MERCHANT BANKING

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Merchant Banking - Definition

• According to Dictionary of Banking & Finance• “A bank which arranges loans to companies, deals in

international finance, buys & sells shares, launches new companies on the stock exchanges but does not provide normal banking services to the general public”.

• Service oriented activity.• Arranging finance and Trading in shares.• Helps to launch new stock issuances.

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Merchant Banking - Definition

• “Merchant Banking is the activity of making direct investments of the investment bank’s own funds in some asset not directly related to the investment bank’s traditional business”.

• Merchant Banking is an integral part of Investment Banking.

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Merchant Banking - Definition• According to Bloomberg

“Merchant banking is a term for a bank that specializes not in lending out of its own funds but in providing various financial services like accepting bills arising out of trade, underwriting new issues and providing advice on acquisitions, mergers, foreign exchange and portfolio management”.

General Definitions of MB

• An institution which covers a wide range of activities such as underwriting of shares, portfolio management, project counseling, insurance etc…They render all these services for a fee.

• A MB is a financial institution primarily engaged in offering financial services and advice to corporations and to wealthy individuals.

• An activity that includes corporate finance activities, such as advice on complex financings, merger and acquisition advice (international or domestic), and at times direct equity investments in corporations by the banks.

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Merchant Banking - SEBI Definition

• As per SEBI (Merchant Bankers) Rules 1992 :• “A merchant banker is any person who is engaged in the

business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as management consultant , adviser or rendering corporate advisory service in relation to issue management”.

• Assisting issuers to raise capital.• Promote quality issues• Maintain integrity and ensure compliance• Merchant banker called as “Lead Manager” in India.

THE HISTORICAL MERCHANT BANK

• Merchant Banking evolved in Europe in the 18th century pertained to an individual or a banking house whose primary function was to facilitate the business process between a product and the financial requirements for its development.

• The merchant banker acted as a capital sources whose primary activity was directed towards a commodity trader/cargo owner who was involved in the buying, selling, and shipping of goods.

• The role of the merchant banker, who had the expertise to understand a particular transaction, was to arrange the necessary capital and ensure that the transaction would ultimately produce "collectable" profits. Often, the merchant banker also became involved in the actual negotiations between a buyer and seller in a transaction.

The Historical Merchant Bank

• The origin of MB in traditional form was originated in Italy & France in 18th century for trading in commodities.

• The system was introduced in UK in late 18th /early 19th century.

• The oldest MB in London was Bearings Bank.• In US in early 20th century, MB activity spread.• It was in US new dimensions & various other activities for MB

was chartered, which led to present day investment & merchant banking.

THE MODERN MERCHANT BANK

• During the 20th century, the European merchant banks expanded their services. They became increasingly involved in the actual running of the business for whom the transaction was conducted.

• Since the 18th century, the term merchant banker has been considerably broadened to include a composite of modern day skills. These skills include those inherent in an entrepreneur, a management advisor, a commercial and/or investment banker plus that of a transaction broker.

• Today a merchant banker has the ability to merchandise that is, create or expand a need and fulfill capital requirements.

Merchant banking- Genesis- India

• It was originated in 1969 with the setting up of the Merchant Banking Division by Grindlays Bank.

• Grindlays started with management of capital issues.• Slowly, they recognized the need for diverse financial needs

of the market & started providing other consultancy services to corporates.

• Following Grindlays, Citibank set up its Merchant Banking division in 1970.

• Apart from MB functioning, it provided management consultancy services also.

Merchant Banking – Genesis- India

• Banking Commission report of 1972 advised setting up of Merchant banking in India by Indian banks for providing multiple finance related services.

• SBI started MB Division in 1972.• ICICI started MB in 1973.• After SBI, other PSU banks started MB from 1977 & onwards• IFCI started MB in 1986 & IDBI in 1991.

• No of SEBI Regd MBs in India are 146

SEBI Regulation on MB

Objectives of MB Authorization by SEBI:• Regulate raising of funds in primary market.• Enable Issuer company to raise resources at low cost.• Ensure high degree of protection to the interest of investors.• Provide high standard of professional competence, honesty,

integrity & solvency.• Promote a primary market which is fair, efficient, flexible &

inspires confidence in the investing public both in India and outside.

SEBI Regulation for MB- Eligibility Norms

SEBI factors the following for permitting MB activities by the Corporate entities:• Professional qualification in Finance, Law & Business Mgmt• Adequate Infrastructure• Experienced & Qualified people• Past track record• Experience• Reputation• Fairness in the dealings.

SEBI regulation for MB- Eligibility Norms

• Only a corporate entity is permitted to be MB.• Minimum NW Rs 5 crore.• Authorization is valid for 3 years & renewed later on.• MBs to adhere to code of conduct prescribed by SEBI.• MBs are governed by MB Rules issued by Ministry of Finance, MB

regulations issued by SEBI, apart from adhering to companies act 1956.

• MBs are to be compulsorily regd with SEBI.• The company is not involved in any litigation relating to securities

market.• Not found guilty of any economic offences.• Renewal is subject to satisfactory functioning of MBs

Charges payable to SEBI by MBs for every issue

Issue Size (IPO/FPO) Fee payable to SEBI Upto Rs 1 crore Flat Rs 10000/ > Rs 1 crore upto Rs 5000 crore 0.1% of the issue > Rs 5000 crore upto Rs 25000 crore Rs 5 crore + 0.025% of the issue >Rs 25000cr > Rs 25000 crore Flat Rs 10 crore Rights Issue: Upto Rs 2 crore Flat Rs 10000/ > Rs2 cr upto Rs 5000 cr 0.5% of the issue > Rs 25000 cr Flat Rs 25 lacs.

Activities of MBs.

Merchant banking activity helps:• In channelizing the financial surplus of the general public into

productive investment avenues.• To coordinate the activities of various intermediaries to the share

issue such as the registrar, bankers, advertising agency, printers, underwriters, brokers etc.

• To ensure compliance with rules and regulations governing the securities market

• Merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase these securities.

• Merchant Banking is an important service provided by a number of financial institutions that helps in the growth of the corporate sector which ultimately reflects into the overall economic development of the country.

Major Functions of MBs

• Issue Management Services – to act as Book Running Lead Manager/Lead Manager for the IPOs/FPOs/Right issues/Bonus Issues/ Private placements.

• Debt Issue Management• Project Appraisals• Monitoring Agency Assignments• Security Trustee Services• Agriculture Consultancy Services• Corporate Advisory Services• Mergers and Acquisitions• Buy Back Assignments• Share Valuations• Syndication• Securitisation

ISSUE MANAGEMENT SERVICES :

• Project Appraisal• Capital structuring• Preparation of offer document• Tie Ups (placement)• Formalities with SEBI / Stock Exchange / ROC, etc.• Underwriting• Promotion /Marketing of Issues through a strong network of

QIBs/HNIEs/Corporates and Retail investor.• Collecting Banker / Banker to an issue• Post Issue Management• Refund Bankers• Debenture Trusteeship• Registrar & Transfer Agency

Role of MB in Primary Issue Mgmt

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MB is the intermediary appointed by companies in the primary market issue. It has to look at the entire issue management and work as the Manager to the Public Issue.

Principal steps in a Public issue are as follows :

- Vetting of Prospectus - Appointment of underwriters - Appointment of bankers - Appointment of Registrars - Appointment of Brokers and Principal Brokers - Filing of the Prospectus with the Registrar of Companies - Pricing of the issue.

Role of MB in Primary Issue Mgmt

- Printing & Dispatch of prospectus. - Filing of initial listing agreement with the exchanges within 10

days of filing the prospectus. - Promotion of the issue. - Statutory Announcement of the issue. - Collection of application. - Processing the application. - Establishing the liability underwriters. - Allotment of shares. - Listing of the issue.

• Portfolio Management:

Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds issued by different companies and government securities. Portfolio management refers to maintaining proper combinations of securities in a manner that they give maximum return with minimum risk.

• Advisory Service Relating to Mergers and Takeovers:

A merger is a combination of two companies into a single company where one survives and other loses its corporate existence. A takeover is the purchase by one company acquiring controlling interest in the share capital of another existing company. Merchant bankers are the middlemen in setting negotiation between the two companies.

• Off Shore Finance:

The merchant bankers help their clients in the following areas involving foreign currency.(a) Long term foreign currency loans(b) Joint Ventures abroad(c) Financing exports and imports(d) Foreign collaboration arrangements

• Non-resident Investment:

The services of merchant banker includes investment advisory services to NRI in terms of identification of investment opportunities, selection of securities, investment management, and operational services like purchase and sale of securities.

Functions of MB

• Loan Syndication:

Loan syndication refers to assistance rendered by merchant bankers to get mainly term loans for projects. Such loans may be obtained from a single development finance institution or a syndicate or consortium. Merchant bankers help corporate clients to raise syndicated loans from banks or financial institutions.

• Corporate Counseling:

Corporate counseling covers the entire field of merchant banking activities viz. project counseling, capital restructuring, public issue management, loan syndication, working capital, fixed deposit, lease financing acceptance credit, etc.

Functions of MB – Security Trustee Services

• Drafting/Vetting necessary security documentation .• Creation of security and registration of charges and necessary

filings with the appropriate regulatory authorities .• Safekeeping of all the original title documents of

properties / assets in accordance with the financial structure .

• Providing clearances on behalf of the Lenders for the future borrowings .

• Acting on the instructions of the Lenders .• Enforcing security in the event of default

Functions of MB- Monitoring Agency Assignments

• Act as ‘Monitoring Agency’ to undertake the assignments of monitoring of project implementation by companies raising equity through public issues, where the issue size exceeds Rs.500 crores.

• Appointment of a monitoring Agency is mandatory in terms of SEBI guidelines wherever the public issue is Rs.500 crores or more. Also, the regulators (SEBI / SEs) may insist for engaging the service of a monitoring agency even in other cases.

• The assignment requires the agency to monitor the investments of the IPO funds in the various projects for which the funds are raised by the issuer company from the public. An implementation progress report has to be submitted to SEBI on half yearly basis till full utilisation of the funds raised.

Functions of MB

• Conduct Share valuation based on different scientific methods and provide information to the users for a price.

• Help the companies to evolve policy relating to buy back arrangement of shares/ debentures, or debt instruments through Call option.

Code of Conduct for MBs

• Make all efforts to protect the interest of the investors.• Maintain high standards of integrity, dignity & fairness in conduct

of business.• Fulfill the obligation in prompt, ethical& professional manner.• At all times exercise due diligence.• Ensure proper care & exercise independent professional judgment.• Ensure adequate & timely disclosures.• Ensure providing true & fair information to the investors & all other

concerned.• Not to discriminate the investors.• Not to misrepresent to anybody.

Code of Conduct for MBs

• Avoid conflict of interest.• Render best possible advise to clients always.• Maintain secrecy of clients where it is essential.• Not to indulge in unfair competition.• Maintain arms length between MB activity & other activities.• Maintain appropriate knowledge & competence.• Always abide by the regulatory norms.• Provide adequate freedom to the compliance officer.• Develop internal codes of conduct for internal operations.• Put in place good corporate & corporate governance policy.

Code of Conduct for MBs

• Merchant banker for Issue Market NOT to associate with any business other than that of securities market (exception being a bank/PFI).

• Maintenance of proper books & records for a minimum period of 5 years.

• Furnish financial papers to SEBI every year.• Furnish un audited financial papers half yearly.• One of the MB shall work as a Lead Manager to the issue: - Issue size Maximum No of MBs < Rs 50 cr 2 Rs 50 cr & < Rs 100 cr 3 Rs 100 cr& <Rs 200 cr 4 Rs 200 cr & <Rs 400 cr 5 Rs 400 cr& above 5 or more as decided by SEBI

Code of Conduct for MBs

• No MB or any of its directors or directors or principal officer shall either on their own or through their associates or relatives enter into any security transactions with the company based on unpublished sensitive information.

• Allow inspection of its books by SEBI.

MB- LOAN SYNDICATION

• What is Loan Syndication?

Syndication is an arrangement where a group of banks participate for a single loan.

A syndicated facility is a lending facility, defined by a single loan arrangement, in which several or many banks /Fis participate.

Syndicated loans are loans made by two or more lenders and administered by a common agent using similar terms and conditions and common documentation

Advantages of Loan Syndication

• Uniform approach.• Qualitative appraisal.• Risk Dispersement.• Common lending norms.• Uniform rate of interest.• Common loan documents.• Common monitoring.• Enhances lending opportunities.• Common approach for recovery.• Generally considered safe lending option.• Provides opportunity for increasing the Fee based income.

Loan Syndication- Process by MB

• Scout for opportunities for arranging high value funding.• Discuss with the project promoters about the entire project &

the kind/structure of credit needs.• Obtain Mandate from the company to syndicate the loan.• Study the Detailed Project Report(DPR) prepared by the

technical consultants.• Based on DPR, draw Project Information Memorandum(PIM).• PIM to contain complete information about the project with

detailed SWOT analysis of the project, sources of funds, its application, loan structuring, financials, rate of interest, security, repayment, etc.

Loan syndication- Process

• Circulate the PIM among banks &FIs• After a few days, convene a meeting of the promoters with

the banks/FIs to get complete information about the project.• Arrange for a site visit to familiarize the banks/FIs about the

project.• Banks/FIs to approach their higher authorities for obtaining

necessary sanction.• Upon receipt of sanction from all the banks/FIs, allocate limits

to all the lenders on pro rata basis.• Achieve Financial closure.

Loan syndication- Process

• Appoint Lending Legal council to draft the loan documents.• Get the loan documents executed by all the banks/Fis.• Appoint Security trustee for safe keeping of the documents as also

ensuring creation of charge, etc.• Appoint lead manager for the loan.• Arrange for disbursement of loan by all banks/Fis in agreed

proportion.• Create security in favour of lenders.• Appoint Lenders’ Engineer for conducting periodical inspection of

the project site & submit progress report of the project.• Convene periodical meeting of the lenders including unit visits.

Loan syndication- Process

• Monitor project implementation to achieve the Commercial Operation Date(COD).

• Appoint Escrow Agent and open Escrow a/c with the bank.• Monitor inflow of funds to escrow a/c.• Ensure repayment among the lenders in the prescribed

manner.

INVESTMENT BANKING

• What does Investment bank mean?

• A financial intermediary that performs a variety of financial services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.

• The role of the investment bank begins with pre-underwriting counseling and continues after the distribution of securities in the form of advice.

• Investment banking is a field of banking that aids companies in acquiring funds.

• In addition to the acquisition of new funds, investment banking also offers advice for a wide range of transactions a company might engage in.

Investment Banking

• An investment banking firm also does a large amount of consulting. • Investment bankers give companies advice on mergers and

acquisitions.• They also track the market in order to give advice on when to make

public offerings and how best to manage the business' public assets.

• Some of the consultative activities investment banking firms engage in overlap with those of a private brokerage, as they will often give buy-and-sell advice to the companies they represent.

• The line between investment banking and other forms of banking has blurred in recent years, as deregulation allows banking institutions to take on more and more such functions in the name of Universal banking.

• The IB defn is more driven by American concept evolved during the last one century.

INVESTMENT BANKING

• Functions of Investment Banking: Investment banks have multilateral functions to perform:

• IB help public and private corporations in issuing securities in the primary market, guarantee by standby underwriting or best efforts selling and foreign exchange management .

• Other services include acting as intermediaries in trading for clients. • It provides financial advice to investors and serves them by assisting in

purchasing securities, managing financial assets and trading securities. • Investment banking differ from commercial banking in the sense that they

don't accept deposits and grant retail loans. However the dividing line between the two fraternal twins have become flimsy with loans and securities becoming almost substitutable ways of raising funds.

Evolution of Investment Banking

• The origin of Investment banking functions commenced from the end of 1st world war, i.e. from 1920 onwards.

• The commercial banks in US started doing MB kind of an activity like acquisition of the company and dealing in securities, etc in anticipation of a boom in the capital market.

• The 1st acquisition of a company took place in 1920 when National City Bank of New York acquired Hasley Stuart & company.

• This marked the beginning of shifting the focus from commercial banking to investment banking.

• Boom of 1920 & thereafter, these investment banks made huge profits by selling Yankee Bonds in US market.

Evolution of Investment Banking

• On account of the prolonged capital market boom, the commercial banking activity was relegated to a subsidiary kind of function & investment activity became predominant.

• In fact, many investment banks borrowed money from their parent banks to pursue IB functions.

• The stock market was over heated, which eventually burst in 1929, causing huge losses to the investors/banks/IBs, which led to bankruptcy of Bank of United States.

• In order to restore confidence in the banking & financial system, Banking Legislation Act of 1933 was passed, which is popularly known as Glass- Steagall Act.

Evolution of Investment Banking

• The act restricted the commercial banks in undertaking stock market activities & made this as the domain of exclusive investment banks.

• Simultaneously, investment banks were restricted to perform the functions of commercial banks like acceptance of deposits from public, etc.

• This paved the way for setting up of exclusive investment banks in US.

Evolution of Investment Banking

• Since 1930s until the beginning of 21st century, Investment banking had seen several phase of transformation which had disturbed the exclusivity functions between commercial banking & investment banking.

• Due to 1973 Arab oil embargo, world economies were under pressure & inflation & interest rate became highly volatile.

• At this time the Institutional Investors made their advent into securities market. It was also the time when industrial & financial services sectors were beginning to expand & globalise.

• Due to these developments, the Investment & commercial banking once again became constrained, which necessitated for relaxations of various norms to the Act.

Evolution of Investment Banking

• Commencing from 1980s, the investment banking functions expanded to various new areas encompassing host of other functions.

• Since 80s till recently(2008), US economy witnessed unprecedented growth(barring few upheavals like Iraq war, etc), resulting in huge liquidity & surplus funds for investments in the hands of the public/organisations.

• This paved the way for setting up of new Investment banks as also launching of various exotic financial instruments in the shape of Derivatives,etc.

• The derivatives created huge financial leverages resulting in further liquidity in the system.

Investment Banking

• US is a huge financial market where the functions of commercial banks are distinct from that of IB.

• Commercial banks perform the functions of providing basic banking, where as IBs act as window for Investing public to park their surplus funds in anticipation of good return.

• Functions of IB is more akin to the functions of MB.• IB specializes in financial fields not only in US but also

constantly studies the economies world wide to look for investment opportunities to maximize the return to the investors as also to themselves.

• In Indian context, these IBs can be termed as FIIs.

Difference Between MB & IB

The word merchant bank does not have a fixed definition as this term is used differently in different countries.

In United States these are called as “Investment Banks” and in UK they are called as “accepting and issuing houses”.

The notification of Ministry Of Finance in India defines 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, consultant, adviser in relation to such an issue management”.

In general the merchant banks are the financial institution which provides financial services, solutions, & advice to corporate houses. Some of the world famous merchant banks are Goldman Sachs, Credit Suisse & Morgan Stanley etc.

In India there are many banks which are into the field of merchant banking some of the banks are ICICI, State Bank Of India, Punjab National Bank etc.

DIFFRENCE BETWEEN IB & MB

• MB &IB in their purest forms, are different kinds of financial institutions that perform different services, though the functions tend to blur.

• Pure investment banks raise funds through different modes and deploy the same for profitable ventures/investments.

• The IB also perform international financing activities such as foreign corporate investing, foreign real estate investment, trade finance and international transaction facilitation.

• Some of the activities may include issuing letters of credit, transferring funds internationally, trade consulting and co-investment in projects involving trade in one or the other form.

• An Investment Banker is total solution provider to a corporate, desirous of mobilizing capital.

• The services range from investment research to investor service on the one side and from preparation of offer documents to legal compliances and post issue monitoring on the other. There exists a long lasting relationship between the Issuer Company and the Investment Banker.( similar to MB)

• A "Merchant Banker" could be defined as "An organisation that acts as an intermediary between the issuers and the ultimate purchasers of securities in the primary security market"

Differences between IB & MB

• MB provide fee based service for management of public offer.• MB activity is a Non fund based activity earning income through

fee only.• Investment banking has wider connotation inclusive of both

Fund based & non fund based activities.• Fund based includes direct investment in equities or activities

to maximise the profits.• NFB includes advisory roles also. Thus, IB also includes MB

activities.• Another distinction between an IB and a MB is that an IB

invests its own capital in a client company whereas a MB purely distributes the securities of that company.

Difference between IB & MB

• Investment banks in the US are modern merchant banks offering a wide range of activities, including portfolio management, credit syndication, acceptance of credit, counsel on M&A, insurance, etc.

• U.S. variant of Merchant Banks i.e. IB initiates loans and then sells them to investors through Derivative products.

• An IB is pure profit oriented more skewed towards Speculation, whereas, a MB is only an intermediary providing certain services for a fee.