHANT BANKS IN DETAIL

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.

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.

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.

Managers, Consultants or Advisers to the Issue:

The managers to the issue assist in the drafting of prospectus, application forms and completion
of formalities under the Companies Act, appointment of Registrar for dealing with share
applications and transfer and listing of shares of the company on the stock exchange. Companies
can appoint one or more agencies as managers to the issue.

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 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.

Portfolio Management:

Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds
issued by different companies and government securities. Portfolio management refers to
maintaining proper combinations of securities in a manner that they give maximum return with
minimum risk.

Restructuring strategies

A merger is a combination of two companies into a single company where one survives and
other loses its corporate existence. A takeover is the purchase by one company acquiring
controlling interest in the share capital of another existing company. Merchant bankers are the
middlemen in setting negotiation between the two companies. Merchant bankers assist the
management of the client company to successfully restructure various activities, which include
mergers and acquisitions, divestitures, management buyouts, joint venture among others. To help
companies achieve the objectives of these restructuring strategies, the merchant banker
participates in different activities at various stages which include understanding the objectives
behind the strategy (objectives could be either to obtain financial, marketing, or production
benefits), and help in searching for the right partner in the strategic decision and financial
valuation of the proposal.

Off Shore Finance:

The merchant bankers help their clients in the following areas involving foreign currency.

(a) Long term foreign currency loans

(b) Joint Ventures abroad

(c) Financing exports and imports

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(d) Foreign collaboration arrangements

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 clients financial problems. Like 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.

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.

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ROLE OF MERCHANT BANKER IN A PRIMARY MARKET ISSUE MANAGEMENT

Merchant banker is the intermediary appointed by companies in the primary market issue. It has
to look at the entire issue management and work as the Manager to the Public Issue.

Principal steps that Merchant bankers have to perform in a bringing up a Public issue are as
follows :

Vetting of Prospects: The prospectus is a document to communicate information about the

company and the proposed security issue to the investing public. The draft prospectus containing
the disclosures has to be vetted by SEBI before a public issue is made.

Appointment of Underwriters: An underwriter agrees to subscribe to a given number of shares

in the event the public do not subscribe to them. The underwriter, in essence, stands guarantee
for public subscription in consideration for the underwriting commission.

Appointment of bankers: The bankers to the issue collect money on behalf of the company
from the applicants.

Appointment of Registrars: The registrars to issue perform a series of tasks from the time the
subscription is closed to the time the allotment is made.

Appointment of Brokers and Principal Brokers: The brokers to the issue facilitate its
subscription. Filing of the Prospectus with the Registrar of Companies

Printing and dispatch of prospectus and application form: After the prospectus is filed with
the Registrar of Companies, the company should print the prospectus and the application form.

Filing of Initial Listing Application: Within ten days of filing the prospectus, the initial listing
application must be made to the concerned stock exchanges, along with the initial listing fees.

Promotion of the Issue: The promotional campaign typically commences with the filing of the
prospectus with the Registrar of Companies and ends with the release of the statutory
announcement of the issue.

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Statutory Announcement: The statutory announcement of the issue must be made after seeking
the approval of the lead stock exchange. This must be published at least ten days before the
opening of the subscription list.

Collection of Applications: The statutory announcement (as well as the prospectus) specifies
when the subscription would open when it would close, and the banks where the applications can
be made.

Processing of Applications: The application forms received by the bankers are transmitted to
the registrars to the issue for processing.

Establishing the Liability Underwriters: If the issue is undersubscribed, the liability of the
underwriters has to be established.

Allotment of Shares: If the issue is under-subscribed or just fully subscribed, the company may
allot shares applied for by the applicants after securing the formal approval of the concerned
stock exchanges(s)

Listing of the Issue: The detailed listing application should be submitted to the concerned stock
exchanges along with the listing agreement and the listing fee.

Costs of Public Issue: The cost of public issue is normally between 8 and 12 per cent depending
on the size of the issue and the level of marketing effort. The important expenses incurred for a
public issue are Underwriting Expenses, Brokerage, Fees to the Managers of the Issue, Fees for
Registrars to the Issue, Printing Expenses, Postage Expenses, Advertising and Publicity
Expenses, Listing fees, Stamp duty. In addition to the above procedural matter, the most
important issue relates to the pricing of the issue. The merchant banker has to see that the issue is
priced properly.

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 CODE OF CONDUCT FOR MERCHANT BANKERS

1. A Merchant Banker shall make all efforts to protect the interests of investors.
2. A Merchant Banker shall maintain high standards of integrity, dignity and fairness in the
conduct of its business.
3. A Merchant Banker shall fulfill its obligations in a prompt, ethical, and professional
manner.
4. A Merchant Banker shall at all times exercise due diligence, ensure proper care and
exercise independent professional judgment.
5. A Merchant Banker shall endeavor to ensure that Inquiries from investors are adequately
dealt with and Grievances of investors are redressed in a timely and appropriate manner.
Where a complaint is not remedied promptly, the investor is advised of any further steps
which may be available to the investor under the regulatory system.
6. A Merchant Banker shall ensure that adequate disclosures are made to the investors in a
timely manner in accordance with the applicable regulations and guidelines so as to
enable them to make a balanced and informed decision.
7. A Merchant Banker shall endeavor to ensure that the investors are provided with true and
adequate information without making any misleading or exaggerated claims or any
misrepresentation and are made aware of the attendant risks before taking any investment
decision.
8. A Merchant Banker shall endeavor to ensure that copies of the prospectus, offer
document, letter of offer or any other related literature is made available to the investors
at the time of issue or the offer.
9. A Merchant Banker shall not discriminate amongst its clients, save and except on ethical
and commercial considerations.
10. A Merchant Banker shall not make any statement, either oral or written, which would
misrepresent the services that the Merchant Banker is capable of performing for any
client or has rendered to any client.
11. A Merchant Banker shall avoid conflict of interest and make adequate disclosure of its
interest.

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 12. A Merchant Banker shall put in place a mechanism to resolve any conflict of interest
situation that may arise in the conduct of its business or where any conflict of interest
arises, shall take reasonable steps to resolve the same in an equitable manner.
13. A Merchant Banker shall make appropriate disclosure to the client of its possible source
or potential areas of conflict of duties and interest while acting as Merchant Banker
which would impair its ability to render fair, objective and unbiased services.
14. A Merchant Banker shall always endeavor to render the best possible advice to the clients
having regard to their needs.
15. A Merchant Banker shall not divulge to anybody either orally or in writing, directly or
indirectly, any confidential information about its clients which has come to its
knowledge, without taking prior permission of its clients, except where such disclosures
are required to be made in compliance with any law for the time being in force.

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 SEBI REGULATIONS FOR MERCHANT BANKERS

Merchant Bankers have been barred from undertaking activities other than related to the
securities market. The SEBI (Merchant Bankers) Regulations, 1992 have been amended on
December 19, 1997 to provide that:

a) The applicant should be a fit and proper person;

b) A merchant banker has to seek separate registration for its underwriting or portfolio
management activities;
c) The categorization of merchant bankers I, II, III and IV has been dispensed with;
d) A merchant banker, other than a bank or a public financial institution, has been prohibited
from carrying any activities not pertaining to the securities market; and
e) The applicant should be a body corporate other than non-banking finance company.

The Merchant Bankers Regulations were amended on January 21, 1998 to provide time up to
June 30, 1998 to sever its activities or hive off its activities not pertaining to the securities
market. The Reserve Bank of India has exempted merchant banking companies from the
provisions of Reserve Bank of India Act, 1934 relating to compulsory registration (section
451A), maintenance of liquid assets (section 451B), creation of reserve fund (section 451C ) and
all the provisions of the recent Directions relating to deposit acceptance and prudential norms.

Merchant banking companies, to be eligible for the above exemption, are required to satisfy the
following conditions:

i. such companies are registered with the SEBI under section 12 of the SEBI Act, 1992 and
are carrying on the business of merchant banker in accordance with the Rules /
Regulations framed by the SEBI;
ii. they acquire securities only as part of their merchant banking business;
iii. they do not carry on any other financial activities as mentioned in section 451 (c ) of the
RBI Act, 1934;
iv. they do not accept / hold public deposits.

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Maintenance of books of accounts, records etc.

1. Every merchant banker shall keep and maintain the following books of accounts, records
and documents namely:-
a. a copy of balance sheet as at the end of each accounting period;
b. a copy of profit and loss account for that period;
c. a copy of the auditor's report on the accounts for that period; and
d. a statement of financial position.
2. Every merchant banker shall intimate to the Board the place where the books of accounts,
records and documents are maintained.
3. Without prejudice to sub- regulation (1), every merchant banker shall, after the end of
each accounting period furnish to the Board copies of the balance sheet, profit and loss
account and such other documents for any other preceding five accounting years when
required by the Board.

Submission of Half-yearly results

Every merchant banker shall furnish to the Board half-yearly unaudited financial results when
required by the Board with a view to monitor the capital adequacy of the merchant banker.

Maintenance of books of account, records and other documents

The merchant banker shall preserve the books of accounts and other records and documents
maintained under regulation 14 for a minimum period of five years.

Report on steps taken on Auditor's report

Every merchant banker shall within two months from the date of the auditors' report take steps to
rectify the deficiencies, made out in the auditor's report.

Appointment of lead merchant bankers

1. All issues should be managed by at least one merchant banker functioning as the lead
merchant banker: Provided that, in an issue of offer of rights to the existing members
with or without the right of renunciation the amount of the issue of the body corporate

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 does not exceed rupees fifty lakhs, the appointment of a lead merchant banker shall not
be essential.
2. Every lead merchant banker shall before taking up the assignment relating to an issue,
enter into an agreement with such body corporate setting out their mutual rights,
liabilities and obligations relating to such issue and in particular to disclosures, allotment
and refund.

The number of lead merchant bankers may not, exceed in case of any issue of Size of issue No.
of Merchant Bankers:

a) Less than rupees fifty crores-Two

b) Rupees fifty crores but less than rupees one hundred crores-Three
c) Rupees one hundred crores but less than rupees two hundred crores-Four
d) Rupees two hundred crores but less than rupees four hundred crores-Five
e) Above Rupees four hundred crores five or more as may be agreed by the board

Responsibilities of lead managers

1. No lead manager shall agree to manage or be associated with any issue unless his
responsibilities relating to the issue mainly, those of disclosures, allotment and refund are
clearly defined, allocated and determined and a statement specifying such responsibilities
is furnished to the Board at least one month before the opening of the issue for
subscription: Provided that, where there are more than one lead merchant bankers to the
issue the responsibilities of each of such lead merchant banker shall clearly be
demarcated and a statement specifying such responsibilities shall be furnished to the
Board at least one month before the opening of the issue for subscription.

2. No lead merchant banker shall, agree to manage the issue made by any body corporate, if
such body corporate is an associate of the lead merchant banker.

A lead merchant banker shall not be associated with any issue if a merchant banker who is not
holding a certificate is associated with the issue. In respect of every issue to be managed, the lead
merchant banker holding a certificate under Category I shall accept a minimum Underwriting
obligation of five percent of the total underwriting commitment or rupees twenty-five lakhs,

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whichever is less: Provided that, if the lead merchant banker is unable to accept the minimum
underwriting obligation, that lead merchant banker shall make arrangement for having the issue
underwritten to that extent by a merchant banker associated with the issue and shall keep the
Board informed of such arrangement.

The lead merchant banker, who is responsible for verification of the contents of a prospectus or
the Letter of Offer in respect of an issue and the reasonableness of the views expressed therein,
shall submit to the Board at least two weeks prior to the opening of the issue for subscription, a
due diligence certificate in Form C.

The lead manager responsible for the issue shall furnish to the Board, the following documents,
namely: -

1. particulars of the issue;

2. draft prospectus or where there is an offer to the existing shareholders, the draft letter of
offer;
3. any other literature intended to be circulated to the investors, including the shareholders;
and
4. such other documents relating to prospectus or letter of offer as the case may be.

The documents referred to in sub-regulation (1) shall be furnished at least two weeks prior to
date of filing of the draft prospectus or the letter of offer, as the case may be, with the Registrar
of Companies or with the Regional Stock Exchanges, or with both.

The lead manager shall ensure that the modifications and suggestions, if any, made by the Board
on the draft prospectus or the Letter of Offer as the case may be, with respect to information to
be given to the investors are incorporated therein.

No merchant banker or any of its directors, partner or manager or principal officer shall either on
their respective accounts or through their associates or relatives enter into any transaction in
securities of bodies corporate on the basis of unpublished price sensitive information obtained by
them during the course of any professional assignment either from the clients or otherwise.

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Disclosures to the Board

A merchant banker shall disclose to the Board as and when required, the following information,
namely:

(i) his responsibilities with regard to the management of the issue;

(ii) any change in the information or particulars previously furnished, which have a bearing on
the certificate granted to it;

(iii) the names of the body corporate whose issues he has managed or has been associated with;

(iv) the particulars relating to breach of the capital adequacy requirement as specified in
regulation 7;

(v) relating to his activities as a manager, underwriter, consultant or adviser to an issue as the
case is.

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 CONCLUSION

As planning and industrial policy of the country envisaged the setting of up of new industries and
technology, greater financial sophistication and financial services are required. There is a well
proven link between economic growth and financial technology.

Economic development requires specialist financial skills, savings banks to marshal individual
savings; finance companies for consumer lending and mortgage finance; insurance companies
for life and property cover; agricultural banks for rural development; and a range of specialized
government or government sponsored institutions. As new units have been set up and business is
expanding, they require additional financial services. A public equity or debt issue is the logical
source of fund in this situation and merchant banks can tap this opportunity of growth. The areas
of great scope could be,

Growth of Primary market:

If the primary market grows and number of issues increases, the scope of merchant banking will
be enhanced.

Entry of Foreign Investors:

Now India capital market directly taps foreign capital through euro issues. FDI is increased in
capital market. So Merchant bankers are required to advice them for their investment in India.
The increasing number of joint ventures also requires expert services of Merchant Bankers. If
more and more NRIs participate in capital market, there will be great demand for merchant
banker services.

Changing policy of Financial Institutions:

Now the lending policies of financial institutions are based on project orientation, So the
merchant banker services will be needed by corporate enterprise to provide expert guidance.

Development of debt markets:

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If the debt market is enhanced, there will be tremendous scope for Merchant bankers. Now NSE
and OTCEI are planned to raise their fund through debt instruments.

Corporate restructuring:

Due to liberalization and globalization Companies are facing lot of competition. In order to
compete, they have to go for restructuring, merger, acquisitions or disinvestments. They may
offer good opportunities to merchant bankers.

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