Module 4

MERCHANT BANKING & FINANCIAL SERVICES

Merchant banker
Section 2(e) of SEBI Act, 1992 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 securities as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management.

SEBI Merchant Banking Regulations

Categorization Category I to act as lead manager and carry on any activity of the issue management, including preparation of prospectus and other information relating to the issue, determining financial structure, tie up of financiers and final allotment and refund of the subscription and to act as a adviser ,consultant, manager, underwriter, portfolio manager. Category II : to act as adviser ,consultant, co-manager, underwriter, portfolio manager. Category III : to act as underwriter , adviser and consultant to an issue Category IV : to act only as advisor or consultant to an issue

Capital adequacy requirement

The capital adequacy requirement referred to in clause (d) of regulation 6 shall be a net worth of not less than five crore rupees. Explanation: For the purposes of this regulation, net worth means the sum of paidup capital and free reserves of the applicant at the time of making application under sub-regulation (1) of regulation 3.

Category Minimum Amount

Category I Rs. 5, 00, 00, 000 Category II Rs. 50, 00, 000 Category III Rs. 20, 00, 000 Category IV Nil

SCHEDULE III Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 [Regulation 13] CODE OF CONDUCT FOR MERCHANT BANKERS

1.

A merchant banker shall make all efforts to protect the interests of investors. 2. A merchant banker shall maintain high standards of integrity, dignity and fairness in the conduct of its business. 3. A merchant banker shall fulfil its obligations in a prompt, ethical, and professional manner. 4. A merchant banker shall at all times exercise due diligence, ensure proper care and exercise independent professional judgment. 5. A merchant banker shall endeavour to ensure that (a) inquiries from investors are adequately dealt with; (b) grievances of investors are redressed in a timely and appropriate manner; (c) where a complaint is not remedied promptly, the investor is advised of any further steps which may be available to the investor under the regulatory system. Code of conduct for merchant bankers.docx

Appointment of compliance officer

1. Every merchant banker shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, etc., issued by the Board or the Central Government and for redressal of investors grievances. 2. The compliance officer shall immediately and independently report to the Board any non-compliance observed by him and ensure that the observations made or deficiencies pointed out by the Board on/in the draft prospectus or the letter of offer as the case may be, do not recur.

Functions of merchant banking

Project appraisal, Designing capital structure and instruments, issue pricing, preparation of prospectus, Issue Management, Underwriting, Mergers & Amalgamations, Corporate Advisory Services, Bought out deals, Private Placement, Institutional Placement, Debt Syndication

Project appraisal
This service helps corporates analyze the soundness of a project, which may be setting up a new unit/expansion/modernization etc. It is a process of examining the technical, commercial, financial and economic viability of a project to ensure that it generates sufficient returns on the resources invested in it. The study of viability involves detached verification of projects ability to stand the tests of technical, financial and commercial feasibilities and managements capabilities to successfully implement and run the project. A service project report will be prepared for the company, including finalization of capital structure.

Project appraisal includes:

Financial appraisal (liquidity analysis, capital structure analysis, profitability analysis etc. Technical appraisal (factors of production, technology, civil works, site location etc.) Economic appraisal (also known as cost-benefit analysis, social cost, impact on employment, impact on the economy)

Issue Pricing
The issuer in consultation with the merchant banker on the basis of market demand decides the price. The offer document contains full disclosures of the parameters which are taken in to account by merchant Banker and the issuer for deciding the price. The Parameters include EPS, PE multiple, return on net worth and comparison of these parameters with peer group companies.

Issue Pricing
On the basis of Pricing, an issue can be further classified into Fixed Price issue or Book Built issue. Fixed Price Issue: When the issuer at the outset decides the issue price and mentions it in the Offer Document, it is commonly known as Fixed price issue. Book built Issue: When the price of an issue is discovered on the basis of demand received from the prospective investors at various price levels, it is called Book Built issue.

Prospectus
Prospectus refers to any document by which a capital is offered to the public and upon the basis of which the applicants actually subscribe. Its main purpose is to invite offers from the public for the subscription/ purchase of any securities (shares/debentures) of a company. Every prospectus has to comply with the requirements of the Companies Act. The Act prescribes the form of prospectus.

Offer document
Offer document is a document which contains all the relevant information about the company, promoters, projects, financial details, objects of raising the money, terms of the issue etc and is used for inviting subscription to the issue being made by the issuer. Offer Document is called Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue.

Draft offer document

Draft offer document: is an offer document filed with SEBI for specifying changes, if any, in it, before it is filed with the Registrar of companies (ROCs). Draft offer document is made available in public domain including SEBI website, for enabling public to give comments, if any, on the draft offer document. ..\Additional reading\Draft offer document with SEBI.pdf

Red herring prospectus

Red herring prospectus is an offer document used in case of a book built public issue. It contains all the relevant details except that of price or number of shares being offered. It is filed with RoC before the issue opens. ..\Additional reading\Redherring document filed with RoC.pdf

Prospectus
Prospectus is an offer document in case of a public issue, which has all relevant details including price and number of shares being offered. This document is registered with RoC before the issue opens in case of a fixed price issue and after the closure of the issue in case of a book built issue. ..\Additional reading\Final offer document filed with RoC.pdf

Letter of offer Letter of offer is an offer document in case of a Rights issue and is filed with Stock exchanges before the issue opens.

Abridged prospectus Abridged prospectus is an abridged version of offer document in public issue and is issued along with the application form of a public issue. It contains all the salient features of a prospectus.

Abridged letter of offer

Abridged letter of offer is an abridged version of the letter of offer. It is sent to all the shareholders along with the application form.

Shelf prospectus Shelf prospectus is a prospectus which enables an issuer to make a series of issues within a period of 1 year without the need of filing a fresh prospectus every time. This facility is available to public sector banks /Public Financial Institutions.

Placement document
Placement document is an offer document for the purpose of Qualified Institutional Placement and contains all the relevant and material disclosures.

Issue management a) Public issue (i) Initial Public offer (IPO) (ii) Further public offer (FPO) b) Rights issue c) Bonus issue d) Private placement (i) Preferential issue (ii) Qualified institutional placement

A. Public issue When an issue / offer of securities is made to new investors for becoming part of shareholders family of the issuer it is called a public issue. Public issue can be further classified into Initial public offer (IPO) and Further public offer (FPO).

Initial public offer (IPO) When an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public it is called an IPO. This paves way for listing and trading of the issuers securities.

Further Public Offering When an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document it is called an FPO. An offer for sale in such scenario is allowed only if it is made to satisfy listing or continuous listing obligations.

B. Rights Issue
When a listed company which proposes to issue fresh securities to its existing shareholders as on a record date it is called as rights issue. The rights are normally offered in a particular ratio to the number of securities held prior to the issue. This route is best suited for companies who would like to raise capital without diluting stake of its existing shareholders unless they do not intend to subscribe to their entitlements.

C. Bonus issue
When an issuer makes an issue of securities to its existing shareholders as on a record date, without any consideration from them, it is called a bonus issue. The shares are issued out of the Companys free reserve or share premium account in a particular ratio to the number of securities held on a record date.

D. Private Placement A private placement is an issue of shares or of convertible securities by a company to a select group of persons under Section 81 of the Companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital.

Preferential allotment
A private placement of shares or of convertible securities by a listed company is generally known by name of preferential allotment. A listed company going for preferential allotment has to comply with the requirements contained in Chapter XIII of SEBI (Disclosure and Investor Protection) Guidelines pertaining to preferential allotment in SEBI (DIP) guidelines which interalia include pricing, disclosures in notice etc, in addition to the requirements specified in the Companies Act.

Qualified Institutions Placement

A Qualified Institutions Placement is a private placement of equity shares or securities convertible in to equity shares by a listed company to Qualified Institutions Buyers only in terms of provisions of Chapter XIIIA of SEBI (DIP) guidelines. The Chapter contains provisions relating to pricing, disclosures, currency of instruments etc.

Qualified Institutional Buyer

a) a public financial institution as defined in section 4A of the Companies Act, 1956; b) a scheduled commercial bank; c) a mutual fund registered with the Board; d) a foreign institutional investor and subaccount registered with SEBI, other than a sub account which is a foreign corporate or foreign individual; e) a multilateral and bilateral development financial institution; f) a venture capital fund registered with SEBI; g) a foreign venture capital investor registered with SEBI; h) a state industrial development corporation; i) an insurance company registered with the Insurance Regulatory and Development Authority (IRDA); j) a provident fund with minimum corpus of Rs. 25 crores; k) a pension fund with minimum corpus of Rs. 25 crores; l) National Investment Fund set up by resolution no. F. No. 2/3/2005DDII dated November 23, 2005 of Government of India published in the Gazette of India.

Underwriting
Underwriting, as per rule 2(g) of the Regulations, is defined to mean an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them.

Hard underwriting
Hard underwriting is when an underwriter agrees to buy his commitment at its earliest stage. The underwriter guarantees a fixed amount to the issuer from the issue. Thus, in case the shares are not subscribed by investors, the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares. The underwriter bears a risk which is much higher in soft underwriting.

Soft underwriting
Soft underwriting is when an underwriter agrees to buy the shares at later stages as soon as the pricing process is complete. He then, immediately places those shares with institutional players. The risk faced by the underwriter as such is reduced to a small window of time. Also, the soft underwriter has the option to invoke a force Majeure (acts of God) clause in case there are certain factors beyond the control that can affect the underwriters ability to place the shares with the buyers.

Bought out deals

It is a method in which the shares are offered to the investment banker who sells it to the public at a later date. Advantages: The funds can be realised by the promoters without any delay. The cost of raising the funds is reduced. It helps those entrepreneurs to raise funds who are not familiar with the share market.

Debt/ Loan Syndication

Merchant bankers arrange to tie up loans for their clients. This takes place in a series of steps. Firstly, they analyze their clients, the pattern of the client's cash flows, based on which the terms borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending on the basis of which the final allocation is done.