Merchant Banking Essay
EXECUTIVE SUMMARY Although merchant banking activity was ushered in two decades ago, it was only in 1992 after the formation of Securities and Exchange Board of India that it is defined and a set of rules and regulations in place. Today a merchant banker is who has the ability to merchandise that is, create or expand a need and fulfill capital requirements. I have given an overview about the financial markets and the role of merchant bankers in the growth of these markets. My project covers how the merchant banks works, rules & regulations laid by SEBI & its impact on the merchant banking activities.
Their importance in the economy is expected to grow even further in the coming years with an increasing proportion of household savings getting invested in corporate & other securities. Hence, my project covers the challenges and advantages, which India will get and is getting by merchant banking activities. I have covered several services provided by Merchant Bankers & the role of Merchant bankers in providing those services to the business world. Finally, the top players, which exist in merchant banking, are also covered; their services are also been focused.
To get the practical knowledge about merchant banking activities I have interviewed visited State bank of India, Kotak mahindra bank and SPA Merchant bankers ltd. INDEX |SR. NO. |CONTENTS |PAGE NO. | |1. |Introduction |1 | |2. |History |2 | |3. Definition |4 | |4. |Evolution & Emergence of Merchant Banking |5 | |5. |Merchant Banking in India | | |6. |Merchant banking past and present |7 | |7. Need & Importance in India |8 | |8. |Role of Merchant Bankers |9 | |9. |Merchant Bankers Commission |11 | |10. |Commercial Banks & Merchant Baks |12 | |11. Growth of Merchant Banks in India |13 | |12. |Problems of Merchant Bankers |14 | |13. |Current Scenario |15 | |14. |Merchant Banking Indian Scenario |16 | |15. Merchant Banking International Scenario |17 | |16. |Merchant Banking Organisation |19 | |17. |Qualities of good Merchant Bankers |20 | |18. |Responsibilities of Merchant banker |22 | |19. Registration of Merchant Banker |24 | |20. |Scope of services |26 | |21. |Services Rendered by Merchant Bankers |27 | |22. |Recent Trends |39 | |23. |Players in Merchant Banking |41 | |24. Merchant Banking – Future Development |48 | |25. |Questionnaire |51 | |26. |Annexure |53 | |27. |Conclussion |62 | |28. Bibliography |63 | INTRODUCTION The term Merchant Banking has its origin in the trading methods of countries in the late eighteenth and early nineteenth century when trade-taking place was financed by bill of exchange drawn by merchanting houses. At that time the merchants were merely financing their own activities. As international trade grew and other lesser-known names wanted to import goods from abroad, the established merchants ‘lent their names’ to the newcomers by agreeing to accept bills of exchange on their behalf.
The acceptance houses would charge a commission for this service and thus there grew up the business of accepting bills of finance trade not merely of themselves, but of others. Acceptance business thus became and to a degree always has been hallmark of true Merchant Banks. The second historical of Merchant Banks was the raising of capital for foreign Government. In many cases, the Merchant Banks have been trading in the countries concerned and gained the confidence of Governments and other authorities in those countries.
Thus the second principal ingredient of Merchant Banking became and still is raising of capital through the issue of stocks and bonds. Therefore, Merchant Banks can be accepting houses or issuing houses or both. Merchant Banking started in the beginning of 20th century in UK and USA. More recently, the services offered by Merchant Banks have entered into the other areas of operations. Their role is wide ranging and they can now provide most of the financial services required by a company, touching almost all aspects of establishing and running of industrial units on sound financial footing.
Dictionary meaning of ‘merchant bank’ refers to an organization that underwrites corporate securities and advises such clients on issues like corporate mergers, etc. involved in the ownership of commercial ventures. This organization may be a bank, corporate body, firm or proprietary concern. HISTORY OF MERCHANT BANKING During the seventeenth and most of the eighteenth century international finance was centered on Amsterdam. Consequently Amsterdam merchants became the first masters of the various financial techniques and developments which, in the course of time, became identified with the emergent profession of ‘Merchant Bankers’.
Commercial Banking and Investment Banking are often confused with Merchant Banking. In many ways, there may be similarities in their functions. However, in certain ways, Merchant Banking is distinctly different from commercial Banking and Investment Banking. The primary function of a commercial bank is to receive deposits from the public and lend the same to others. Commercial Banks can undertake some of the merchant banking activities like Issue Management whereas Merchant Banking Units can not undertake commercial banking activities. However, the functions of Merchant Banking may not widely vary from Investment Banking.
The Merchant Banker mainly deals with Issue Management, post issue services, corporate adviser services etc. the Investment Banker undertaken trading in securities, Investment advises and Bought out deals which are not the main activities of Merchant Bankers. In today’s Scenario the Merchant banker and management consultants undertake advisory services to the corporate sector. The Merchant Banker advices corporation and firms relating to opening of issues, receiving loans etc, which the management consultants also do. The management consultant have a wide area operations like production, Marketing, Personnel Relations, of finance etc. ut they lack statutory recognition to undertake capital market related activities which has enabled the merchant banker to cater to the needs of the Corporate Sector. A merchant bank may be considered as an institution which centres its operation on all or most of the following activities. (1) Corporate financial advice, on such diverse matters as new share and bond issues, capital reconstructions, mergers and acquisitions; (2) The taking of deposits and currency, money market operations including foreign exchange dealing; (3) Medium-term lending and syndication of loans; (4) Acceptance credits and all forms of export finance; 5) The holding and dealing in quoted and unquoted investment; and (6) Fund management on behalf of clients, most typically pension funds, unit trust, investment trusts and wealthy individuals. DEFINITION The first authoritative definition for the term ‘Merchant Banker’ has been given in the Rule 2 (e) of SEBI (Merchant Bankers) Rules, 1922. Accordingly, “A Merchant Banker means 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, Adviser of rendering Corporate Advisory Service in relation to such Issue Management”.
Sec/5 (b) of the Banking Regulation Act, 1949 defines Banking as “accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise”. 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 the securities as manager, consult, adviser or rendering corporate advisory service in relation to such issue management”.
Merchant bankers and market making Many successful public issues get listed on the stock exchanges but later do not see any trade i. e liquidity in the market. Listing remains a formality only and investors practically cannot buy/sell shares of that company for lack of liquidity (volume). In well organized markets, there is a system of market makers who offer two way quotes on any scrip, so that continuous liquidity is provided to all scrips. Market making means that a trader or a company puts both buy and sell orders into the market, and wait for people to trade with him on either sides.
Market making could be made compulsory at least for a period of six to twelve months after listing of issues. Most merchant bankers and brokers are significantly undercapitalized to perform EVOLUTION & EMERGENCE OF MERCHANT BANKING India has entered the 21st century as one of the Asia’s most dynamic economies. This is the part of the assessment made by International Financial and Capital Market Institutions based on India’s economic and financial reforms initiated in 1991 and brought to fruition in various budget.
The progress of any economy mainly depends on the efficient financial system of the country. Indian economy is no exception financial system of the country. The importance of the financial sector reforms affirms an effective means for solving the problems of economic, financial and social in India and elsewhere in the developing nations of the world. The progress of the Securities Industry of any country depends mainly on the flow of funds.
In fact, capital generation is the lifeblood of the capital market without which the health and soundness of the financial system cannot be geared and for which well-developed capital market as well as money market is essential. India’s capital market is among the largest in the developing world. The market is comprised of 24 stock exchanges transacting long-term debt; debentures and equity shares both electronic and physical forms. Derivatives financial instruments are also be added to the market shortly. The number of firms listed on the Indian Stock Exchange is more than the USA.
Market Capitalization of listed firms is 1980s was similar to Brazil, Malaysia, Singapore and Denmark. The capital market of the country, however, underwent dramatic changes since the beginning of 1980s basically because of a progressive realization that the command economy on which the emphasis was placed could not lead to higher levels of economic development and that a slant towards a market-oriented economy is necessary. It is in the context of fast expanding economy and a liberalized and deregulated atmosphere that the growth of the Indian Stock Market activities has to be viewed.
No wonder that the markets have registered a quantum jump judge by any standards. MERCHANT BANKING IN INDIA In India prior to the enactment of Indian Companies Act, 1956,managing agents acted as issue houses for securities, evaluated project reports, planned capital structure and to some extent provided venture capital for new firms. Few share broking firms also functioned as merchant bankers. The need for specialized merchant banking services was felt in India with the rapid growth in the number and size of the issues made in the primary market.
The merchant banking services were started by foreign banks, namely the National Grindlays Bank in 1967 and the City Bank in 1970. The Banking Commission in its report in 1972 recommended the setting up of merchant banking institutions. This marked the beginning of specialized merchant banking in India. To begin with, merchant banking services were offered along with other traditional banking services. In the mid-Eighties, the Banking Regulation Act was amended permitting commercial banks to offer a wide range of financial services through the subsidy rule.
The State Bank of India was the first India Bank to set up merchant Banking division in 1972. Later ICICI set up its Merchant Banking division followed by Bank of India, Bank of Baroda, Canada Bank, Punjab National Bank and UCO Bank. The merchant banking gained prominence during 1983-84 due to new issue boom. MERCHANT BANKING: PAST AND PRESENT Many banks entered merchant banking in the 1960s to take advantage of the economies of scope produced when private equity investing is added to other bank services, particularly commercial lending.
As lenders to small and medium-sized companies, banks become knowledgeable about individual firms’ products and prospects and consequently are natural providers of direct private equity investment to these firms. As mentioned above, commercial banks were the largest providers of venture capital in the 1960s. In the middle to late 1980s, the decision to enter merchant banking was thrust on other banks and bank holding companies by unforeseen events.
In those years, as a result of the LDC (less-developed-country) debt crisis, many banks received private equity from developing nations in return for their defaulted loans. At that time, many of these banks set up merchant banking subsidiaries to try to get some value from this private equity. Also at about that time, most commercial banks began refocusing their private equity investments to middle-market and public companies (often low-tech, already profitable companies) and, rather than providing seed capital, financed expansion or changes in capital structure and ownership.
Most particularly, they took equity positions in LBOs, takeovers, or recapitalizations or provided subordinated debt in the form of bridge loans to facilitate the transaction. Often they did both. Commercial banks financed much of the LBO activity of the 1980s. Then, in the mid-1990s; major commercial banks began once again focusing on venture capital, where they had substantial expertise from their previous exposure to this kind of investment. Some of these recent venture-capital investments have been spectacularly successful.
For example, the Internet search engine Lycos was a 1998 investment of Chase Manhattan’s venture-capital arm. Commercial banks are permitted to report either realized or unrealized gains on their merchant-banking portfolios, as long as they are consistent in the reporting. This option makes it difficult for one to compare different entities’ financial results and could lead to an overly liberal reporting of profits. NEED & IMPORTANCE IN INDIA ? Important reason for the growth of merchant banking is due to exerting excess demand on the sources of funds forever expanding industry and trade. 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 consultancy firms to enter into the field of merchant banking and share the growing capital market. ? In India have opened their merchant banking windows and are competing in this field, and also doing advisory functions as merchant bankers as well as managing public issues in syndication with other merchant bankers. Merchant banks can play highly significant role in mobilizing funds of savers to investible channels assuring promising return on investments activity. ? With the growth of merchant banking profession corporate enterprises in both public and private, sectors would be able to meet the growing requirements for the funds for establishing new enterprises, undertaking expansion/modernization/diversification of the existing enterprises. Merchant banks have been procuring impressive support from capital market for the corporate sector for financing their projects. ? 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. ? Merchant bankers advise the investors of he 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. ? 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 organizations for higher yields. ROLE OF MERCHANT BANKERS 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 suggests 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 policies affecting business conditions frequently change; where science and technology create new innovations in production processes of industries envisaging immediate renovations, diversification, 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 set up industrially backward areas to eliminate regional imbalances in industrial development of the country. 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 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 t be dynamic.
For this reason, a merchant banker is sometimes, called M. B i. e. Moving Bottom, i. e. , one who never sits at one place, always moving- attending meetings and meeting clients and constituents, doing business and getting business by attending meetings and conferences, imparting knowledge to others and acquiring new knowledge to maintain his supremacy in possession of latest information. His role depicts a personality cult, which is unique and envious to be followed by others.
In the days ahead, merchant bankers have very significant role to play tuning their activities to the requirements of the growth pattern of 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. ROLE IN THE MARKET
The Securities and Exchange Board of India (SEBI) has stated that merchant bankers must be involved more closely in the market making process as share brokers do not have the requisite expertise to evaluate the fundamentals of the scrips before taking over the role of market makers. Further, share brokers generally being partnership; firms do not have the financial clout which is necessary for market making activity. Resultantly, the SEBI has suggested that any member of the stock exchange along with one merchant banker registered with SEBI could act as a market maker.
The SEBI has felt that to ensure liquidity of scrip it was necessary to facilitate greater movement, which could only be achieved through the institution of market makers. Market makers would also create a market for the scrip’s by offering two way quotes to the investors. A minimum of ten scrip’s has been proposed by SEBI for the market makers. MERCHANT BANKERS COMMISSION As determined by the Finance Ministry, Government of India, Merchant Bankers are eligible to charge commission / fee from their clients as detailed below : i) A Merchant Banker can charge 0. % as the maximum as commission for whole of the issue. (ii) They can charge project appraisal fees. iii) A lead manager can claim a commission of 0. 5% up to Rs. 25 crore and 0. 2% in excess of Rs. 25 crore. iv) Underwriting Commission. | |On amount |On amount subscribed by public | |Type of Security |Devolving on underwriters | | |1. Equity shares |2. 50 |2. 0 | |2. Preference share/debentures | | | |(a) Upto Rs. 5 lakh |2. 50 |1. 50 | |(b) Excess of Rs. 5 lakh |2. 00 |1. 00 | v) Brokerage commission 1. 5%. vi) Other expenses like advertising, printing, Registrar’s expenses, stamp duty etc. , in connection with the issue can be reimbursed from its clients.
COMMERCIAL BANKS AND MERCHANT 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 |MERCHANT BANKS | |Basically deal in debt related finance and their activities |Basically they deal with mainly funds raised through money | |are appropriately arrayed around credit proposals, redit |market and capital market and the area of activity is | |appraisal and loan sanctions. |‘equity and equity related finance’. | | |Are management oriented. They generally are willing to | |Are asset oriented and their lending decisions are based on |accept risks of business. | |detailed credit analysis of loan proposals and the value of | | |security offered against loans.
They generally avoid risks. | | |They are merely financiers. |There activities include project counseling, corporate | | |counseling in areas of capital restructuring, amalgamations,| | |mergers, takeovers etc. discounting and rediscounting of | | |short term paper in money markets, managing, underwriting | | |and supporting public issues and new issue market and acting| | |as brokers and advisers on portfolio management in stock | | |exchange.
This activities have impact on growth, stability | | |and liquidity of money markets. | GROWTH OF MERCHANT BANKING IN INDIA Formal merchant banking activity in India was originated in 1969 with Merchant Banking Division set up by the Grindlays Bank, the largest foreign bank in the country. The main service offered at that time to the corporate enterprises by the merchant banks included the management of public issues and some aspects of financial consultancy.
Other foreign banks like City Bank, Chartered Bank also assumed the merchant banking activity in India. State Bank of India started merchant banking in 1973 followed by ICICI in 1974. Both these Indian merchant bankers emerged as leaders in merchant banking having done significant business during the period of 1974-1987 in comparison to foreign banks.
The early and mid-seventies witnessed a boom in the growth of merchant banking organizations in the country with various commercial banks, financial institutions, and broker’s firms entering in to the field of merchant banking. The early growth of merchant banking in the country is assigned to the Foreign Exchange Regulation Act, 1973 (FERA) where under large number of foreign companies operating in India were required to dilute their foreign holdings in order to continue business in the country. This had caused two-pronged effect viz. irstly, in the form of spate in ‘Foreign Exchange Regulation Act Issues’ eliciting interest of the investors by creating massive awareness about capital markets amongst the new class of investing public, secondly, merchant banking activity became attractive to banks and the firms of consultants and share brokers who entered into this fields vigorously to reap the advantages of the expanding capital markets. PROBLEMS OF MERCHANT BANKERS 1. SEBI guidelines have authorized merchant bankers to undertake issue related activities only with an exception of portfolio management.
These guidelines have made the merchant bankers either to restrict their activities or think of separating these activities from the present one and float new subsidiary and enlarge the scope of its activities. 2. SEBI guidelines stipulate a minimum net worth of Rs. 1 crore for authorization of merchant bankers. Small 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. 3.
Non 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 co-operation of the issuing company to shoulder the responsibility. CURRENT SCENARIO Merchant banking is an area that we need to build and grow in the years to come. As India forms part of the global village, it becomes increasingly necessary for us to look at this business in a more holistic manner.
Obviously, international players with strong domestic partners such as DSP Merrill Lynch, JM Morgan Stanley, Kotak Mahindra Capital, together with experienced organizations like Enam and institutional backed investment bankers such as ICICI Securities, etc. , are the ones who have expertise, muscle, and placement power in a greater measure than relatively new entrants. The red hot economy is the obvious starting point. India is likely to end the year with GDP growth in excess of 7 percent. Companies and private equity investors are sitting on large piles of cash.
In 2006 deal activity was largely restricted to the IT and Telecom sectors. Thus, while there is a steady flow of deals, there is now a shortage of talent to do the job. MERCHANT BANKING: INDIAN SCENARIO Merchant Banking activity was formally initiated into the Indian capital markets when Grindlays Bank received the license from Reserve Bank in 1967. Grindlays which 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.
Apart from meeting specially, the needs of small-scale units it provided management constancy services to large and medium sized companies. Following Grindlays Bank, Citi Bank set-up its Merchant Banking division in 1970. The division took up the task of assisting new entrepreneur and existing units in the evaluation of new projects and raising funds through borrowing and issue of equity. Management consultant services were also offered. Consequent to the recommendations of Banking Commission in1972, that Indian bank should start 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 economic reforms initiated by the Government since July 1991 in the files of industry, trade and financial sector have paved the way for rapid development of the economy. Several projects have been conceived since then and almost all the major groups in the country that have announced their intentions to set-up mega projects in infrastructure sector envisaging investment of thousands of crores.
With several large projects been set-up and many more on the drawing board, the demand for a complete range of Merchant Banking services encompassing project advisory services, issue management and financial advisory services for corporate sector has increased considerably. This has led to a sharp growth in the Merchant Banking business in the last 2 years. MERCHANT BANKING: INTERNATIONAL SCENARIO The Merchant Banking scenario in developed countries like USA and UK are different from Indian Merchant Banking activities.
The Merchant banker is also called as Investment Bankers. A brief outline of Merchant Banking in USA and UK has shown in the following paragraphs. Merchant Banks in UK In United Kingdom, Merchant Banks came on the scene in the late eighteenth century and early nineteenth century. Industrial revolution made England into a powerful trading nation. Rich merchant houses that made their fortunes in a colonial trade diversified into banking. Their principle activity started with the acceptance of commercial bills pertaining to domestic as well as international trade.
The acceptance of the trade bills and their discounting gave rise to acceptance houses, discount houses, and issue houses. Merchant Bankers initially included acceptance houses, discount houses and issue houses. A Merchant Banker was primarily a merchant rather than his customers entrusted banker but him with funds. Merchant Banks in UK: ? Finance foreign trade, ? Issue capital, ? Manage individual funds, ? Undertake foreign security business, and ? Foreign loan business. They also used to finance sovereign government through grant of long-term loans.
Since the end of Second World War commercial banks in Western Europe have been offering multiple services including Merchant Banking services to their individual and corporate clients. British banks set-up division or subsidiaries to offer their customers Merchant Banking services. Merchant Banking in USA Merchant banks make the primary markets in USA, arrange mergers and acquisitions, undertake global, custody, proprietary trading and market making, niche business, fund management and advisory services to governments and firms.
The increased regulation and control of domestic operations gave a fillip to large US banks to undertake Merchant Banking functions in international capital markets. The US investments Banks have extended their operations to the international level. They are largely responsible for the development of the Euro-dollar market in the securities and globalization of capital markets. They have a prominent presence in London and other European financial centers. Merchant Banks have today a strong parent, a strong balance sheet and a strong international network to play a global role.
MERCHANT BANKING ORGANISATIONS In India, merchant banks operate in the form of Divisions of Indian and Foreign banks and financial institutions, subsidiary companies established by banks like SBI Capital Markets Ltd. , can Bank Financial Services Ltd. , PNB Capital Services Ltd. , Indian Bank Merchant Banking services Ltd. , etc. , the firm organized by the stock brokers, stock exchange dealers, the financial and technical consultants and chartered accountants. Securities and Exchange Board of India (SEBI) has divided merchant bankers into four categories, which are as follows: – CATEGORIES |ACTIVITIES |NETWORTH | |Category I |To carry on the activity of issue management and to act as adviser, |Rs. 1crore | | |consultant, manager, underwriter, portfolio manager. | | |Category II |To act as adviser, consultant, co-manager, underwriter, portfolio |Rs. 50 lakhs | | |manager. | |Category III |To act as underwriter, adviser or consultant to an issue. |Rs. 20 lakhs | |Category IV |To act only as adviser or consultant to an issue |Nil | Merchant Bankers are classified into 4 categories as shown in the above table having regard to their nature and range of activities and their responsibilities to SEBI, investors and issuers of securities. The minimum net worth and initial authorization fee depends on the category.
The first category consists of merchant bankers who carry on any activity of issue management, determining financial structure, tie-up of financiers, advisor or consultant to an issue, portfolio manager and underwriter. The second category consists of those authorized to act in the capacity of co-manager/advisor, consultant, and underwriter to an issue or portfolio manager. The third category consists of those authorized to act as underwriter, advisor or consultant to an issue. The fourth category consists of merchant bankers who act as advisor or consultant to an issue.
QUALITIES OF GOOD MERCHANT BANKERS Merchant bankers are individual experts who organize and manage the merchant banks. The operations of merchant banks are, therefore, influenced by the personality trait of these individuals. For the success of merchant bank’s operations, the qualities which merchant bankers should have are discussed below:- ? LEADERSHIP:– merchant banker should possess all relevant skills, update knowledge to interact with the clients and effectively communicate. Leadership is synonymous with followers who follow the one who leads. AGGRESSIVE ACTION:- aggressiveness is a personality trait of a good leader but in merchant banking it has a wider connotation. Aggressive merchant bankers are always looking for new business. Once a business opportunity has been located, the merchant banker has got to obtain the mandate for the merchant banking assignment from the clients at once which will depend upon his own communication skills, persuasiveness and the background of the organization to which he belongs. A good merchant banker is one who does not allow his client to think anything outside except what has been advised. COOPERATION AND FRIENDLINESS:- These two characteristics are the symbols of good leadership but it hardly needs to be stressed that cooperation and friendliness coupled with persuasiveness are the main instruments with which a merchant banker mixes with the people, gathers information, obtains business mandate and renders satisfactory services to the clients. Business of an honest business merchant banker spreads with geometrical propagation when he shares the thoughts of his clients with sympathetic gestures and offers pragmatic suggestions without greed or favours.
Very often, rude, intemperate and indifferent disposition or blunt out burst withdrew fortunate business opportunities forever. Friendliness and cooperation must flow as natural traits in the merchant banker to win the trust of the clients. ? CONTACTS :– success of merchant banker depends upon his sociable nature and the richness of wider contacts. A merchant banker is supposed to be acquainted deeply with all the constituents of merchant banking.
The scope of contact encompasses intimate contiguity and acquaintances within his own organization, Central and State Government Offices where compliances under various relevant enactments are to be reported, Indian and foreign banks, financial institutions at Central and State levels, promoters/directors/owners and chief executives of the private and public enterprises which would be prospective beneficiaries of merchant banking services, printers, advertising agencies, brokers and stock exchange dealers, advocates and solicitors and members of the press whose services are availed of in executing merchant banking assignments.
Merchant bankers should widen contacts and references and continue to maintain them with goodness, honour and humour by meeting people. ? ATTITUDE TOWARDS PROBLEM SOLVING:– The most important personality trait of a merchant banker is his attitude towards problem solving. Even client coming to him has got to return fully satisfied having consulted a merchant banker. Positive approach to understand the view points of others, their difficulties and their adverse circumstances is possible only when a person is skilled in human relations particularly the inter-personal and intra-personal behavior.
Effective communication and proper feedback are the pre-requisite for creating a positive attitude towards problem solving. Many persons are effective in this trait without any training for reasons of cultivating a habit from environment in which they have been brought up at home, in school, college and office. This is so important that it must be treated as a separate objective quality of a good merchant banker. ? INQUISITINESS FOR ACQUIRING NEW SKILLS, INFORMATION AND KNOLEDGE: – merchant bankers lice on their wits they earn by giving information to needy clients.
Therefore, they should keep abreast with latest information in the area of the service product, they market. This is possible if merchant bankers possess the quality of inquisitiveness. The above qualities of a merchant banker are only illustrative. All good qualities in merchant bankers are difficult to be defined so elaborately. Nevertheless, merchant banker should possess super business acumen, managerial abilities, administrative capacities and salesmanship so as to understand the problems and sell the service product to the needy clients.
RESPONSIBILITIES OF MERCHANT BANKER ? To the Investors Investor protection is fundamental to a healthy growth of the Capital Maerket. Protection is not to be conceived as that of compensating for the losses suffered. The responsibility of the Merchant Banker in ensuring the completeness of the disclosures is of paramount importance in view of the fact that entire reliance is based on offer Document either Prospectus or Letter of Offer because an independent agency like a Merchant Banker has done the scrutiny. ? Capital structuring
The Merchant Bankers while designing the capital structure take into account the various factors such as Leverage effect on earnings per share, the project cost and the gestation period, cash flow ability of the company, the cost of capital, the considerations of management control, size of the company, and general economic factors. These exercise are done mainly in order to meet the fund requirement of the company taking due cognizance of the investor’s preference. ? Project Evaluation and due Diligence Due diligence and project evaluation is another major responsibility of the Merchant Banker.
Where the project has already been appraised by a bank/financial institution, the Merchant Banker relies on the said appraisal before accepting an assignment. However, where the project has not been appraised by as bank/financial instituion, the Merchant Bank undertakes a detailed evaluation of the project before taking up an assignment for issue management. ? Legal aspect The factors that are looked into in case of the legal aspects are: ? Compliance with the SEBI guidelinesand the various guidelines issued by the Ministry of Finance and Department of CompanyAffairs. Pending litigation’s towards tax liabilities or any criminal/civil prosecution any of the directors for any offenses. ? Fair and adequate disclosures in the prospectus. ? Pricing of the Issue The Merchant Banker looks into the various factors while pricing the issue. Some of the factors are past financial performance of the company, Book value per share, stock market performance of the shares. The Merchant Banker has a vital role to play in pricing of the instrument. ? Marketing of the Issue Marketing of the issue is a vital responsibility of the Merchant Banker.
The first stage is Pre-issue marketing for placement of the issue with the financial institutions, banks, mutual funds, FII’s and NRI’s. The second stage is the marketing of the issue to the general public through various vehicles such as press, brokers, etc. ? Bought out Deals The concept of wholesale but out of public offerings by the Merchant Bankers started off with over the Counter Exchange of India where a Merchant banker acts also as a sponsor and either takes up the entire issue to be offered wholly of jointly with other co-investors and off-loads the same to the public at a later date by an offer for sale.
Major amendments were made to the SEBI regulations regarding Merchant Bankers. The duration of this transaction period has not officially been announced. REGISTRATION OF MERCHANT BANKER The term ‘Merchant Banking’ originated in the 18th and early 19th centuries in the United Kingdom when trade between countries was financed by bills of exchange drawn on the principal merchant houses. With the increase in international trade, the established merchants started the practice of lending their names to the new comers and accepting the bills of exchange on their behalf.
They would charge a commission for the purpose and thus acceptance business became the hallmark of Merchant Bankers. Once these banks had gained the confidence of the government, they also entrusted with the job of issuing bonds in the London market. Although Merchant Banking activity ushered in two decades ago, it was only in 1992, in India, after the formation of SEBI that is defined and a set of rules and regulations governing it are in place. In fact, the origin of Merchant Banking is to be traced to Italy in late medieval times and France during the seventeenth and eighteenth centuries.
Merchant Banker invested accumulated profits in all kinds of promising activities. Since they added banking business into the profession of Merchant activities and became a Merchant Banker. A distinction was existed in banking systems between moneychanger and exchanger. Moneychangers concentrate on the mutual exchange of different currencies, operated locally and later accepted deposits for security reasons. Passage of time money changers evolved into public or deposit banks whereas exchangers, who operated internationally, engaged in bill-broking that raising foreign exchange and provision of long-term capital for public borrowers.
The exchanges were remitters and Merchant Bankers. In the seventeenth century, a Merchant Banker was a dealer in bills of exchange who operated with correspondents abroad and speculated on the rate of exchange. Initially, Merchant Bankers were not banks at all and a distinction was drawn between banks, Merchant Banks and other Financial Institutions. Among all these, Institutions it was only banks that accepted deposits from public. No person s allowed carrying out any activity as a Merchant Banker unless he or she holds a certificate grated by 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 MERCHANT BANKING SERVICES: SCOPE In the present dynamic environment where public money is playing a vital role in financing a large number of projects, both in the public and private sectors, Merchant Banking has a significant role in managing the show and meeting the growing demands for funds by the corporate sector. Merchant
Banking includes a whole gamut of activities which meet the needs of both corporate and individual investors and which range from identification, evaluation, promoting and financing of projects (both domestic and overseas) by raising resources in the equity and long-term loans, to organize and participate in international consortia, to raise foreign currency loans and to offer advisory services on various matters related to finance, investment, capital management, structure, mergers, amalgamation, takeovers and acquisitions. They also play a useful role in the portfolio management, money market operations, venture capital, leasing, etc.
Merchant bankers act as a guide for the entrepreneurs who are unaware, or have little knowledge or experience, of the complexities involved in the above spheres. In addition to the above, the scope of Merchant Banking services has extended to providing advisory services to companies to increase or divest their stakes, public sector undertaking disinvestments, international issues, etc. With the OTCEI being operation now, Merchant Bankers will have a key role to play in terms of appraising the projects and offering two-way quotes for market making in case of entrepreneur going for listing in the above exchange.
Merchant Bankers act as a critical link between the corporate who are intend to raise funds and the investors who are interested to invest in securities Industry. Besides issue management, the Merchant Bankers are also undertake the activities like underwriting connected with the public issue management business, Managing/advising on International offerings of Debt/Equity i. e. , GDR, ADR, Bonds and other instruments, Private placement securities, Primary or Satellite dealership of government securities, Corporate Advisory services related to securities market (e. . , Takeovers, acquisitions, disengagement), Stock-Broking, Advisory Services for projects, Syndication of rupee term loans and International Financial Advisory Services. The services can be represented as follows: – SERVICES RENDERED BY MERCHANT BANKERS Among the important financial intermediaries are the merchant bankers. The services of Merchant bankers have been identified in India with just issue management. It is quite common to come across reference to merchant banking and financial services as though they are distinct categories.
The services provided by merchant banks depend on their inclination and resources – technical and financial. Merchant bankers (Category 1) are mandated by SEBI to manage public issues (as lead managers) and open offers in take-overs. These two activities have major implications for the integrity of the market. They affect investors’ interest and, therefore, transparency has to be ensured. These are also areas where compliance can be monitored and enforced. Merchant banks are rendering diverse services and functions, which are as follows: ? ISSUE MANAGEMENT:
The public issue of securities is the core of merchant banking function. At one time it was constructed as the sole function. Merchant bankers were identified as issue houses. It was later perceived that they provide other financial services. When companies seek to raise resources for implementation of a new project or finance expansion or modernization or diversification of an existing unit or fund long term working capital requirement, they retain the services of a merchant banker. To a large extent the type of issue would vary with the purpose for which funds are raised.
Merchant bankers when retained as managers to issue will have to assist the company in all the stages connected with public issue. The merchant bankers help corporate to raise money from the markets through the issue of shares, debentures, bonds etc. They are designated as managers to the issue. Their main business is to attract public money to capital issues. They usually render the following services: ? Drafting of prospectus and getting it approves from the stock exchanges. ? Obtaining consent/acknowledgement from SEBI. ? Appointing bankers, underwriters, brokers, advertisers, printers etc. Obtaining the consent of all the agencies involved in the public issue. ? Holding road shows, to sell the issue. These shows are held for the analysts, brokers ; institutional investors. The purpose of these shows is to answer queries from these people about the company and the project for which the funds are being raised. ? Deciding the pattern of advertising. ? Deciding the branches where application money should be collected. ? Deciding the dates of opening and closing of the issue. ? Obtaining the daily report of application money collected at various branches. ? Obtaining subscription to the issue. After the close of the issue, obtaining consent of stock exchange for deciding basis of allotment etc. ? CORPORATE ADVISORY SERVICES RELATING TO THE ISSUE In India, the pricing of issues is now freely decided by the company, with valuable inputs from the merchant bankers, who have to sell the issue at the decided price. The pricing of the issue especially in a public issue is very important. The pricing has to be such, that the investors will be attracted to invest in the issue at that price, at the same time the company should get the premium that it is looking for.
After all, the premium can play a very role in deciding the company’s capital structure, as larger the premium lesser will be the requirement for borrowed funds. The promoter also needs to decide whether to go in for a fresh issue or to go for a rights issue. However this will depend mainly on the quantum of funds that the company needs to raise. The success of the issue is dependent on the selection of the right type of security. In this matter, the expert advice of merchant bankers is of immense importance. In the issue management the merchant bankers have to coordinate the various agencies to the issue.
The success of the issue depends on the cooperation of all the agencies involved. The merchant bankers offer following services during the public issues: ? Preparing an action plan and budget for the total expenses for the issue. ? Preparation of application to SEBI and assistance in obtaining the consent from SEBI. ? Drafting of the prospectus. ? Selection of underwriters, Brokers etc. ? Selection of bankers to the issue. ? Selection of advertising agency for publicity. ? Obtaining approval of the institutional underwriters and stock exchanges for publication of the prospectus.
Companies are free to appoint one or more agencies as Managers to an issue. SEBI guidelines insist that all issues should be managed by at least one authorized merchant banker, functioning either as the sole or lead manager to the issue. Ordinarily, not more than two merchant bankers should be associated as lead managers, advisors and consultants to a public issue. In issues of over Rs. 100 crores, the number could be up to a maximum of four. The responsibilities of merchant bankers in management of public issues are many. Some of these are: We have seen that many unscrupulous promoters have raised money from the market.
This has hurt the investors a lot and has also made investors nervous about stock market investments. This in turn affects the functioning of stock markets both the primary and the secondary markets. It is therefore necessary that merchant bankers are satisfied with the viability of the project, which they can then sell to the investors with confidence. It is therefore important for the reputation of merchant bankers, to only associate themselves with good issues. The merchant banker should act as the custodians of the investors money and this puts a lot of responsibility on them.
To discharge this function the merchant bankers have to exercise due diligence independent by verifying the contents of the prospectus and the reasonableness of the views expressed therein. It is the responsibility of the merchant bankers to get the securities listed on all the stock exchanges mentioned in the prospectus. With the introduction of Demat accounts the complaints about allotment have surely gone down. It is the responsibility of the merchant bankers to ensure timely refunds and allotment of securities to the investors. The merchant bankers have to certify that they verified everything and that they believe it to be true.
This assures the investing public about the safety of their investment. The precautions by the merchant bankers would ensure that all the fake companies, whose intention is to defraud the investors, don’t have access to the market. ? UNDERWRITING Underwriting is like insurance against the failure of an issue. It is a guarantee to the issuing the company, that the money that it requires for its project will definitely be raised. It means that even if the issue is not fully subscribed to by the public, the underwriters will make up the short fall.
Underwriting involves the underwriter agreeing to subscribe directly, or to procure subscription for the unsubscribe portion of the issue, which is not taken up. For the risk that the underwriter takes, he is paid commission. New companies entering the markets for the first time, always face number of problems in raising funds from the market. One of the biggest problems of course that the company is not well known to the investors and many of them will be unwilling to invest their money in such ventures. Many a times even existing companies may find it difficult to raise money, due to some reasons.
Issuing companies therefore approach different underwriters with a request to underwrite the issue. Underwriters on their part need to satisfy themselves about the viability of the project and also about the integrity of the promoters of the company. It must be noted that when an issue is under subscribed, the underwriters will pick the shares and only if the project is good enough, then in future they can sell the shares in the market and get not only their money back, but can also make a decent profit as well. It is obligatory for the merchant bankers to accept a minimum 5% underwriting in the issue subject to a ceiling.
By taking underwriting in an issue managed by them, they show their full commitment to the issue that they are managing. ? MERGERS AND ACQUISITIONS Mergers and acquisitions (M) and corporate restructuring are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M transactions, which bring separate companies together to form larger ones. When they’re not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spin-offs, carve-outs or tracking stocks. Role of Merchant Banker
Mergers & Acquisitions is an area where Merchant Bankers act as intermediaries in negotiating on one with corporate interested in hiving of divisions/companies which are not with in the purview of the long-term business strategy of the group/company, and on the other hand for Corporate interested in non organic growth by acquiring companies/units for reason strategic or non strategic in nature. Mergers can be beneficial for both the entities, as due to competition the companies unable to survive or prosper on their own may like to merge and face competition and achieve growth targets.
Takeovers may be hostile or friendly in nature, hostile takeovers are without the consent of the company and company being takeover may work out an anti takeover strategy to counter the threat. Merchant Bankers provide following services in M&A: – ? Identification of potential takeover targets. ? Financial & Technical appraisal of the merger/takeover proposal. ? Negotiation with the parties for arriving at the suitable price or exchange ratio. ? Assistance in obtaining necessary approval & addressing procedural & legal issues. PROJECT COUNSELLING Project counseling is very important and lucrative merchant banking services which only very few merchant bankers having advantages of knowledge, skills and experience over others are able to render satisfactorily. The corporate seek advice in respect of identification of profitable investment opportunities in the related business areas (like forward/backward integration) or as part of diversification process. The merchant bankers carry out detailed studies on product demand patterns, cost structures, etc. to enable the corporate in preparation of feasibility study may involve arrangement of a foreign collaboration, advice on technical parameters and also legal issues. ? Scope of services Project counseling services are needed by industrial entrepreneurs in India in the following areas: – ? Preparation of project report ? Deciding upon the financing pattern to finance the cost of the project. ? Aspects of project appraisal with financial institutions/banks. ? Project report Project report consists of technical process, location, management profile, means of financing, reports on market surveys and market explorations.
Merchant bankers advise the clients on project preparation. Merchant bankers, on behalf of their clients, engage technical consultants specialized in the specific area, and marketing experts to prepare technical feasibility report and market survey reports. Merchant bankers maintain the list of such experts approves by financial institutions and assign the work to these experts. ? Project report purpose Project report about the proposed activity is prepared to obtain government approvals particularly in the following areas: ? Grant of industrial license to undertake specified industrial activity. Foreign investment and technology tie-up. ? Grant import license for importing raw material, plant, machinery and equipments. ? Grant of foreign exchange allocation for import of capital goods or raw materials, etc. ? Grant of subsidies and other concessions from the government at center or state levels or from government sponsored agencies, etc. ? LOAN SYNDICATION It refers to assistance rendered by merchant banks to get mainly term loans for projects. Such loans may be obtained from a single development finance institution or a syndicate or consortium as in the case of large term loans.
Merchant banks can also help corporate clients to raise syndicated loans from commercial banks. ? Scope of service Once the client company has decided about the project proposed to be undertaken, the next step is looking for the sources wherefrom funds could be procured to implement the project. The responsibility of locating the sources of finance, approaching these sources by putting in requisite prescribed applications and complying with all the formalities involved in the sanction and disbursal of loan rests with the merchant bankers who provide the service of loan/credit syndication.
Loan syndication in the case of domestic borrowing is undertaken with the institutional lenders and the banks. Amongst institutional lenders the following institutions are the main suppliers of the long and medium term funds with which the merchant bankers contact, liaison and arrange loans working for and on behalf of their clients. 1. All India financial institutions i. Industrial Finance Corporation of India (IFCI) ii. Industrial Development Bank of India (IDBI) iii. Industrial Credit & Investment Corporation of India Ltd (ICICI) 2. State level financial bodies i. State Financial Corporations (SFCs) ii.
State Industrial Development Corporations (SIDCs) iii. State Industrial & Investment Corporations (SIICs) 3. All India level investment institutions i. Life Insurance Corporation of India (LIC) ii. Unit Trust of India (UTI) iii. General Insurance Corporation of India (GIC) & its subsidiary companies. 4. Commercial banks: Commercial banks join in consortium loan being provided by the above institutions. 5. Mutual Funds & Venture Capital Funds: these funds generally invest in equity but mutual funds contribute to the issues of Debentures/Bonds on private placement basis as well as subscribe to public issues. ? RESTRUCTURING SERVICES
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. CAPITAL ASSISTANCE In providing financial assistance, merchant banks offer a full understanding of all facets of the capital markets. This includes all types of debt and equity financing available from both the domestic and international markets. It should be understood that interest rates are not the only definition of capital costs. Restrictions on availability, prepayment terms, and operating effectiveness can often outweigh what might appear to be inexpensive capital with low interest rates. Too often, capital includes costs, which force an entrepreneur or a business to undertake undesirable actions.
In the short-run, some actions might b