Private equity activities of banking

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MERCHANT BANKING

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

First Merchant Bank Limited (popularly known as FMB) was incorporated on 13 November 1994 and opened to the public on 26 June 1995. FMB is a registered commercial bank listed on the Malawi Stock Exchange. FMB currently conducts its banking business through a countrywide network of 19 branches.

Merchant Banking in India

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Merchant banking activity was formally initiated into the Indian capital Markets when Grindlays bank received the license from reserve bank in 1967. Grindlays started with management of capital issues, recognized the needs of emerging class of Entrepreneursfor diverse financial services ranging from production planning and system design tomarket research. Even it provides management consulting services to meet the requirements of small and medium sector rather than large sector. Citibank Setup its merchant banking division in 1970. The various tasks performed by this divisions namely assisting new entrepreneur, evaluating new projects, raising funds through borrowing and issuing equity. Indian banks Started banking Services as a part of multiple services they offer to their clients from 1972. State bank of India started the 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. Merchant banking activities is of course organized and undertaken in several forms. Commercial banks and foreign development finance institutions have organized them through formation divisions, nationalized banks have formed subsidiaries companies and share brokers and consultancies constituted themselves into public limited companies or registered themselves as private limited Companies. Some merchant banking outfits have entered into collaboration with merchant bankers abroad with several branches.

Registration of Merchant bankers with SEBI

It is mandatory for a merchant banker to register with the SEBI. Without holding a certificate of registration granted by the Securities and Exchange Board of India, no person can act as a merchant banker in India.

  1. Only a body corporate other than a non-banking financial company shall be eligible to get registration as merchant banker.
  2. The applicant should not carry on any business other than those connected with the Securities market.
  3. All applicants for Merchant Bankers should have qualification in Finance, law or Business Management.
  4. The applicant should have infrastructure like office space, equipment, manpower etc.
  5. The applicant must have at least two employees with prior experience in merchant banking.
  6. Any associate company, group company, subsidiary or interconnected company of the applicant should not have been a registered merchant banker
  7. The applicant should not have been involved in any securities scam or proved guilt for any offence
  8. The applicant should have a minimum net worth of Rs.5 Crores.

Merchant Bankers in India:

There are 135 Merchant bankers who are registered with SEBI now in India. There are public sector, Private sector and foreign players registered with SEBI. The below are the examples of few of the Merchant bankers in each of the Public, private and foreign players.

Public sector Merchant Bankers:

  • SBI CAPITAL MARKETS LTD
  • PUNJAB NATIONAL BANK
  • BANK OF MAHARASHTRA
  • IFCI FINANCIAL SERVICES LTD
  • KARUR VYSYA BANK LTD,
  • STATE BANK OF BIKANER AND JAIPUR

Private Sector Merchant Bankers:

  • ICICI SECURITIES LTD
  • AXIS BANK LTD.(FORMERLY UTI BANK LTD.)
  • BAJAJ CAPITAL LTD
  • TATA CAPITAL MARKETS LTD
  • ICICI BANK LTD
  • RELIANCE SECURITIES LIMITED
  • KOTAK MAHINDRA CAPITAL COMPANY LTD
  • YES BANK LTD.

Foreign Players in Merchant Banking:

  • GOLDMAN SACHS (INDIA) SECURITIES PVT. LTD.
  • MORGAN STANLEY INDIA COMPANY PVT LTD
  • BARCLAYS SECURITIES (INDIA) PVT. LTD
  • BANK OF AMERICA, N.A
  • DEUTSCHE BANK
  • DEUTSCHE EQUITIES INDIA PRIVATE LIMITED
  • BARCLAYS BANK PLC
  • CITIGROUP GLOBAL MARKETS INDIA PVT. LTD.
  • DSP MERRILL LYNCH LTD
  • FEDEX SECURITIES LTD

Major difference between Merchant banking and Investment Banking:

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The major difference between the Merchant bankers and Investment Bankers is:

  • Merchant Banking is purely fee based.
  • Investment banking is both fee based and fund based.

A merchant banker can undertake only those activities, which are relating to securities market and which do not require registration / have been granted exemption from registration as an NBFC from RBI

In particular a merchant Banker can undertake the following activities:

  • Managing of public issue of securities
  • Underwriting connected with the public issue Management Services acting like as Book Running
  • Lead Manager/Lead Manager for the IPOs/FPOs/Right issues/Debt issues
  • Managing advising on international offerings of dept / equity i.e. GDR, ADR, bonds and other instruments
  • Private placements of securities
  • Primary or satellite dealership of GOVT securities
  • Corporate advisory services relate to securities market eg: takeovers acquisitions and disinvestments
  • Stocking broking
  • Advisory services for projects and Project appraisals.
  • Syndication of rupee term loans
  • International financial advisory services.
  • Project counseling and pre investment activities
  • Undertaking Feasibility studies
  • Issuing Project reports
  • Design of capital structure
  • Mobilization of funds from NRIs
  • Foreign currency finance
  • Mergers and takeovers

Services of Merchant Banks in detail

Project Counseling:

Project counseling includes preparation of project reports, deciding upon the financing pattern to finance the cost of the project and appraising the project report with the financial institutions or banks. It also includes filling up of application forms with relevant information for obtaining funds from financial institutions and obtaining government approval.

Management of debt and equity offerings

This forms the main function of the merchant banker. He assists the companies in raising funds from the market. The main areas of work in this regard include: instrument designing, pricing the issue, registration of the offer document, underwriting support, and marketing of the issue, allotment and refund, listing on stock exchanges.

Issue Management

Management of issue involves marketing of corporate securities viz. equity shares, preference shares and debentures or bonds by offering them to public. Merchant banks act as an intermediary whose main job is to transfer capital from those who own it to those who need it. After taking action as per SEBI guidelines, the merchant banker arranges a meeting with company representatives and advertising agents to finalize arrangements relating to date of opening and closing of issue, registration of prospectus, launching publicity campaign and fixing date of board meeting to approve and sign prospectus and pass the necessary resolutions. Pricing of issues is done by the companies in consultant with the merchant bankers.

Managers, Consultants or Advisers to the Issue:

The managers to the issue assist in the drafting of prospectus, application forms and completion of formalities under the Companies Act, appointment of Registrar for dealing with share applications and transfer and listing of shares of the company on the stock exchange. Companies can appoint one or more agencies as managers to the issue.

Underwriting of Public Issue:

Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount underwritten would be subscribed by him. Banks/Merchant banking subsidiaries cannot underwrite more than 15% of any 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.

Restructuring strategies

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. 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.

Off Shore Finance:

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The merchant bankers help their clients in the following areas involving foreign currency.

  • Long term foreign currency loans
  • Joint Ventures abroad
  • Financing exports and imports
  • 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.

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 and advisory services:

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. Merchant bankers also offer customized solutions to their client's financial problems. Like determining the right debt-equity ratio and gearing ratio for the client; the appropriate capital structure theory is also framed. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds. Another area of advice is rehabilitation and turnaround management.

In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. He advises the client on different hedging strategies and suggests the appropriate strategy.

Placement and distribution

The merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors.

CURRENT SCENARIO

Known as “accepting and issuing houses” in theU.K. and “investment banks” in theU.S.., modern merchant banks offer a wide range of activities including:-

  • Portfolio Management
  • Credit Syndication
  • Acceptance Credit.
  • Counsel onmergers and acquisitions.
  • Insurance, etc.

U.S. merchant banks initiate loans and then sell them to investors.As planning and industrial policy of the country envisaged the setting of up of new industries and technology, greater financial sophistication and financial services are required.

There is a well proven link between economic growth and financial technology. Economic development requires specialist financial skills: savings banks to marshal individual savings; finance companies for consumer lending and mortgage finance; insurance companies for life and property cover; agricultural banks for rural development; and a range of specialized government or government sponsored institutions. As new units have been set up and business is expanding, they require additional financial services. A public equity or debt issue is the logical source of fund in this situation and merchant banks can tap this opportunity of growth. The areas of great scope could be,

Growth of Primary market:

If the primary market grows and number of issues increases, the scope of merchant banking will be enhanced.

Entry of Foreign Investors:

Now India capital market directly taps foreign capital through euro issues.FDI is increased in capital market. So Merchant bankers are required to advice them for their investment in India. The increasing number of joint ventures also requires expert services of Merchant Bankers. If more and more NRIs participate in capital market, there will be great demand for merchant banker services. Changing policy of Financial Institutions: and the lending policies of financial institutions are based on project orientation, so the merchant banker services will be needed by corporate enterprise to provide expert guidance.

Development of debt markets:

If the debt market is enhanced, there will be tremendous scope for Merchant bankers. Now NSE and OTCEI are planned to raise their fund through debt instruments.

Corporate restructuring:

Due to liberalization and globalization Companies are facing lot of competition. In order to compete, they have to go for restructuring, merger, acquisitions or disinvestments. They may offer good opportunities to merchant bankers

The scope could be extended to

  1. Advising the company on designing of its Capital Structure.
  2. Advising the company on the instrument to be offered to the public.
  3. Pricing of the instrument.
  4. Advising the company on Legal/ regulatory matters and interaction with SEBI/ ROC/ Stock
  5. Exchanges and other regulatory authorities.
  6. Assisting the company in marketing the issue.
  7. In channelizing the financial surplus of the general public into productive investment avenues.
  8. To coordinate the activities of various intermediaries to the share issue such as the registrar, bankers, advertising agency, printers, underwriters, brokers etc.
  9. To ensure the compliance with rules and regulations governing the securities market

THE FACTORS ON WHICH GROWTH OF MERCHANT BANKING DEPENDS:

  1. Planning and industrial policy of the country i.e. India in this case
  2. Prevailing Economic condition of the country
  3. Regulatory system of the market and economy prevailing in India
  4. Confidence of the people, traders, buyers, marketers, business houses, financial institutions etc
  5. The economic environment of the outside world.
  6. Competition among the existing players and the upcoming entrants.

Bibliography

Book: -

  • Financial Institutions and Services by Mittal and Varshney
  • Merchant Banking Principles and Practices by H.R. Machiraju

Web Page:-

  • http://www.scribd.com/doc/19695663/Merchant-Banking
  • http://en.wikipedia.org/wiki/Merchant_bank
  • http://www.docstoc.com/docs/15553034/[finance]Financing-Solutions--What-is-a-Merchant-Banking-Operation-[1641]
  • http://www.vedamsbooks.com/no52522.htm
  • http://www.indianmba.com/Faculty_Column/FC378/fc378.html
  • http://www.asialaw.com/Article/1988860/Merchant-Banking.html