merchant bank project

Merchant Banking In India

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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.


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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. but 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.


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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.


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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


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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.


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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.


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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.


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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 the 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.


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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


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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.


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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 0.5% 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.

Type of Security

On amount

Devolving on

underwriters

On amount

subscribed by

public

1.Equity shares

2.Preference share/debentures

(a) Upto Rs. 5 lakh

(b) Excess of Rs. 5 lakh

2.50

2.50

2.00

2.50

1.50

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.


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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 are appropriately

arrayed around credit proposals,

credit appraisal and loan sanctions.

Are asset oriented and their lending

decisions are based on detailed credit

analysis of loan proposals and the

value of security offered against

loans. They generally avoid risks.

They are merely financiers.

Basically they deal with mainly

funds raised through money market

and capital market and the area of

activity is ‘equity and equity

related finance’.

Are management oriented. They

generally are willing to accept risks

of business.

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.


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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. firstly, 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.


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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.


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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.


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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.


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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.


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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.


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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, consultant, manager,

underwriter, portfolio manager.

Rs.1crore

Category II To act as adviser, consultant, co-manager,

underwriter, portfolio manager.

Rs.50 lakhs

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


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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


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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.


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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.


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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.


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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.


~ 25 ~

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.


~ 26 ~

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


~ 27 ~

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.g.,

Takeovers, acquisitions, disengagement), Stock-Broking, Advisory Services for


~ 28 ~

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:


~ 29 ~

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.


~ 30 ~

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


~ 31 ~

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.


~ 32 ~

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&A) and corporate restructuring are a big part of the

corporate finance world. Every day, Wall Street investment bankers arrange M&A

transactions, which bring separate companies together to form larger ones. When

they're not creating big companies from smaller ones, corporate finance deals do


~ 33 ~

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.


~ 34 ~

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


~ 35 ~

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.


~ 36 ~

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 be

necessary, but often in the long run are detrimental. The traditional merchant

banker understands these capital limitations and can structure a transaction, which

is beneficial to all sides of the table -- not just the capital source.

He also knows how to substitute one type of capital for another, sometimes

utilizing internal sources from asset repositioning or cash creation from

improvements in working capital. He understands fully the risk versus return

elements necessary to complete the capital procurement process.


~ 37 ~

CORPORATE ADVISORY SERVICES

Merchant bankers offer customised solutions to solve the financial problems of

their clients. Advice is sought in areas of financial structuring (as shown in the

Modern Manufacturing case above). Merchant bankers study the working capital

practices that exist within the company and suggest alternative policies. They also

advise the company on rehabilitation and turnaround strategies, which would help

companies to recover from their current position.

FACTORING SERVICE

Factoring involves the outright sale of account receivable. By such sale a client (the

exporter or manufacturer) transfers his/her ownership of the accounts to a factor (an

organization, firm). The factor buys all the client’s outstanding invoices and takes over

all the subsequent dealings with the buyer/importer/customer. It is short-term debt

financing. Here three parties are involved

1. The factoring organization /firms

2. The manufacturer/exporter/seller

3. The importer/customer/buyer

Role Of Merchant Banker In Factoring

The merchant banker may act as factor organization with a view to earning a great

amount of commission. The factor provides the following services:

(a) Financing

(b) Advisory services if necessary

(c) Collection of bills/Account Receivable against sales proceeds.

(d) Maintenance of sales ledger

(e) Provide further if necessary

(f) Covering losses if there are any

ASSET SECURITIZATION

It is a process through which some inactive assets (mortgage assets) are converted

into cash/active assets. It is long-term debt financing. Here assets are converted


~ 38 ~

into long-term bonds. The whole process is done by the Special Purpose Vehicle

(SPV). In this approach, the merchant banker for issuance of security bonds

against the assets with a matching of time and terms between mortgage property

and security bonds. Here the selection of asset is generally considered on the basis

of the following:

(I) Quality of assets

(ii) Certainty of repayment

(iii) Good ranking from the credit rating agency.

The process of asset securitization takes place in the following firms:

Originating Institutions/Firm

Special Purpose Vehicle (SPV)

Merchant Banker (MB)

FOREX SERVICES

This aspect of banking is becoming increasingly important as the forex flow in the

country is increasing and the international markets are funding the operations of

the corporate in India. The success of any business is measured by the fund

management; this makes treasury management as a very critical finance function.

Management of treasury profit center requires a wide variety of knowledge in the

area of global money markets and financial instruments such as deposit

certificates, treasury bills, forecasting, source evaluation and cost of domestic and

foreign currency funds. Treasury and risk management ensures cost effectiveness

in planning strategies in this era of deregulation.

Role of merchant banker in Forex function

The currency values, interest rates, share index and commodities affect the

financial derivatives like futures, swaps and other tools of risk management.

Corporates therefore employ well-trained professionals to manage treasury and

forex functions so that they can ensure competent management. Thus, this service

is provided to Corporates through merchant bankers. Merchant bankers assess

various markets to advice Corporates or other banks that needs currency.

Merchant bankers constantly update about the policies of the regulatory bodies,

monitors the current prices, makes predictions based on the analysis of trends etc


~ 39 ~

HIRE PURCHASE SERVICE

It involves a system under which term loans for purchases of goods and services

are advanced to be liquidated in stages through a contractual obligation. The

goods whose purchases are thus financed may be consumer goods or producer

goods or they may be simply services such as air travel. Hire-purchase credit may

be provided by the seller himself or by any financial institution. However, unlike

in other countries, the emphasis in India is on the provision of instalment credit

for productive goods and services rather than for purely consumer goods.


Merchant Banker undertakes the activity of financing for hire-purchase activities.

The merchant banker looks more to the credit-worthiness and business morality of

the buyer than the value of security

LEASE FINANCE COMPANIES

Lease finance companies provide finance to acquire the use of assets for a

stipulated period of time without owning them. The user of the asset is known as

the lessee, and the owner of the asset is known as the Lessor. Leasing is medium-

term arrangement for finance.


Merchant Bankers helps in assessing the credit risk of industrial borrowers. The

merchant bankers provide help in evaluating lease proposals. He analyse the

merits and demerits of lease finance with reference to a given proposal and leave

it to their clients to decide on the appropriate source and type of finance, thus

enlarging their range of choices and the variety of services available to them.

VENTURE CAPITAL

Venture capital is money provided by professionals who invest alongside

management in young, rapidly growing companies that have the potential to

develop into significant economic contributors. Venture capital is an important


~ 40 ~

source of equity for start-up companies. Professionally managed venture capital

firms generally are private partnerships or closely-held corporations funded by

private and public pension funds, endowment funds, foundations, corporations,

wealthy individuals, foreign investors, and the venture capitalists themselves.


Merchant Bankers assist ventures proposals of technocrats, with high technology,

which are new, and high risk. To seek assistance from venture capital funds or

companies.

They also provide technical, financial & managerial services & help the company

to set up a track record.

The assistance should mainly be for equity support, through loan support to

supplement this may be extended.

RECENT TRENDS

Merger & Acquisition transaction -- Merchant banks' services not taxable

The Finance Ministry has excluded services provided by merchant banks and other

agencies in a merger and acquisition (M&A) transaction from the scope of taxable

services provided by a `management consultant.'

The rationale accorded is that the role of such agencies is limited to compliance of

any statute or regulation -- such as takeover regulations of the Securities and

Exchange Board of India (SEBI) -- and not governed by any contractual

relationship with the advisee company.

Merchant banks do not provide any consultancy on an M&A transaction, but merely

verify and submit a report to the authorities concerned, according to the Central Board

for Excise and Customs (CBEC).


~ 41 ~

Barring the services of merchant banks, any service rendered in relation to an M&A

transaction will be covered under the scope of taxable service provided by the

management consultant and will be liable to service tax, the Board has ruled. Industry

representatives held that services provided in respect of M&A cannot be construed as

a management consultancy service, but were in the nature of financial advisory

service.

They further opined that acquisition or divesting of shareholdings was a purely

financial transaction and distinct from the advice or service provided prior to taking a

decision to divest, merge or acquire an organisation.

RAPID RISE IN VALUATION IMPEDES M&As

The surging stock market is creating an unusual problem: Mergers & Acquisitions

(M&A) deals are becoming tougher to close as the two parties to a deal keep looking

over their shoulders to figure out how the market is pricing their shares. The key to

any deal is valuation. And when the market booms, agreed valuations for proposed

M&A are thrown into disarray.

In this scenario, M&A rankings will change depending on who has been able to close

deals faster. In the first nine months of 2005, (ended September), Kotak

Mahindra/Goldman Sachs topped the heap by executing 13 deals valued at $2.53

billion (about 11,000 crore). This bank was ranked No. 4 last year in the process, the

investment bank has increased its share by 420 basis points from 13.1% for last year

to 17.3% now. Morgan Stanley retained its No 2 position, having sewn up 11 deals

worth $2.23 billion so far. Its market share is up 50 basis points to 15.2%. Stock

prices have gone up because of profitability. Indian companies are also looking at

overseas opportunities. M&A are also getting hit because more & more companies

are opting for the global depository receipts/foreign currency convertible bonds issue

to sate their capital needs. The analyst sees pharmaceuticals, information technology

& engineering specifically auto ancillaries as the areas where an increasing amount of

M&As will take place in India.


~ 42 ~

Rapid valuation changes do cause some delays, but in the end, the deals go through if

there are benefits to both parties. Infrastructure related business, airlines and the auto

component sectors as being prime for acquisitions.

INDIA’S TOP 10 M&A PLAYERS

PLAYERS Rank

‘05

Rank

’04

Mkt

share’

05

Mkt

share’

04

Value

($m)

Deals

Kotak/Goldman Sachs 1 4 17.3 13.1 2,534 13

Morgan Stanley 2 2 15.2 14.7 2 ,227 11

Merrill Lynch & Co. 3 3 12.1 14 1,771 12

Standard Chartered 4 9 6.7 4.8 981 5

Ernst & Young 5 1 6.7 16.9 980 37

Citigroup 6 6 6.6 11 962 8

Ambit Corporate Fin 7 8 6.4 4.9 936 21

DBS Group 8 - 4.8 - 704 1

ICICI Securities 9 5 4.4 12.2 649 10

UBS 10- - 3.8 - 550 3

Rankings based on deals in up to 30th September, 2007 .

PLAYERS IN MERCHANT BANKING

1. ENAM

ENAM was founded in1984 to provide knowledge-driven financial services at the

time when Indian economy investors faced a bewildering array of options. ENAM is

the one of the largest underwriters in India. ENAM offers promising & exciting

companies the opportunity of assessing the public market equity finances. ENAM’s


~ 43 ~

long-term association with capital markets & primary markets has provided it with

deep insights of the functioning of Indian financial institutions.

The merchant banking services provided by ENAM are: -

Equity debt/syndication: Raising capital through a private placement of a

company’s securities is an effective & timely offering to a public offering.

ENAM represents the clients in the private placement of debt and equity with

institutional & high net worth investors.

Corporate Restructuring: - ENAM provides client with strategic and practical

solutions to financial challenges. Their restructuring services includes Mergers &

Acquisitions, Takeovers, Debt restructuring, Buyers services etc.

ENAM also provide the seed stage services, value creation services and IPO’s

advisory services which are represented below:

2. ICICI SECURITIES

ICICI Securities Limited is a leader across the spectrum of Merchant Banking. We are

experienced in every aspect of the business from domestic and international capital

markets advisory, to M&A advisory, Private Equity syndication, Restructuring and

infrastructure advisory. Our investment banking team, based across key cities in India


~ 44 ~

and New York, London, and Singapore consists of professionals with expertise across

a range of industries.

ICICI SECURITIES provide following services:

Mergers and Acquisitions: - ICICI Securities Limited is amongst the first Indian

investment Banks to form a dedicated M&A practice and continues to be a leader

by providing innovative and unique solutions to achieve varied objectives of the

client. They offer a full range of advisory services, which include joint ventures,

mergers, acquisitions, and divestitures.

Equity Capital Markets: - ICICI Securities Limited is at the forefront of capital

markets advisory having been involved in most major book building and fixed

price offerings over the last decade. It is amongst the leading underwriters of

Indian equity and equity-linked offerings.

Infrastructure Advisory: - ICICI Securities Limited has a dedicated infrastructure

vertical focused on assisting clients in identifying and capitalising on the

opportunities thrown up by the all pervasive boom in the Indian infrastructure

sector.

Dealing with Bulls and Bears: - ICICI Securities Limited assists global

institutional investors to make the right decisions through insightful research

coverage and a client focused Sales and Dealing team. The equity group

leverages research and distribution reach to domestic and foreign institutional

investors in case of public offerings.

Thus the quality of analysis and client servicing standards, are a testimony to the

quality of ICICI SECURITIES team.

3. KOTAK SECURITIES LIMITED

Kotak Securities Limited, a subsidiary of Kotak Mahindra Bank, is the stock broking

and distribution arm of the Kotak Mahindra Group. The company was set up in 1994.

Kotak Securities is a corporate member of both The Bombay Stock Exchange and The

National Stock Exchange of India Limited. Its operations include stock broking and

distribution of various financial products - including private and secondary placement


~ 45 ~

of debt and equity and mutual funds. Currently, Kotak Securities is one of the largest

broking houses in India with wide geographical reach.

The company has four main areas of business:

Kotak Institutional Equities: - Kotak Institutional Equities, among the top

institutional brokers in India. It mainly covers secondary market broking and the

marketing of equity offerings, including IPOs, to domestic and foreign

institutional investors.

Structured Finance (Project Finance & Advisory Business): -KMCC has

developed expertise in various vertical segments in the infrastructure sector

including power, oil, gas, ports, automobiles, steel & metals and hotels, by

offering structured finance solutions. Some of the transactions executed by this

team include:

Advisor to Ford on financial closure for its Car project in India.

Advisor to one of the largest LNG projects on the Western coast of India.

Financial advisors and loan syndications to British Gas and GAIL.

Mergers & Acquisitions: -In the area of Mergers & Acquisitions, we provide

our clients expertise and a comprehensive set of services that help them achieve

their strategic and financial objectives. Our spectrum of services include:

Divestments

Spin-Offs / Restructuring & Joint Ventures / Strategic Alliances

4. CITIGROUP

Citigroup Corporate and Investment Banking achieve the extraordinary for our clients

around the world. No financial institution is more committed to advancing the goals

of its clients—our diverse and talented staff in more than 100 countries advises

companies, governments and institutions on the best ways to realize their strategic

objectives. We create solutions for and provide the broadest possible capital and


~ 46 ~

market access to thousands of issuer and investor clients. And no institution better

executes the increasingly complex payment and cash management solutions required

in today's global economy. The features Citigroup are as follows: -

Over the years, Citigroup has established a track record of outstanding business

milestones such as Cash Management, pioneered by Citigroup in 1986 and

utilized by over 900 Corporates with through-puts totaling around $ 35 billion

(8% of India's GDP).

It is India's largest foreign bank in the FX (foreign exchange) market with a 14 per

cent market share.

MERCHANT BANKING-FUTURE DEVELOPMENT

Time and again the Merchant banking Industry in India witnessed, experienced and

underwent significant changes. The very purpose for which these firms are

commences their services should be taken care of and they should mould their policy

decision and activities to move in tune with the main objectives of Investor’s

protection and to create healthy environment in capital markets. No doubt, Merchant

Banking firms are subject to a host of control measures, regulations and rules framed

and guided by SEBI. To some extent, frequent changes and /or amendments to

policies and control measures, though needed for smooth working of the securities

Industry, proves to be detrimental to the very existence of the Merchant Banking

system in the country. The SEBI’s Act 1992 confers power upon SEBI to supervise

and control the affairs of the Merchant Banking firms in India.

The various studies which had been undertaken in India for evaluating the

performance of Merchant Banking firms and the implications of these on securities

industry. No single study has been emerged so far pertaining to the evaluation of

Merchant Banking firms and in-depth study on their activities as well as operational

and financial performance in the light of changing regulatory environment.

In recent past, the small investor has turned his back on the primary capital market.

Issue after issue as failed to capture his imagination, rekindle his enthusiasm, and

reinforce his faith. He has lost all hopes of appreciation of his investment. And this


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when all these years millions have though capital market, ate capital market and

dreamt capital market. It needed an extraordinary effort and skill the drive the small

investor away! High premiums, false premiums and gray market operations. The

professed protector of his interests first laid down the dictum of proportionate

allotment, then of minimum subscription, all working against his interests. This

would make an observant student of the stock market infer that there is some game

plan afoot to dethrone the small investor from his prominent; he was believed to be

the king.

With the coming to SEBI, an organisation that was ostensibly brought into existence

to guard the interest of the small investor, hopes ran high that the small investor

would now have a safe playing field. But these hopes were soon belied. Far from

guarding the interests of the investing public, SEBI embarked on a course of action,

which has positively hurt them. The latest fiat of EBI bans corporate advertising after

the receipt of acknowledgement card by a company wanting to go public. SEBI’s this

action has caused the closure of an information window. Now 50 million potential

investors are deprived of official and authentic information given by the Issuer. It is

hard to understand reasons for this drastic and totally uncalled for action. While there

has been no official explanation for this fiat, there is reason to believe that it may be

based on a wrong perception of the role for corporate advertising.

All this has been done perhaps because the corporate and intermediaries is to follow

the practices of Western capital markets here, oblivious of the fact that our capital

markets are altogether different in structure, in systems and in the number of

participants Freedom of commercial expression could be exploited by some to serve

their own ends, just a s freedom of speech and expression could be abused but this has

not led our Government to put arbitrary restrictions on our freedom.


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Merchant Bankers have reason to believe they will be handicapped without the

marketing support. But the worst sufferer would be the investor, especially the small

investor it is this class, which forms the backbone of the capital market. As a result of

the ban, the small investor would be deprived of the opportunity to study the

corporate profile of the Issuer. In the absence of adequate information, they will have

to depend on manipulated facts and information fed by unreliable sources.

Besides, there are larger issuers arising out of SEBI’s action. From the point of view

of liberalization of the economy, SEBI has taken a retrograde step. A market

economy flourished through bigger markets, higher sales and lesser profits. To

achieve this performance, a company needs an aggressive marketing plan and

advertising effort is the main thrust to such a plan. No marketing plan can be

worthwhile unless it is backed by an effective advertising plan. The ban imposed by

SEBI nips the marketing plan in the bud.

The Indian primary capital market is basically a retail market. It consists of

innumerable investors who take own individual investment decisions. Whatever, the

system, it is this market that will bring in the funds. If these markets destabilized, the

investors will look for alternative avenues to invest their funds. SEBI in its one of the

first documents on “SEBI and Investor Protection, Development and Regulation of

Securities Market” clearly specifies significance of regulating capital market and its

future plans for fulfilling the twin objectives viz., Development of capital market and

investor protection are explained in introductory paragraphs. It speak out that, “The

decade of the 1980 witnessed a phenomenal growth and development of the securities

market, demonstrated its potential not only to mobilize the savings of the horses hold

sector but also to allocate it with some degree of efficiency for industrial

development. The dilution of the holdings of the multinational companies at

affordable prices in the latter part of the 1970s had generated considerable interest,

which was, carries well into the next decade. Several companies’ came in the early

part of the 1980s and successfully raised large resources from the market especially

through debt instruments, which further sustained investor interest. By the end of the

decade, the securities market in India came to be firmly integrated with the financial

system of the country. With the corporate sector increasingly relying on the securities


~ 49 ~

market for meeting their long-term requirement of funds, the securities market their

long-term requirement of funds; the securities market competed on equal terms with

the Development Financial Institutions, which were the traditional purveyors of long-

term capital. The emergence of the securities markets into the main stream of the

financial system of the country was thus one of the major economic processes of the

1980s – an inevitable outcome of the maturing process of the financial system. They

brought about notable changes in the capital structure of the companies across

industries, gave birth to new intermediaries and institutions in the securities market

and created a new awareness and interest in investment opportunities in the securities

market among investor. In spite market, its quality lagged far behind and there was

absence of adequate professionalism and fair competition among the various players

in the market. Besides, the regulatory framework then prevailing was fragmented

difficult, if not effective.


~ 50 ~

Data Analysis & Interpretation

Q 1 Do you take any financial services from bank?

Sr. No.

Take Financial

Service Nos. Percentage

1 Yes 36 45

2 No 44 55

Total 80

GRAPH

Interpretation

Out of total respondents, 45% respondents have taken Financial Service and rest 55%

respondents have not taken the Financial Service.


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Q 2 Do you Know about Merchant Banking?

Sr. No.

Know about

Merchant Nos. Percentage

1 Yes 32 40

2 No 48 60

Total 80

Interpretation

Out of total respondents, 40% respondents Know about merchant banking and rest

60% respondents don’t know about merchant banking.


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Q 3 Are you satisfied with the services provided by your bank?

Sr. No. Satisfied Nos. Percentage

1 Yes 35 43.75

2 No 45 56.25

Total 80 100

Interpretation

Out of total respondents, 43.75% respondents Satisfied and rest 60% respondents

don’t Satisfied.


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Q4 Are you satisfied with services offered by banks?

Sr. no Bank Percentage

1 ICICI 20

2 SBI 35

3 PNB 20

4 BOI 15

5 Other 10

Interpretation

Large no. of companies takes financial services from SBI.


~ 54 ~

Q 5 What is the position of Merchant Banking in Private Sector?

sr.no Position Percentage

1 Good 50

2 Normal 35

3 Bad 15

Total 100

Interpretation

Out of total respondents, 50% respondents Say Good, 35% Say Normal and rest 15%

respondents say bad.


~ 55 ~

Q 6 What is the position of Merchant Banking in Public Sector?

sr.no Position Percentage

1 Good 40

2 Normal 55

3 Bad 5

Total 100

Interpretation

Out of total respondents, 40% respondents Say Good, 55% Say Normal and rest 5%

respondents say bad.


~ 56 ~

Q7 What type of security have you deposited/you will deposit with the banks ?

Sr.No. Type of Security Nos. Percentage

1. Bank Security (F.D.) 18 22.5

2. Gold 0 0

3. Land Papers 50 62.5

4. Third person security 12 15

Total: 80 100

Interpretation:

Out of total respondence Bank security are 22.5% , Gold are 0%, Land papers are

62.5%, Third Person security are 15%.


~ 57 ~

Q 8 Are you satisfied by Security margin of bank?

Sr.No. Satisfaction by Security

Margin

Nos. Percentage

1. Yes 64 80

2. No 16 20

Total: 80 100

Interpretation

Out of total respondents, 80% respondents Satisfied and rest 20% respondents don’t

Satisfied.


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Q 9 Are you satisfied with timely services provide by banks?

Sr. No. Depends on M.B Nos. Percentage

1 Yes 56 70

2 No 24 30

Total 80 100

Interpretation

Out of total respondents, 75% respondents Say that They are timely heared and rest

25% say that They are not timely served by merchant banking.


~ 59 ~

Q10 Will it differ from investment banks?

Sr. No. Difference Nos. Percentage

1 Yes 60 75

2 No 20 25

Total 80 100

Interpretation

Out of total respondents,75% respondents Think that It is differ and rest 25%

respondents don’t Think so.


~ 60 ~

Findings

Companies making large size issues of equity shares relied more on foreign

merchant bankers than on Indian merchant bankers because of their vast

international network.

Year wise participation of merchant bankers in the management of public

issues of equity showed that the majority of small merchant bankers were

involved in one or two issues only during the year.

SBI Capital Markets Ltd. was the preferred choice of maximum issuers (43 in

numbers). This was followed by Enam Securities Ltd with 35 equity issues.

224 Karvy Investor Services Ltd. managed 34 equity issues. ICICI Securities

Ltd, UTI Securities Ltd and Kotak Mahindra Capital Co. Ltd managed 32, 33

and 30 public issues respectively.

SBI Capital Markets Ltd was the preferred choice of public and private banks

for the management of their public issues of equity. Out of 40 public issues of

equity floated by public sector banks in India during the period under review,

SBI Capital Markets Ltd was the lead manager/BRLM/co- lead manager in as

many as 31 equity issues.

In most of the cases, the issuer 225 companies appointed their own subsidiary

company/sister concern to advise on their equity issue.

With the exception of SBI Capital Markets Ltd and Canara Bank, no other

public sector bank performed a significant role in the public issue

management activities.. Other public sector banks’ subsidiaries/merchant

banking divisions who showed their presence in public issue management

were BOB Capital Markets Ltd, All bank Finance Ltd, BOI Finance Ltd, PNB

Capital Markets Ltd. etc.


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Conclusion

Longstanding client relationships

Strong positions in high-growth client and product niches.

Multiple revenue growth initiatives are in place with detailed and concrete

action plans, and with rigorous follow-up mechanisms.

Growth is controlled by a sound Risk Management System and disciplined

cost management.

Small & Medium scale enterprises SMEs need immediate attention from

merchant bankers to get access to finance.

SMEs are facing stiff competition from large scale companies.


~ 62 ~

BIBLIOGRAPHY

BOOKS REFFERED

Merchant Banker – H.R. SUNEJA

Merchant Banking Principles & Practices- H.R.MACHIRAJU

Merchant Banking in India-

B.C. LAKSHMANNA & C.N. KRISHNA NAIK

Merchant Banking – J.C.VERMA (3rd & 4th Edition)

WEBILOGRAPHY

www.google.co.in

www.yahoo.com

www.economictimes.com

www.jmmorgansranley.com

www.dspml.com

www.sebi.com

http://www.google.co.in/

http://www.yahoo.com/

http://www.economictimes.com/

http://www.jmmorgansranley.com/

http://www.dspml.com/

http://www.sebi.com/


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ANNEXURE

Respondent’s Profile

Name :_______________

Age :_______________

Gender :_______________

Occupation :_______________

1. Do you take any financial services from bank?

(a) Yes ( ) (b) NO ( )

2. Do you know about Merchant Banking?

(a) Yes ( ) (b) No ( )

3. Are you satisfied with the services provided by your bank?

(a) Yes ( ) (b) No ( )

4. Which bank provide you maximum services?

(a) ICICI ( ) (b) SBI ( )

(c) PNB ( ) (d) BOI ( )

(e) OTHER(specify)


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5. What is the position of Merchant Banking in Private Sector?

(a) Good ( ) (b) Normal ( )

(c) Bad ( )

6. What is the position of Merchant Banking in Public Sector?

(a) Good ( ) (b) Normal ( )

(c) Bad ( )

7. What type of security have you deposited/you will deposit with the

banks

(a)Bank security ( ) (b) Gold ( )

(c) Land paper ( ) (d) Third party security ( )

8. Are you satisfied by Security margin of bank?

(a) Yes ( ) (b) No ( )

9. Non-financial institution depends on merchant banking. Are you

satisfied?

(a) Yes ( ) (b) No ( )

10. Will it differ from investment banks?

(a) Yes ( ) (b) No ( )

merchant bank project

Documents

merchant banking activities

merchant banking units

functions of merchant

term merchant banking

history of merchant

investment banking

commercial banking activities

true merchant banks