Chapter Notes: Merchant Banking Services
Merchant banking refers to a range of specialised financial services provided to corporations, institutions and high-net-worth clients. Merchant banks do not provide ordinary retail banking services; instead they advise on and arrange for capital market transactions, corporate restructuring, and allied services connected with the issuance and management of securities.
Definition
Merchant Banker (as defined under Indian regulatory practice) is any person engaged in the business of issue management-that is, making arrangements regarding selling, buying or subscribing to securities as a manager, consultant or advisor-or rendering corporate advisory services in relation to such issue management. Merchant banking therefore combines advisory, managerial and facilitation roles in capital market transactions.
Key differences: Merchant Banking versus Commercial Banking
- Regulation: Merchant banks are regulated primarily by SEBI for capital-market activities; commercial banks are regulated by the RBI (and also interact with SEBI where they act as market intermediaries).
- Primary activity: Merchant banks focus on equity and equity-related finance, corporate advisory and fee-based services. Commercial banks mainly provide deposit taking and debt finance (loans and advances).
- Orientation: Merchant banks are management and advisory oriented; commercial banks are asset and deposit oriented.
- Common services: Merchant banks undertake project counselling, capital structuring, issue management, amalgamations and takeovers. Commercial banks act mainly as financiers and deposit custodians.
- Revenue model: Merchant bankers earn fee and commission income; commercial banks earn interest and fee income from deposit and lending activities.
Licences and registrations required
To carry on merchant banking activities in India, specific registrations/authorisations from SEBI are required depending on the functions undertaken. Important registrations include:
- Certificate of Registration as a Merchant Banker: Issued by SEBI for Category I/II/III/IV merchant bankers to render issue management (public, rights or private placement of equity/debt), underwriting, consultancy and corporate advisory services.
- Banker to the Issue: SEBI registration is required for banks acting as collecting banker/"banker to the issue" to handle applications, ASBA procedures, escrow collections, refunds and paying banker functions.
- Debenture Trustee: SEBI guidelines require a debenture trustee for public debenture issues where the maturity period exceeds 18 months; the trustee's name must appear in the prospectus. A merchant bank cannot itself act directly as trustee, but a trustee entity may be a subsidiary of a merchant bank subject to regulations.
- Portfolio Manager: If a merchant bank wishes to manage client portfolios, a separate Certificate of Registration under the SEBI (Portfolio Managers) Regulations, 1993 must be obtained.
SEBI certification categories for merchant bankers
SEBI classifies merchant bankers by the scope of services they are authorised to perform. The common categories are:
- Category I Merchant Banker: Authorised to act as issue managers. Activities include preparation of the prospectus and other documentation for the issue, determining financial structure, arranging financiers, final allotment and refunds. Category I may also act as advisor, consultant, manager, underwriter and portfolio manager.
- Category II Merchant Banker: Can act as advisor, consultant, co-manager, underwriter and portfolio manager (but not as lead issue manager).
- Category III Merchant Banker: Can act as underwriter, advisor or consultant to an issue.
- Category IV Merchant Banker: Can act only as advisor or consultant to an issue.
Capital adequacy and net worth requirements
SEBI prescribes minimum capital/net worth requirements for applicants seeking merchant banker registration. For example, an applicant for registration as a Category I Merchant Banker is required to have a minimum net worth of Rs. 5 crores. Here, net worth normally means the sum of paid-up capital and free reserves of the applicant. A certificate of registration remains valid until it is suspended or cancelled by SEBI, subject to compliance with ongoing requirements.
Key SEBI authorisation criteria and ongoing governance requirements
When considering applications and supervising merchant bankers, SEBI looks at:
- Professional qualifications and competence in finance, law or business management.
- Infrastructure adequacy: office premises, equipment and manpower appropriate to the scale of operations.
- Capital adequacy and financial strength.
- Track record, experience and reputation for fairness and integrity in past transactions.
Ongoing regulatory and governance requirements typically include:
- Maintenance of proper books of account, balance sheets and profit & loss statements; submission of half-yearly unaudited results to SEBI where required.
- Appointment of a Compliance Officer responsible for monitoring compliance with applicable regulations.
- Prohibition on trading in client securities on the basis of unpublished price sensitive information obtained during engagements.
- Restrictions on associating merchant banking activities with unrelated businesses (banks and financial institutions being an exception where permitted by law).
- Prohibition on acting for an associate or for clients in situations of conflict of interest unless proper disclosures and safeguards are in place.
- Payment of initial authorisation fees, annual fees and renewal fees to SEBI as prescribed.
- SEBI's right to inspect books, records and operations; merchant bankers must permit and cooperate with inspections.
Codes of conduct and ethical obligations
Under SEBI regulations (for example, Regulation 13 of the SEBI (Merchant Bankers) Regulations), merchant bankers must adhere to a code of conduct (Schedule III of the Regulations). Key obligations include:
- Act in the best interest of investors and clients and take reasonable steps to protect investor interest.
- Maintain high standards of integrity, dignity and fairness in business conduct.
- Fulfil obligations professionally and ethically; avoid discrimination among clients.
- Ensure that prospectuses, letters of offer and other material information are made available to investors at the time of the issue.
- Provide impartial, competent and best-possible advice to clients; disclose any penal action taken by regulatory authorities against the merchant banker.
- Inform the board and regulators of any legal proceedings affecting the merchant banker's ability to perform its duties.
- Develop and maintain an internal code of conduct governing operations and staff behaviour.
- Employ personnel who are fit and proper and capable of performing merchant banking functions; the merchant banker is responsible for the acts of its employees and agents.
Principal activities and functional responsibilities
Merchant bankers provide a suite of services across the lifecycle of a securities issue and beyond. Major activities include:
Issue management
Issue management covers the full set of services required to plan, launch and complete a public or rights issue, or a private placement. It can be broken down into:
Pre-issue functions
- Conducting due diligence and feasibility assessment of the issuer's project or business.
- Advising on capital structure, pricing, timing and type of securities to be issued.
- Drafting and preparing the prospectus, letter of offer and other disclosure documents in compliance with regulatory requirements.
- Arranging underwriting, tie-ups with financiers, syndication and co-managers.
- Designing the marketing and distribution strategy for the issue (including roadshows and investor outreach).
- Co-ordinating with registrars, bankers to the issue and stock exchanges for listing requirements.
Post-issue functions
- Final allotment of securities and processing of refunds (where applicable).
- Assisting with listing and liaison with stock exchanges and registrars.
- Ensuring compliance with post-issue obligations, disclosure and reporting requirements.
- Providing post-issue advisory services including follow-on offerings, compliance and investor relations support.
Banker to the issue (Collecting and Paying Banker)
When acting as banker to the issue, a bank or merchant banker with SEBI registration performs functions such as:
- Receiving application monies (including handling ASBA-applications supported by blocked amounts-in the bank account of the investor).
- Maintaining escrow/collection accounts and ensuring proper reconciliation of receipts.
- Processing refunds and issue proceeds; making payments of dividends, interest and refund orders as paying banker.
- Issuing certificates of receipt of application monies and co-ordinating with the registrar for allotment.
Underwriting
Merchant bankers may underwrite issues, committing to subscribe for unsubscribed portions of an issue within agreed limits. Underwriting provides assurance to the issuer that a minimum amount will be raised. Underwriting arrangements and obligations must comply with SEBI rules and be disclosed in the offer documents.
Debenture trustee services
For public debenture issues with maturity exceeding 18 months, a debenture trustee must be appointed. The trustee acts on behalf of debenture holders to protect their interests, ensure compliance with trust deeds and monitor the issuer's obligations under the terms of the debentures.
Monitoring agency
In project financing or specific debt issues, a merchant bank or an appointed monitoring agency may be required to inspect and certify the utilisation of issue proceeds, physical progress of projects and compliance with the terms of the sanction. The monitoring agency helps lenders and investors ensure funds are used for stated purposes.
Corporate advisory and other services
- Advisory on mergers, acquisitions, takeovers and corporate restructuring.
- Capital raising through private placements, preferential allotments and rights issues.
- Valuation services, fairness opinions and financial modelling.
- Portfolio management (only after separate registration as portfolio manager).
- Project appraisal, feasibility studies and finance syndication.
Compliance, conflicts of interest and market conduct
Merchant bankers are expected to adopt internal controls and policies to manage conflicts of interest, maintain client confidentiality and prevent misuse of unpublished price sensitive information. Specific requirements include:
- Not trading in client securities on the basis of confidential information obtained while acting for the client.
- Not acting for conflicted parties without appropriate disclosure and client consent.
- Maintaining separate teams or information barriers where necessary to avoid conflicts between advisory, underwriting and proprietary activities.
- Prompt disclosure to clients and regulators of any regulatory or disciplinary action taken against the merchant banker.
Inspections and enforcement
SEBI has statutory powers to inspect merchant bankers' books, records and operations to ensure compliance with applicable regulations. Inspections may lead to directions, supervisory action, suspension or cancellation of registration and imposition of penalties where violations are found.
Practical notes for students and practitioners
- When preparing for roles in merchant banking, focus on corporate finance, securities law, accounting, valuation techniques and project appraisal.
- Understand SEBI regulations applicable to issue management, underwriting and portfolio management; keep updated with amendments and circulars.
- Strong documentation practices, transparent disclosure and robust internal compliance frameworks are essential for regulatory acceptance and client trust.
Summary: Merchant banking is a specialised, regulated advisory and intermediation function in the capital markets. It requires specific SEBI registrations, adherence to codes of conduct and capital adequacy norms, and the ability to perform a range of pre-issue, issue and post-issue services while maintaining high standards of integrity and investor protection.
