A

PROJECT REPORT

ON

MERCHANT BANKING SYSTEM

SUBMITTED TO: SUBMITTED BY:

MR.ARUN MITTAL SANGEETA SINGH MBA (4507/09)

PRIYANKA VERMA MBA (4544/09)
 MERCHANT BANK

A merchant bank is a financial institution primarily engaged in offering financial services and advice
to corporations and to wealthy individuals. The term can also be used to describe the private
equity activities of banking. The chief distinction between an investment bank and a merchant bank is
that a merchant bank invests its own capital in a client company whereas an investment bank purely
distributes (and trades) the securities of that company in its capital raising role. Both merchant banks
and investment banks provide fee based corporate advisory services, including in relation to mergers
and acquisitions.

MERCHANTBANKING
Merchant banks invest their own capital in client companies and provide fee-based advice services for
mergers and acquisitions, among other services they provide.
Merchant banking practices take care of the needs of commercial international finance, stock
underwriting, and long-term company loans. This type of bank primarily works with other merchant
banks and financial institutions with its prominent role being that of stock underwriting, and the bank
works in the realm of private equity where securities of a company are not available for public trading.

Of the most common private equity investment strategies, these include venture capital, leveraged
buyouts, distressed investments, growth capital, and mezzanine capital. Leveraged buyouts generally
obtain majority control over existing or mature firms, whereas growth capital and venture gains invest
in younger or emerging corporations without obtaining the majority of control.

ORIGIN OF MERCHANT BANKING

The origin of merchant banking is to be traced to Italy in late medieval times and France during the
seventeenth and eighteenth centuries. The Italian merchant bankers introduced into England not only
the bill of exchange but also all the institutions and techniques connected with an organised money
market. Merchant banking consisted initially of merchants who assisted in financing the transactions of
other merchants in addition to their own trade. In France, during seventeenth and eighteenth centuries a
merchant banker (le merchand Banquer) was not merely a trader but an entrepreneur par excellence. He
invested his accumulated profits in all kinds of promising activities. He added banking business to his
merchant activities and became a merchant banker.
 MERCHANT BANK V/S INVESTMENT BANK

MERCHANT BANK INVESTMENT BANK

Expand into the field of Securities Participate in trade Financing Activities

Underwriting

Focus on small scale companies And Focus on IPO’s (initial Public offerings ),
offer creative equity financing, Bridge & and large Public and Private share
mezzanine financing. Offerings.

Provide service to small and Medium Provide service to large institutions

institutions.

Merchant banks facilitate mergers and Investment banks did not deal with the
acquisitions general public

NOTIFICATIONS OF THE MINISTRY OF FINANCE AND SEBI

Merchant bankers, irrespective of the form in which they are organised are governed by the Merchant
Bankers Rules (M.B. Rules) issued by Ministry of Finance, and Merchant Bankers Regulations (M.B.
Regulations) issued by SEBI (22.12.1992) and Amendment Regulations, 9.12.1997.

RATIONALE OF NOTIFICATIONS
For orderly growth and development of the securities market, investor confidence is a prerequisite. In
the primary market investor confidence depends in a large measure on the efficiency of the issue
management function which covers drafting and issue of prospectus or letter of offer after vetting by
SEBI to timely dispatch of share certificates or refund orders. To ensure proper disclosure and to bring
about transparency in the primary market with a view to protect investors interests, SEBI has issued
M.B. Regulations.

OBJECTIVES OF THE MERCHANT BANKERS REGULATIONS

The M.B. Regulations which seek to regulate the raising of funds in the primary market would assure
for the issuer a market for raising resources at low cost, effectively and easily, ensure a high degree of
protection of the interests of the investors and provide for the merchant bankers a dynamic and
competitive market with high standard of professional competence, honesty, integrity and solvency.
The regulations would promote a primary market which is fair, efficient, flexible and inspires
confidence. The Regulations stipulate that any person or body proposing to engage in the business of
merchant banking or presently engaged as managers, consultants or advisors to issue would need a
certificate granted by Securities and Exchange Board of India.
The Board may grant or renew a certificate to a merchant banker subject to the following conditions
namely:
(a) Merchant banker, in case of any change in its status and constitution shall obtain the prior
permission of the Board to carry on its activities as a merchant banker;
(b) He shall pay the amount of fees for registration or renewal; as the case may be, in the manner
provided in the regulations;
(c) He shall take adequate steps for redressal of grievances of the investors within one month of the
date of the receipt of the complaint and keep the Board informed about the number, nature and other
particulars of the complaints received;
(d) He shall abide by the rules and regulations made under the Act in respect of the activities carried on
by the merchant banker. The certificate of registration or its renewal, as the case may be, issued
under rule 4 shall be valid for a period of three years from the date of its issue to the applicant.

PROSPECTUS (FILING AND REGISTRATION)

The Registrar of Companies (ROC) has also been advised that prospectus for public issue can only be
filed by merchant bankers who are authorised by SEBI and given a code number. Further the Registrar
of Companies is required not to register a prospectus where he has been informed by SEBI that the
contents of the prospectus are in contravention of provisions of any law or statutory roles and
regulations.

EXEMPTION FROM RBI REGULATIONS

SEBI in 1997 had made companies ineligible for registration as merchant bankers if they are carrying
on any of the financial activities mentioned in the RBI Act. As it is quite likely that as part of treasury
management these merchant banking companies may deploy a portion of their net worth in securities
and they may also perform the activities of underwriting which demands acquisition of securities and
the said activities constitute financial activities. SEBI has suggested to RBI certain exemptions for
these merchant banking companies from the provisions of RBI Act and NBFC Directions. RBI, has
accordingly decided to exempt fully dedicated merchant banking companies from its exempted stock
broking and stock exchange companies from certain core provisions of the RBI Act as these entities are
registered with SEBI. Reserve Bank of India exempted merchant banking companies from compulsory
registration (section 45 IA), maintenance of liquid assets (section 45 IB), creation of reserve fund
(section 45 IC) 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 SEBI under section 12 of the SEBI Act, 1992 and are carrying
on the business of merchant banker in accordance with rules/regulations framed by 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 45 IC of the RBI Act,
1934; and
(iv) they do not accept/hold public deposits.

CODE OF CONDUCT
The code of conduct stipulates that in the performance of duties, merchant banker should act in an
ethical manner, inform the client that he is obliged to comply with the code of conduct, render high
standard of service and exercise due diligence, not to indulge in unfair practices, not to make
misrepresentations, give best advice, not to divulge confidential information about the clients,
endeavour to ensure that true and adequate information is provided to investors. Finally merchant
bankers have to deal adequately with complaints from investors. Merchant bankers should not be a
party in respect of issue of securities, creation of false market, price rigging or manipulation or pass
price sensitive information, to abide by all rules, regulations, guidelines, resolutions issued by the
Government of India and SEBI from time to time.

GENERAL OBLIGATIONS AND RESPONSIBILITIES

Maintenance of books of accounts, records and documents: merchant bankers have to keep and
maintain a copy of the balance sheet, a copy of the auditor’s report and a statement of financial
position, Merchant bankers should inform SEBI where the accounts, records and documents are
maintained. Merchant bankers have to furnish annually to SEBI copies of balance sheet, profit and loss
account and such other documents for any other preceding five accounting years as required.
Merchant bankers are required to submit SEBI half yearly working results with a view to monitor their
capital adequacy. Books, records and documents should be preserved for five years. Auditor’s report
should be acted upon within two months. Merchant bankers should execute an agreement with the
issuing company setting out their mutual rights, liabilities and obligations relating to such issue and in
particular to disclosures, allotment and refund

The merchant banking activity in India is governed by SEBI (Merchant Bankers) Regulations, 1992.
Registration with SEBI is mandatory to carry out the business of merchant banking in India. An
applicant should comply with the following norms:
i) The applicant should be a corporate body.
ii) The applicant should not carry on any business other than those connected with the securities
market.
iii) The applicant should have necessary infrastructure like office space, equipment, manpower, etc.
iv) The applicant must have at least two employees with prior experience in merchant banking.
v) Any associate company, group company, subsidiary or interconnected company of the applicant
should not have been a registered merchant banker.
vi) The applicant should not have been involved in any securities scam or proved guilt for any offence.
vii) The applicant should have a minimum net worth Rs50 million.

EMERGING AREAS

 Private placements with NRI’s and FII’s.

 Brought out deals.
 Market Making
 OTC
 NSE
 Forex
 Financial engineering- M&A’s, capital restructuring.

FUNCTIONS OF MERCHANT BANKING

i) 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 undergoing tasks include instrument
designing, pricing the issue, registration of the offer document, underwriting support, marketing of
the issue, allotment and refund and listing on stock exchanges.
 PRE ISSUE OBLIGATION:
 Due Diligence :the standard of due diligence should be such that he should satisfy himself on
all the aspects of offering , veracity and adequacy of disclosure in the offer documents.

 Requisite fee : the lead merchant banker should pay the requisite fee in accordance with
regulation 24-A of the SEBI merchant bankers Rules and Regulations.

 Submission Of Documents

 Memorandum of understanding (MOU)

 Inter –se allocation of responsibilities
 Due diligence certificate
 Certificate in case of further issues by listed companies.
  Undertaking
 List of promoter’s group.

 Appointment of intermediaries

 Underwriting

 Offer document made public :

1. While filing the draft offer document /red herring prospectus/letter of offer with the
SEBI.
2. Make its copies available o the public ,host the draft and final offer documents on the
website of all the lead managers associated with the issue.

 Pre – issue advertisement : under sec 66 of companies act ,The issuer company should son
after receiving final observations from SEBI make an advertisement in an English national daily
with wide circulation , one Hindi Daily and a reqional newspaper with wide circulation at the
place of its regitered office in the specified format both in case of fixed-price as well as book
built issues.

 Despatch of issue material

 No complaints certificate

 Appointment of compliance office

 Mandatory collection centres :


 The four metropolitian centres situated at Mumbai ,Delhi , Calcutta and Chennai
 All such centres where the stock exchanges are located in the region in which the
registered office of the company is situated.



 POST ISSUE OBLIGATION:
  Post issue monitoring reports

 Public issues : in case of public issues , 3-day and 78-day monitoring reports are to be
maintained.
 Right issues : 3-day and 50-day monitoring reports are required.

 Coordination with intermediaries :

 Underwriters
 Bankers to issue

ii) Placement and Distribution. The merchant banker helps in distributing various securities like
equity shares, debt instruments, mutual funds, insurance products, and 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.

iii) Corporate advisory services. Merchant bankers offer customized solutions to their clients’
financial problems. Financial structuring includes determining the right debt-equity ratio and the
framing of appropriate capital structure theory.

iv) Project advisory services. Merchant bankers help their clients in various stages of the project
undertaken by the clients. They assist them in conceptualizing the project idea in the initial stage.
Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed
project.

v) Loan Syndication. Merchant bankers arrange to tie up loans for their clients. This takes place
in a series of steps. Firstly, they analyze the pattern of the client’s cash flows, based on which the
terms of the borrowings can be defined. Then the merchant banker prepares a detailed loan
memorandum, which is circulated to various banks and financial institutions and they are invited to
participate in the syndicate. The banks then negotiate the terms of lending on the basis of which the
final allocation is done.
vi) Providing venture capital financing. Merchant bankers help companies in obtaining
venture capital financing for financing their new and innovative strategies.

REGISTRATION OF MERCHANT BANKER WITH SEBI

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

CATEGORIES OF MERCHANT BANKER

Initially, merchant bankers were classified into four categories 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 authorisation fee depend on the category. Since September 5,1997 only Category I
exists. The first category consists of merchant bankers who carry on any activity of issue management,
which will inter alia consist of preparation of prospectus and other information relating to the issue,
determining financial structure, Regulation of Merchant Banking Activity 19 up of financiers and final
allotment and refund of the subscription and to act in the capacity of managers, advisor or consultant to
an issue.
Net worth: Minimum net worth is Rs. 5 crores.
Registration Fee: (2006) Registration fee is Rs. 10 lakhs. Renewal fee is Rs. 5 lakhs. Application fee
Rs. 25,000 for registration and renewal. In addition merchant banker has to pay fees per offer
document:
Public Issues: Less than or equal to Rs. 1 crore: A flat charge of Rs. 10,000; and more than Rs. 25,000
crores: 0.1 per cent of issue size.
Rights Issues: Up to Rs. 2 crores: A flat charge of Rs. 10,000; more than Rs. 2 crores and less than Rs.
500 crores; 0.05 per cent of issue size and more than Rs. 500 crores: a flat charge of Rs. 25 lakhs. The
Amendment Regulations notified on May 29, 2007, revised the filing fees in case of public issue and
rights issue to a flat charge of Rs. 10 crore for public issues above Rs. 25,000 crore and to flat charge of
Rs. 25 lakh for rights issue above Rs. 500 crore.

ORGANIZATIONAL SETUP OF MERCHANT BANKERS

a) Institutional Base:- Where merchant banks function as an independent wing or as subsidiary of

various Private/ Central Governments/State Governments Financial institutions.

b) Banker Base:- These merchant bankers function as division/ subsidiary of banking organization.
The parent banks are either nationalized commercial banks or the foreign banks operating in India.

c) Broker Base :- In the recent past there has been an inflow of Qualified and professionally skilled
brokers in various Stock Exchanges of India.
d) Private Base:- These merchant banking firms are originated in private sectors. These organizations
are the outcome of opportunities and scope in merchant banking business and they are providing skill
oriented specialized services to their clients

ADVANTAGES OF MERCHANT BANKING

 Merchant banks perform functions that cannot be carried out by businesses on their own.
 Merchant banks have access to traders, financial institutions, and markets that companies or
individuals could not possibly reach.

 By using their skills and contacts, merchant banks can get the best possible deals for their
clients.

DISADVANTAGES OF MERCHANT BANKING

 Merchant banks are really only for large corporate customers, or extremely wealthy smaller
businesses owned by individual clients.

 Not all deals carried out by merchant banks meet with unqualified success.

 There is always risk attached to the kinds of deal that merchant banks undertake

DEFAULTS OF MERCHANT BANKERS AND PENALTY POINTS

SEBI categorised defaults and the penalty points they attract.

Defaults Penalty Points
General Defaults 1
Minor Defaults 2
Major Defaults 3
Serious Defaults 4
 GENERAL DEFAULTS

For the purpose of penalty point, the following activities fall under general default and attract one
penalty point:
(a) Non-receipt of draft prospectus/letter of offer from the lead manager by SEBI, before filing with
Registrar of Companies/ Stock Exchanges.
(b) Non-receipt of inter se allocation of responsibilities of lead managers in an issue by SEBI prior to
the opening of issue.
(c) Non-receipt of due diligence certificate in prescribed manner by SEBI, before opening of the issue.
(d) Failure to ensure submission of certificate of minimum 90 per cent subscription to the issue as
required under Government of India, press note no. F.2/14cci/90 dated 6th April, 1990.
(e) Failure to ensure publicising of dispatch of refund orders, shares/ debenture certificates, filing of
listing application by the issuer as required under Government of India, press notification no. 2/6/cci/89
dated 10.1.1990.
MINOR DEFAULTS

The following activities are categorised under minor defaults and attract two penalty points:
(a) Advertisement, circular, brochure, press release and other issue related materials not being in
conformity with contents of the prospectus.
(b) Exaggerated information or information extraneous to the prospectus is given by issuer or
associated merchant bankers in any press conference, investor conference, brokers’ conference or other
such conference/meet prior to the issue for marketing of the issue arranged/ participated by the
merchant banker.
(c) Failure to substantiate matters contained in highlights to the issue in the prospectus.
(d) Violation of the Government of India letter no. F. 123/SE/86 dated 24th March 1986 and/or
Government of India letter no. F.1/23/SE/86 dated 24th June 1987 regarding advertisements on new
capital issues.
(e) Failure to exercise due diligence in verifying contents of prospectus/ letter of offer.
(f ) Failure to provide adequate and fair disclosure to investors and objective information about risk
factors in the prospectus and other issue literature.
(g) Delay in refund/allotment of securities;
(h) Non-handling of investor grievances promptly.
 MAJOR DEFAULTS

The following activities are categorised under major defaults and attract three penalty points:
(a) Mandatory underwriting not taken up by lead manager.
(b) Excess number of lead managers than permissible under SEBI press release of 28th February, 1991.
(c) Association of unauthorised merchant banker in an issue.

SERIOUS DEFAULTS

The following activities are categorised under serious defaults and attract four penalty points:
(a) Unethical practice by merchant banker and/or violation of code of conduct.
(b) Non-cooperation with SEBI in furnishing desired information, documents, evidence as may be
called for. A merchant banker on reaching cumulative penalty points of eight (8) attracts action from
SEBI in terms of suspension/cancellation of authorisation. To enable a merchant banker to take
corrective action, maximum penalty points awarded in a single issue managed by a merchant banker
are restricted to four.
In the event of joint responsibility, same penalty point is awarded to all lead managers jointly
responsible for the activity. In the absence of receipt of inter se allocation of responsibilities, all lead
managers to the issue are awarded the penalty point.

SOME LATEST NEWS ABOUT MERCHANT BANKS

 28 OCT 2009:MUMBAI: Birla Capital & Financial Services Ltd has been granted a merchant-
banking license by the Securities and Exchange Board of India. The license will enable the
company to offer a wide range of on-shore investment banking advisory and underwriting
services in the Indian market.
 1 FEB 2010: MUMBAI: The revival in primary markets has once again made merchant
bankers the most sought-after class of market intermediaries. Seeing intense capital-raising by
companies and several effective investments and acquisition deals, there is a rush among
foreign and domestic financial services institutions to commence merchant banking services, an
activity which has been fairly dormant over the past two years
 30 APRIL 2010 MUMBAI: Mumbai-based Fiduciary-Euromax Capital Markets has received
approval from the Securities and Exchange Board of India to work as a Category-I merchant
banker.

 4 JUNE 2010:MUMBAI: JM Financial group has signed an initial pact with South Africa's
Rand Merchant Bank - a division of FirstRand - to enter into a strategic cooperation to offer
advisory services for mergers and acquisitions.
 25 JULY 2010:CHENNAI: Indian Bank is in the process of inducting partners for its merchant
banking and mutual fund arms and merging the housing finance outfit with itself, a top official
of the public sector lender said
 2 AUGUST 2010 MUMBAI: Private lender, Yes Bank, has entered into a co-operation
agreement with South Korea's Hana Daetoo Investment Bank (HDIB) to advice companies in
cross-border deals.

 5 AUG 2010: The Securities and Exchange Commission on 4 AUG 2010 allowed six more
institutions to roll out full-fledged merchant banking operations in the capital market (Jamuna
Bank, Mutual Trust Bank, The City Bank, Alpha Capital Management, Cosmopolitan
Traders and Green Delta Insurance Company)