Merchant Banking

Merchant Banking-An Overview

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-An Overview

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 flow of capital in the market.

Ministry of Finance: 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

MERCHANT BANKING
ORIGIN : The term merchant banking originated from the London who started financing foreign trade through acceptance of bills Later they helped government of under developed countries to raise long term funds Later these merchants formed an association which is now called Merchant Banking and Securities House Association

Evolution of Investment Banking in India

In 1967, ANZ Grindlays Bank set up a separate Merchant Banking Division to handle new capital issues. Followed by Citi Bank, which started rendering Merchant Banking services. The foreign banks monopolized merchant banking services in the country. The Banking Commission, in its report in 1972, took note of this with concern and recommended setting up of merchant banking institutions by commercial banks and financial institutions.

Evolution of Investment Banking in India

State Bank of India ventured into this business by starting a Merchant Banking Bureau in 1972. In 1973 ICICI became the first financial institution to offer Merchant Banking services.

JM Finance was set up by Mr. Nimesh Kampani as an exclusive Merchant Bank in 1973. The growth of the industry was very slow during this period.
By 1980, the number of Merchant Bankers rose to 33 and were set up by Commercial Banks, Financial Institutions and private sector. The industry remained more or loss stagnant in the eighties.

Evolution of Investment Banking in India

Many of the top rung Indian Merchant Banks, who had strong domestic base, started entering into joint ventures with the Foreign Investment Banks.

This arrangement resulted in synergies as their individual strengths complemented each other. Some of the successful tie-ups are :
JM Finance-Morgan Stanley DSP Financial Consultants-Merrill Lynch Kotak Mahindra-Goldman Sachs Ind Global Fin Trust-Salomon Bros Creditcapital-Lazard Bros SBI Capital Markets-Lehman Bros

Evolution of Investment Banking in India

Some of the alliances failed due to cultural differences, varied aspirations of the partners, etc. Some of the notable failures are :
IDBI-Asian Capital Partners ICICI Securities-J.P. Morgan ITC Classic-Peregrine

Services rendered
Organising finance for investment in projects Assistance in financial management Acceptance of house business Raising Eurodollar loans and issue of foreign currency bonds Financing export of capital goods, hydropower Financing of hire-purchase transaction, leasing Mergers, takeovers, valuation of assets

Business Portfolio of Indian Investment Banks

Non Fund Based Merchant Banking Services for: Management of Public offers of equity and debt instruments Right issues Open offers under the Takeover code Buyback offers De-listing offers Advisory and Transaction Services in Project Financing Syndicated Loans Structured Finance and Securitization Private/ Equity Venture Capital Preferential Issues Qualified Institutional Placements Business Advisory Financial Restructuring Corporate re-organisations such as mergers and demergers, hive-offs, assets sales, divestitures Acquisitions, strategic sale, buyouts and privatization Government disinvestments and privatization Assets recovery agency services Fund Based Underwriting Market Making Bought Out Deals Proprietary investments and trading in equities, bonds and derivatives

Main functions of a merchant banker

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, 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.

Functions
Corporate advisory services Merchant bankers offer customized solutions to their clients financial problems. The following are the main areas in which their advice is sought: Financial structuring 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.

Functions
Project advisory services- (done by foreign MB)
conceptualizing the project idea feasibility studies
Preparing different documents like the detailed project report.

Loan syndication- (done by foreign MB)

Tie up loans for their clients Analyze the pattern of the clients cash flows Prepares a detailed loan memorandum This takes place in a series of steps. Firstly they, based on which the terms of borrowings can be defined. Then the merchant banker, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate.

ISSUE MANAGEMENT : Management of issues involves marketing of corporate securities ieequity shares, preference shares and debentures by offering them to public. Pre-issue activities: They prepare copies of prospectus and send it to to SEBI and then file them to Registrar of Companies They conduct meetings with company representatives and advertising agencies to decide upon the date of opening of issue, closing of issue, launching & publicity campaign etc.. They help the companies in fixing up the prices for their issues (will see the details later)

ISSUE MANAGEMENT :
Post-issue activities:

collection of application forms,

screening of applications, deciding allotment procedure, mailing of allotment letters, and refund orders

UNDERWRITING OF PUBLIC ISSUES :

Underwriting is an insurance to the company which makes public issues. Raising of external resources is easy for the issues backed by well known underwriters.

MANAGERS,CONSULTANTS OR ADVISERS TO THE ISSUE : SEBI insist that all issues should be managed by atleast one authorised merchant banker but not more than two. For an issue of 100 crores, upto a maximum of four merchant bankers shall be appointed. They help in listing of shares in stock exchange, completion of formalities under Companies Act etc..

PORTFOLIO MANAGEMENT : Portfolio refers to investment in different kinds of securities such as shares, debenture issued by different companies. It is a combination of assets but a carefully blended asset combination. Investors are interested in safety, liquidity and profitability of his investment but they cant choose the appropriate securities. Merchant bankers help their investors in choosing the shares. They conduct regular market and economic surveys.(Foreign MB)

NRI INVESTMENT : NRIs has to follow lots of complicated rules for investing in the shares in India.Merchant bankers help them in choosing the shares and offer expert advice fulfilling government regulations thus mobilising more resources for corporate sector. ADVISORY SERVICE RELATING TO MERGERS AND TAKEOVERS : Merger is a combination of two or more companies into a single company where one survives and other loses its existence Takeover is the purchase by one company acquiring controlling interest in the share capital of another company Merchant banker acts as middlemen between offeror and offeree,negotiates mode of payment and gets approval from government.

OFF SHORE FINANCE :

Merchant bankers help their clients in : Long term foreign currency loan

Joint venture abroad

Financing exports and imports Foreign collaboration arrangement

Regulation
Merchant Bankers Regulations -Securities and Exchange Board of India Company Act 1956 Listing guidelines of Stock Exchanges Securities Contracts (Regulation) Act, 1956 Formation of divisions Subsidiaries companies

REGULATORY BANKING

FRAMEWORK

FOR

INVESTMENT

Pure investment banks that do not have presence in the lending or banking business are governed primarily by the capital market regulator (SEBI). Universal banks and NBFC investment banks are regulated primarily by the RBI in their core, business of banking or lending and insofar as the investment banking segment is concerned, they are also regulated by SEBI At the constitutional level, all investment banking companies incorporated under the Companies Act 1956are governed by the provisions of that Act. Universal Banks are regulated by the Reserve Bank of India under the RBI Act and the Banking Regulation Act which put restrictions on capital market exposures to be taken by banks.

REGULATORY FRAMEWORKFOR INVESTMENT BANKING

Investment banking companies that are constituted as non-banking financial companies are regulated operationally by the RBI under Chapter IIIB (sections45H to 45QB) of the RBI Act. Under these sections RBI is empowered to issue directions in the area of resource mobilization, accounts and administrative controls. The following directions have been issued by the RBI so far:
Non-Banking Financial Companies Acceptance of Deposits (Reserve Bank) Directions, 1998. NBFCs Prudential Norms (Reserve Bank) Directions, 1998

REGULATORY FRAMEWORKFOR INVESTMENT BANKING

Merchant banking business consisting of management of public offers is a licensed and regulated activity under the Securities and Exchange Board of India (Merchant Bankers) Rules 1992and Securities and Exchange Board of India (Merchant Bankers) Regulations 1992. Underwriting business is regulated under the SEBI (Underwriters) Rules, 1993 and the SEBI (Underwriters) Regulations 1993. The activity of secondary market operations including stock broking are regulated under the relevant by-laws of the stock exchange and the SEBI (Stock Brokers and Sub Brokers) Rules 1992and the SEBI (Stock Brokers and Sub Brokers)Regulations 1992. For curbing unethical trading practices, SEBI has promulgated the SEBI(Prohibition of Insider Trading)Regulations, 1992and the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations 1995.

REGULATORY FRAMEWORKFOR INVESTMENT BANKING

The business of asset management as mutual funds is regulated under the SEBI (Mutual Funds) Regulations 1996. The business of portfolio management is regulated under the SEBI (Portfolio Managers) Rules, 1993 and the SEBI (Portfolio Managers) Regulations, 1993.

The business of venture capital and private equity by such funds that are incorporated in India is regulated by the SEBI (Venture Capital Funds) Regulations, 1996 and by those that are incorporated outside India is-regulated under the SEBI (Foreign Venture Capital Funds) Regulations 2000. The business of institutional investing by foreign investment banks and other investors in Indian secondary markets is governed by the SEBI(Foreign Institutional Investors)Regulations 1995.

Structure
Category-I
to carry on any activity of the issue management,
preparation of prospectus and other information relating to the issue, determining financial structure, tie-up of financiers final allotment refund of the subscription; and

to act as
adviser, consultant, manager, underwriter, portfolio manager.

Structure
Category II
that is, to act as
adviser, consultant, co-manager, underwriter, portfolio manager;

Category III
that is to act as
underwriter, adviser, consultant to an issue;

Category IV
that is to act only as
adviser or consultant to an issue.

Registration with SEBI

Around 250 Merchant Bankers Abolished all categories and maintained Category-I Separate registration for
underwriters and portfolio manager

Segregation between
fee based and Fund based activities

Registration with SEBI

Registration with SEBI is mandatory to carry out the business of merchant banking in India. An applicant should comply with the following norms:
The applicant should be a body corporate The applicant should not carry on any business other than those connected with the securities market The applicant should have necessary infrastructure like office space, equipment, manpower etc. The applicant must have at least two employees with prior experience in merchant banking Any associate company, group company, subsidiary or interconnected company of the applicant should not have been a registered merchant banker The applicant should not have been involved in any securities scam or proved guilt for any offence The applicant should have a minimum net worth of Rs.5 crores

Terms of Authorization
Authorization is valid for an initial period of 3 years Authorization fee, annual fee and renewal fee All issues should be managed by at least one authorized merchant bankers, functioning as sole manager or lead manager MB expected to exercise due diligence independently Involvement of MB in post-issue management Adhere a code of conduct prescribed by SEBI MB may be cancelled or suspended for suitable duration MB regulations integrate issue management with underwriting

General Obligations and Responsibilities

Maintenance of books of accounts, records and documents Copy of the balance sheet, auditors report and statement of financial position Responsibilities of lead Manager Underwriting obligation Submission of due diligence certificate Insider Trading Acquisition of shares

BANKS PROVIDING MERCHANT BANKING SERVICES IN INDIA Commercial banks Foreign banks like National Grindlays Bank, Citibank, HSBC bank etc.. Development banks like ICICI,IFCI,IDBI etc.. SFC , SIDCs Private firms like JM Financial and Investment service , DSP Financial Consultants, Ceat Financial Services, Kotak Mahindra, VMC Project Technologies, Morgan Stanley, Jardie Fleming, Klienwort Benson etc

SOME PROBLEMS OF MERCHANT BANKERS

SEBI stipulates high capital adequacy norms for authorisation which prevents young, specialised professionals into merchant banking business Non co-operation of the issuing companies in timely allotment of securities and refund of application of money etc.. is another problem Yet merchant banking is vast but should develop adequate expertise to provide a full range of merchant banking services

Product Differentiation
In Investment Banking Industry, product expertise on both the issuing and investing side needs to be developed or acquired. Generally, product differentiation is not very high, because the ultimate deal structure is designed as per the advise of the client. The area where an Investment Banker can make the difference, is in the execution of the deal. Though new financial innovations also help a firm to differentiate from others, but they are easily initiated in this industry. For example, Videocon Leasing and Industrial Finance Ltd., introduced the concept of Bought-Out Deal for the first time for raising capital for Patheja Forgings Ltd., and later on many Investment Bankers followed it by raising money for their clients through this route.

Product Differentiation
JM Financial has designed and executed several innovative deals. In 1979, JM designed Fully Convertible Debentures (FCDs) for TISCO.

It was also instrumental in introducing

Zero coupon FCDs in Mahindra & Mahindras issue, Deep Discount Bonds for IDBI and Triple Option Convertible Bonds in 1993 for Reliance Petroleum. It is however difficult to differentiate between services rendered by various Investment Banking outfits in India.

Bargaining power of buyers..companies

In India, success of issue may also be determined by the reputation of its lead manager. Bargaining power of buyers is very high because they are free to approach any Investment Banker who is ready to offer him quality services.

Bargaining Power of Suppliers

Persons who support the Investment Banker in successful execution of the issue like
registrars, printers, advertisers, underwriters, bankers, legal advisors, etc., can be considered as suppliers because without their co-operation and support the public issue cannot see light.

People rendering these services are in large number in the market, hence bargaining power of suppliers can be considered to be very less.

Merchant Banking-An Overview

Banking commission Report-1972
a) b) c) d) e) Necessity Distinct from commercial Banks Investment Management and Advisory services Medium and small savers Manage

SERVICES OF MERCHANT BANKERS

PROJECT COUNSELLING :

It includes preparation of project reports,deciding upon the financing pattern, appraising the project relating to its technical, commercial and financial viability. It includes filling up of application forms for obtaining funds from financial institutions.
LOAN SYNDICATION : Assistance is rendered to raise loans for projects after determining promoters contribution. These loans can be obtained from a single institution or a consortium.