UNIT-3MERCHANT BANKING

INTRODUCTION:Merchant banking in India is of recent origin. It has its beginning in India in 1967,

when Grindlays Bank established a division, followed by Citibank in 1970 (it has now ceased to provide merchant banking services) and State Bank of India in 1972. Later on, the ICICI set up its merchant banking division followed by a few other banks like Syndicate Bank, Bank of India, Bank of Baroda, Chartered Bank, Mercantile Bank etc. Some leading brokers have also entered the field.

The merchant banks, as they have developed in our country, could be broadly classified into three categories. The first category comprises the divisions of commercial banks. The second category consists of national and state level financial corporations like ICICI and SICOM. 'The third category includes leading broker firms who have extended their activities into merchant banking like H. L. Consultancy & Management Services, Champaklal Investments and Financial Consultancy Company (CIFCO), J.M. Financial and Investment Consultancy Services, DSP Financial Consultancy etc. A closer look at the work of these merchant banks indicates that the whole gamut of merchant banking activities is hardly covered by any of these agencies. They operate more like issue houses than full-fledged merchant banks. For many of these merchant banking firms, there was an extension of broking services rendered earlier.

MEANING AND DEFINITION OF MERCHANT BANKINGMerchant banks are issue houses. They render many services to industrial projects or

corporate units such as floatation of new ventures and new companies, preparation, planning and execution of new projects, consultancy and advice in technical, financial, managerial and organisational fields. They also perform a number of other functions such as restructuring, revaluation of assets, mergers, takeovers, acquisitions etc.

Merchant bankers play a significant role as a catalyst to convert the project ideas into industrial ventures. They help in the promotion of the enterprise by undertaking various activities like market surveys, choice of suitable location and its size, preparation of documents and obtaining consent from various authorities. They also help in taking important decisions regarding financing mix, management of public issues, credit syndication etc. 'The success of the merchant bankers depends on the quality of service and soundness of advice to clients.

DEFINITIONMerchant bank may be defined as "a kind of financial institution that provide a variety

of services, including investment, banking, management of customer's securities, portfolios, insurance, acceptance of bills, etc".

As per the Securities and Exchange Board of India (Merchant Bankers) Rules, 1992, "Merchant Bankers" means "any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as

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manager, consultant, adviser or rendering corporate advisory services in relation to such issue management".

To sum up, merchant bankers may be referred to an "intermediary who provides various financial services, other than lending money, such as managing public issues, underwriting new issues, arranging loan syndications and giving advice on portfolio management, financial restructuring, mergers and acquisitions.

According to SEBI, “a merchant banker is one who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to the securities as manager, advisor or rendering corporate advisory services in relation to such issue management”.

Investment Banking Vs Merchant BankingThe term ‘merchant banking’ and ‘investment banking’ are often used interchangeable in the financial literature. However, we can make out a subtle distinction between these two. The term ‘Investment Banking’ has the US origin whereas the term ‘merchant banking’ is in vogue in countries such as the UK and India.

The following list shows the selected investment banks, both domestic and global:Domestic GlobalICICI Securities Goldman SachsKotak Mahindra Capital Company Morgan StanleyEnam Financials JP Morgan ChaseKarvy Investor Services RothschildSBI Capital Markets HSBCDSP Merill Lynch Credit SuisseKeynore Corporate Services BlackstoneABN Amro UBS

Deutsche BankCity GroupBarclays

INSTITUTIONAL STRUCTURE

In tracing the history of the merchant banking in India, the structure of merchant bankers appeared as follows at one point of time:

1. Merchant banking divisions of commercial banks, both Indian and Foreign.2. Merchant banking divisions of financial institutions (e.g. IDBI, IFCI, etc.)3. Merchant banking companies promoted by stock broking firms. (e.g. JM

Financial, DSP)4. Merchant banking services of NBFCs

However, the above structure has undergone a transformation now. The merchant banking divisions of the commercial banks exist now as independent subsidiary companies of the parent firms. For example, the SBI Capital Markets Ltd is the subsidiary of SBI. The merchant banking activities of the NBFCs almost cease to exist.

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SERVICES OF MERCHANT BANKSMerchant banks generally offer the following services:

1. Conduct Pre-investment Studies: Merchant banks conduct pre-investment studies for the purpose of investors. These are in the nature of financial feasibility explorations in selected areas of interest of the client.2. Working out Package for Project Funding: They assist in working out a comprehensive package for tale project funding and pattern of financing is available from the merchant banks. They work in close liaison with the client, his technical consultants, and the funding institutions. They prepare and submit complete financial dossiers, and arrange for the various sources of finance. They also assist in legal documentation for the finance arranged.3. Financial Structuring and Syndication: They render advice on the financial 'structuring of these projects as well as assist in syndication of the finance itself.4. Arrangement of Lease Financing etc.: Some of the larger banks are also involved in areas such as the arrangement of lease finance, and assistance in acquisitions and mergers etc.5. Provide Counselling Services: Merchant banks provide counsel on capital and capital structure, the form of capital to be raised, preparing the terms and conditions of issue, underwriting, preparation of the prospectus etc. They provide the services of financial and non-financial nature, and a host of related services.6. Management of Issue: The public visibility of merchant banking has been largely confined to management of issue of corporate securities by newly floated companies, existing companies, and foreign companies for complying with the provisions of FEMA. The types of services under this head include obtaining consent/acknowledgement from SERI for issue of capital, preparation of prospectus, tying up arrangement of underwriting, appointment of brokers and bankers to the issues, press publicity, compliance of stock exchange listing requirements etc. 7. Prepare Project Files etc.: Merchant banks undertake preparation of project files, loan application for financial assistance on behalf of promoters from various financial institutions for term loan, working capital finance from commercial banks for new projects etc. Merchant bankers also arrange finance for the projects abroad.8. Guide Promoters: Merchant banks guide promoters in the matter of rules, regulations, capital goods clearance, import clearance etc.9. Help in Raising Public Finance: The companies are also helped by merchant banks to raise finance by way of public finance. In this connection, they provide not only the required guidance but also act as brokers for the mobilisation of public deposits. Management of new accounts of deposits is also undertaken.10. Advise on Investment in Government Securities: It includes advising on investment in Government securities to trusts, charitable institutions, and companies regarding their investment in compliance with the provisions of various Acts. Merchant banks have undertaken purchase and sale of securities and management of individual investment portfolio of investors.11. Cost Audit: Merchant banks provide corporate counselling and advisory services on mergers, acquisition and reorganisation. Some of them also help in taking up cost audit and recruitment of executives.12. Issue Management: Management of the public issue of shares/ debentures including even an offer for sales has been the traditional service rendered by merchant bankers in India. Under this head, they decide on the size and timing of a publ ic issue in the light of the market condition. They prepare the base, of successful issue marketing

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from the initial documentation, liaison with the Controller of Capital Issues for clearances o1c. to the preparation of the actual launch of the proposed issue. They perform underwriting services; appoint bankers and brokers as well as issue houses; manages the issues. They act as an intermediary with share market functionaries like brokers, portfolio managers and financial press for pre-selling and media coverage. Prepare draft prospectus and other documents. Provide coverage throughout the country for collection of applications. Prepare advertising and promotional material.13. Provision of Working Capital: Merchant banking is a part of the banking system. So the client has to be assisted in arranging for' working capital finance especially for the new ventures. If the requirement of the client is substantially large, then it is desirable to arrange for the syndication on behalf of the promoters. There has been recent change in arrangement for the working capital finance by issue of debentures on “Rights” basis. Merchant bankers play a great role in helping the clients in the preparation of the necessary forms for the financial institutions such as LIC, GIC, UTI who are the major supporters for such issue. He arranges for the trustees for the debentures and also ensures that the balance portion is tied up with the other bankers.

14. Foreign Currency Loans: The merchant banker also arranges for export credit for various countries. He also arranges for foreign currency loan like Eurodollar, IFCI loans etc.

15. Portfolio Management for Non-residents: The merchant banker assists in this area by identifying suitable arrangements of investment suitable to each Non-Resident Indian. Under this head, a merchant banker performs various functions, which are as follows:

Guides on buying and selling of securities. Handles the transactions relating to the purchase and sale of securities Advices on market conditions. Keeps the documents safely. Collects of earning such as dividend, interest etc. Serves as a link between non-residents and Reserve Bank of India for obtaining

necessary permission.16. Marketing: It is also a very important function, which the merchant banker has to take into account since he has to create the business for himself. He also has to have a close association with his own clients, understand their future expansion/modernization programs and advise them the way in which these programs are to be carried out. His imagination and expertise play a great role in this area.

Corporate Counseling: Corporate counseling is the beginning of the merchant banking services. Every industrial unit either new or existing needs it. The scope of corporate counseling is very vast. It covers a wide range of merchant banking activities and includes the services such as project counseling, project management, loan syndication, working capital management, capital re-structuring, public issue management, fixed deposit, lease financing, etc.

Project Counseling: Project counseling has originated from corporate counseling. It relates to project finance and includes preparation of project reports, cost of the

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project and also arranging the financing pattern. The projects are appraised on the basis of the location, marketing and technical and financial viability of the project. QUALITIES OF A SUCCESSFUL MERCHANT BANKERThe qualities, which a successful merchant banker should possess, are given below:1. Analysing Ability: Merchant banker should have the ability to analyse various aspects such as technical, financial and economic aspects concerning the formation of an industrial project.

2. Knowledge about Various Aspects: Knowledge about the various aspects of capital markets, trends in stock exchange, psychology of investing public, change in the economic, political and technological environment in the country is another quality which a merchant banker

3. Ability to build up Relationship: Ability to build up the bank client relationship and live up to the clients expectations with total involvement in the project assigned to them is another quality that a merchant banker is expected to possess.4. Innovative Approach: Innovative approach in developing capital market instruments to satisfy the ever changing needs of investing public is another requisite for a successful merchant banker.5. Integrity and High Professional Standards: Integrity and maintenance of high professional standards are the essential requisites for the success of merchant bankers present scenario?

SIGNIFICANCE OF MERCHANT BANKING.The following are the objective of merchant banking:

The merchant banker performs an objective of translating project ideas I to industrial venture.

Merchant banker helps particularly the small entrepreneurs in overcoming the complex problems of promotion of an enterprise.

The merchant banking as specialized institutions, they are capable of reducing the time taken for organizing new issues as well cost of raising capital.

Cost of floating of equity and preference capital is higher for new companies when compared to existing companies, the banks help in saving the cost of new companies and small companies.

The merchant banker renders, professional guidance regarding capital mix, management of public issue, credit syndication, investment counseling.

Merchant banker also plays an important role in rehabilitation when he guides the management at the time of acquisition, merger, take over or amalgamation.

It also advice and give guidance in regarding foreign trade financing and guides non-resident Indians looking for investment opportunities in India.

OBJECTIVES OF MERCHANT BANKERS:The following are the objective of merchant banking:

i. Corporate Counseling:

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Merchant Bankers provide counseling services to companies with regard to their timing of issues of shares. Capital structure and other promotional aspect with regard to the company.

ii. Project Counseling:Here, the new entrepreneur is helped in the conception of idea, identifying various

projects, preparation of projects, feasibility reports, location of factory, obtaining funds, sanctions approvals from state and central Government departments.iii. Capital Structure:

Here, the amount of capital Required rising of the capital, debt-Equity Ratio, issue of shares and debentures, working capital, fixed capital requirements etc., are worked out.iv. Portfolio Management:

In portfolio management, the merchant banker helps the investor in matters pertaining to investment decisions; taxation and inflation are taken into account while advising on investment in different securities. The merchant banker also undertakes the function of buying and selling of securities on behalf of their client companies.v. Issue Management:

Obtaining clearances, drafting of prospectus underwriting, liaising with brokers and bankers and keeping constant communications with investors.vi. Credit indication:

When the funds required are more, different financial institutions are combined for contributing working capital and fixed capital requirements. The credit worthiness of the borrower is more represented by the merchant banker to the various members of the credit syndication. It is also called “consortium finance”.vii. Working capital:

Concerns are given working capital finance depending upon their earning capacity in relation to the interest rate prevailing in the market.viii. Venture Capital:

Venture capital is a kind of finance wherein a new venture proposed by an entrepreneur is financed. Venture capital carries more risks and hence very few financial institutions come forward to finance. As the risk involved is more, the technical competency of the entrepreneur is an important condition for the venture capital finance.ix. Lease Finance:

The leasing companies are provided finance for procuring on different assets which are required by different companies. It is a form of finance employed to acquire use of asset.x. Fixed Deposit:

Merchant banks will enable companies to raise finance by way of fixed deposits from the public. The companies will have to fulfill credit rating requirements which the merchant banker helps the borrowing company to fulfill the required conditions.

LEGAL AND REGULATORY FRAMEWORK

An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being

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satisfied issue a certificate of registration in Form B of the SEBI (Merchant Bankers) Regulations, 1992.

The registration fee payable to SEBI is Rs.5 lakhs which should be paid within 15 days of date of receipt of intimation regarding grant of certificate. The validity period of certificate of registration is Three years from the date of issue.

Renewal, three months before the expiry period, an application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied renew certificate of registration for a further period of 3 years. The renewal fee payable to SEBI is Rs.2.5 lakhs which should be paid within 15 days of date of receipt of intimation regarding renewal of certificate. The person whose registration is not current shall not carry on the activity as merchant banker from the date of expiry of validity period.Categories of Merchant BankersOriginally, as per SEBI regulations, merchant bankers were required to get authorization to act as an issue manager, underwriter or advisor. This authorization was granted by SEBI based on the net worth limits, professional competence, experience in the business, general reputation and the past performance record.

The categories for which registration may be granted are given below: Category I – To carry on the activity of issue management and to act as

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 or consultant to an issue Category IV – To act only as adviser or consultant to an issue

Accordingly, four categories of merchant bankers should full fill the capital requirement as under:

Category I Capital adequacy of Rs.5 crores Category II Capital adequacy of Rs.50 lakhs Category III Capital adequacy of Rs.20 lakhs Category IV No capital adequacy requirement

The functions rendered by these four categories were also stipulated by SEBI. Category I merchant banker could act as an issue manager, underwriter, advisor, consultant and portfolio manager. Although the advisory or consultancy function could be performed by all the four categories, it will not possible for Categories III and IV merchant bankers to act as an issue manager or portfolio manager.

SEBI GUIDELINES

The SEBI Act, 1992 established SEBI as market regulator with all statutory powers. SEBI was established with the objective of protecting the interest of investors and for regulation and development of securities market in India. It has the powers to regulate all the market intermediaries. The SEBI grants registration to the market

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intermediaries and has powers to inspect, monitor and take penal actions on them in case of violations of any provisions of the Act or rules, Issues of securities, stock exchanges and other market intermediaries are subject to regulatory power of SEBI.

Merchant banking in India is governed by SEBI (Merchant Bankers) Regulations 1992. It provides for registration of merchant bankers, general obligations and responsibilities of merchant bankers, procedures for inspection and procedures for action in case of defaults. Besides these, the code of conduct for merchant bankers is also specified. To become a merchant banker the following are the pre-requisites:

The applicant must be corporate body. The applicant should not carry on a business other than the securities market

business. He should have the necessary infrastructure in terms of office space and

experienced man-power. The associate company or the group company should not have been a

registered merchant banker. The applicant should not have been involved in security scams. The minimum net worth of the applicant firm should be Rs.50million

Obligations and Responsibilities of Merchant BankersIn the conduct of his business, a merchant banker is supposed to observe certain codes of conduct. SEBI has issued some guidelines for regulating the merchant banking activities and the code of conduct for the merchant banks is specified in the Schedule III of the SEBI (Merchant Bankers) Regulations 1992.

1. High standards: 2. Due diligence: 3. Dealing with competing merchant bankers: 4. No tall claims: 5. Cost-effective service: 6. Confidentially: 7. Disclosure of information: 8. Avoid market manipulative practices: 9. Restrain on advisory role:

All public issues shall be managed by a merchant banker who acts as the lead merchant banker or the lead manager to the issue. The number of such lead managers is linked to the size of the public issue as given below. The regulations of SEBI specify certain responsibilities of the lead merchant banker. In a public issue, the responsibilities relate to the disclosure of information in the offer documents, allotment of securities and refund of application money.

Size of Public Issue and Number of Lead ManagersIssue Size No.of Lead Managers

Less than Rs.50 crores 2Rs.50 – 100 crores 3

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Rs.100 – 200 crores 4Rs.200 – 400 crores 5Above 400 crores 5 or more

SEBI has pronounced the following guidelines for Merchant Bankers:1. Submission of Offer Document: 2. Dispatch of issue material3. Underwriting: 4. Compliance Obligations: 5) Redressed of investor grievances: 6) The concerned lead merchant banker 7) Issue of No objection Certificate (NOC): 8) Registration of Merchant Bankers: 9) Renewal of Registration: 10) Impositions of Penalty Points:

ROLE OF MERCHANT BANKING IN APPRAISAL OF PROJECTS

Merchant Banking, as a commercial activity, took shape in India through the management of Public Issues of capital and Loan Syndication. It was originated in 1969 with the setting up of the Merchant Banking Division by ANZ Grind lays Bank. 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.

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 into the field of merchant banking. Reform measures were initiated in the capital market from 1992, starting with the conferring of statutory powers on the Securities and Exchange Board of India (SEBI) and the repeal of Capital Issues Control Act and the abolition of the office of the Controller of Capital Issues.

Merchant Bankers and Capital Issues ManagementMerchant Banker has been defined under the Securities & Exchange Board of India (Merchant Bankers) Rules, 1992 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, advisor or rendering corporate advisory service in relation to such issue management.

The capital issue management comprises of the effective management of market related factors. They are:Transition to rolling settlement on the equity marketImpact on different classes of market usersObtaining a liquid bond marketImpact of reforms of 1990s

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Law and taxationTaxation of capitalLegal reformsPolitical economy of financial sector reformsMarket design, market inefficiencies, and trading profitsIssue ManagementThe management of issues for raising funds through various types of instruments by companies is known as issue management. The function of capital issues management in India is carried out by merchant bankers. The Merchant Bankers have the requisite skill and competence to carry out capital issues management. The funds are raised by companies to finance new projects, expansion / modernization/ diversification of existing units etc.

The definition of merchant banker as contained in SEBI (Merchant Banker) Rules and Regulations, 1992 clearly brings out the significance of Issue Management as, “Any person who is engaged in the business of issue management either by making arrangement regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management”.

Merchants of Public Issue ManagementClassification of Securities Issue

Public Issue Right Issue Private Placement

Merchant Bankers FunctionsThe different functions of merchant bankers towards the capital issues management are as follows:

1) Designing Capital Structure2) Capital Market Instruments3) Issue Pricing4) Book Building5) Preparation of Prospectus6) Selection of Bankers7) Advertising Consultants8) Role of Registrar 9) Bankers to the Issue10)Underwriters to the Issue11)Brokers to the Issue

DESIGNING CAPITAL STRUCTURE

The term capital structure refers to the proportionate claims of debt and equity in the total long-term capitalization of a company.

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According to Weston and Brigham, “Capital structure is the permanent financing of the firm, represented primarily by long-term-debt, preferred stock and common equity, but excluding all short-term credit. Common equity includes common stock, capital surplus and accumulated retained earnings”.Decisions on Capital Structure: The decisions regarding the use of different types of capital funds in the overall long term capitalization of a firm are known as capital structure decisions. Any decisions on Capital Structure are based on different principles.

a) Cost Principle b) Control Principle c) Return Principle d) Flexibility Principlee) Timing Principle

Factors affecting Capital Structure Decisions: The major developments taking place in the economy affect the capital structure of firms. In order words, the way the economy of a country is managed determines the way the capital structure of a firm will be determined. Factors that are active in the economy are:

1. Business Activity: 2. Stock Market: 3. Taxation: 4. Regulations: 5. Credit Policy: 6. Financial Institutions:

CAPITAL MARKET INSTRUMENTS

Financial instruments that are used for raising capital resources in the capital market are known as Capital Market Instruments. The changes that are sweeping across the Indian capital market especially in the recent past are something phenomenal. It has been experiencing metamorphic in the last decade, thanks to a host of measures of liberalization, globalization, and privatization that have been initiated by the Government. Pronounced changes have occurred in the realm of industrial policy such as Licensing policy, Financial services, Interest rates, etc. The competition has become very intense and real in both industrial sector and financial services industry. As a result of these changes, the financial services industry has come to introduce a number of instruments with a view to facilitate borrowing and lending of money in the capital market by the participants.

Types of Capital Market Instruments: The various capital market instruments used by corporate entities for raising resources are as follows:

1. Equity Shares2. Non-voting Equity shares3. Preference Shares4. Cumulative Convertible Preference Shares

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5. Company Fixed Deposits6. Warrants7. Debentures and Bonds

Equity Shares: Equity shares, also known as ordinary shares are the shares held by the owners of a corporate entity. Since equity shareholders face greater risks and have no specified preferential rights, they are given larger share in profits through higher dividends than those given to preference shareholders, provided the company’s performance is excellent.

Non-voting Equity Shares: Consequent to the recommendations of the Abid Hussain Committee and subsequent to the amendment to the Companies Act, corporate managements are permitted to mobilize additional capital without diluting the interest of existing shareholders with the help of a new instrument called non-voting equity shares. Such shares will be entitled to all the benefits except the right to vote in general meetings.

Preference Shares: Shares that carry preferential rights in comparison with ordinary shares are called ‘Preference Shares’. The preferential rights are the rights regarding payment of dividend and the distribution of the assets of the company in the event of its winding up, in preference to equity shares.

Types of Preference Shareso Cumulative preference shares: o Non-cumulative preference shares: o Participating preference shares: o Redeemable preference shares: o Fully convertible cumulative preference shares: o Preference shares with warrants attached:

Company Fixed Deposits: Fixed deposits are the attractive source of short-term capital both for the companies and investors as well. Corporate favour fixed deposits as an ideal form of working capital mobilization without going through the process of mortgaging assets. Investors find fixed deposits a simple avenue for investment in popular companies at attractively reasonable and safe interest rates.

Warrants: An option issued by a company whereby the buyer is granted the right to purchase a number of shares of its equity share capital at a given exercise price during a given period is called a ‘warrant’. Although trading in warrants are in vogue in the U.S. Stock markets for more than 6 to 7 decades, they are being issued to meet a range of financial requirements by the Indian corporate.

Debentures and Bonds: A document that either creates a debt or acknowledges it is known as a debenture. Accordingly, any document that fulfills either of these conditions is a debenture. A debenture, issued under the common seal of the company, usually takes the form of a certificate that acknowledges indebtedness of the company. A document that shows on the face of it that a company has borrowed a sum of money

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from the holder thereof upon certain terms and conditions is called a debenture.

Kinds of Debentures: Innovative debt instruments that are issued by the public limited companies are described below:

1. Participating Debentures2. Convertible Debentures3. Debt-equity Swaps4. Zero-coupon Convertible Notes5. Secured Premium Notes (SPN) with detachable Warrants6. Non-Convertible Debentures (NCDs) with detachable Equity Warrant7. Zero-interest Fully Convertible Debentures (FCDs)8. Secured Zero-interest Partly Convertible Debentures (PCDs) with detachable

and separately tradable warrants9. Fully Convertible Debentures (FCDs) with interest (optional)10. Floating Rate Bonds (FRB)

ISSUE PRICING

A listed company can freely price equity shares/convertible securities through public/ rights issues. An unlisted company eligible to make a public issue and desirous of getting its securities listed on a recognized stock exchange can also freely price shares and convertible securities. The free pricing of equity shares by an infrastructure company 8is subject to the compliance with disclosure norms as specified by the SEBI from time to time. While freely pricing their initial public issue of share/convertibles, all banks require approval by the Reserve Bank of India (RBI).

Differential Pricing: Listed/unlisted companies may issue shares/convertible securities to applicants in the firm allotment category (i.e. Allotment on a firm basis made to Indian and multilateral development finance institutions, Indian mutual funds, foreign institutional investors including non-resident Indians/overseas corporate bodies and permanent/regular employees of the issuing company) at a price different from the price at which the net offer to the public (i.e. the Indian public, excluding firm allotments/reservations/ promoters contribution) is made, provided the price at which the security is offered to the applicants in firm allotment category is higher than the price at which securities are offered to the public.

Price Band: The issuer/issuing companies can mention a price band of 20 percent (cap in the price band should not exceed 20 percent of the floor price) in the offer document filed with the SEBI and the actual price can be determined at a later date before filing it with the ROCs (Registrar of Companies). If the Board of Directors (BOD) of the issuing company has been authorized to determine the offer price within a specified price band, a resolution would have to be passed by them to determine such a price.

Payments of Discounts/Commissions: Any direct/indirect payment in the nature of

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discount/commission/allowance or otherwise cannot be made by the issuer company/promoters to any firm allotted in a public issue.Denomination of Shares: Public/rights issue of equity shares can be made in any denomination in accordance with Section 13(4) of the Companies Act and in compliance with norms specified by the SEBI from time to time. The companies that have already issued shares in the denominations of Rs.10 or Rs.100 may change their standard denomination by splitting/consolidating them.

BOOK BUILDING

A method of marketing the shares of a company whereby the quantum and the price of the securities to be issued will be decided on the basis of the bids received from the prospective shareholders by the lead merchant bankers is known as Book-Building method.

Under the book-building method, share prices are determined on the basis of real demand for the shares at various price levels in the market. For discovering the price at which issue should be made, bids are invited from prospective investors from which the demand at various price levels is noted. The merchant bankers undertake full responsibility for the same.

The option of book-building is available to all body corporate, which are otherwise eligible to make an issue of capital to the public. The initial minimum size of issue through book-building route was fixed at Rs.100 Crores. However, beginning from December 9, 1996 issues of any size will be allowed through the book-building route. Book-building facility is available as an alternative to firm allotment. Accordingly, a company can opt for book-building route for the sale of shares to the extent of the percentage of the issue that can be reserved for firm allotment as per the prevailing SEBI guidelines. It is therefore possible either to reserve securities for firm allotment or issue them through the book-building process.

The book-building process involves the following steps:1) Appointment of Book-Runners 2) Drafting Prospectus3) Circulating Draft Prospectus4) Maintaining Offer Records5) Intimation about Aggregate Orders6) Bid Analysis7) Mandatory Underwriting8) Filling with ROC9) Bank Accounts10) Collection of Completed Applications11) Allotment of Securities12) Payment Schedule and Listing13) Under-subscription

Advantages of Book Building: Book-building process is of immense use in the following ways:

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a. Reduction in the duration between allotment and listingb. Reliable allotment procedurec. Quick listing in stock exchanges possibled. No price manipulation as the price is determined on the basis of the bids

received

UNDERWRITERS

Another important intermediary in the new issue/primary market is the underwriters to issues of capital who agree to take up securities which are not fully subscribed. They make a commitment to get the issue subscribed either by others or by themselves. Though underwriting is not mandatory after April 1995, its organization is an important element of the primary market. Underwriters are appointed by the issuing companies in consultation with the lead managers/merchant bankers to the issues. A statement to the effect that in the opinion of the lead manager, the underwriters’ assets are adequate to meet their obligation should be incorporated in the prospectus.

Registration: To act as underwriter, a certificate of registration must be obtained from the SEBI. In granting the certificate of registration, the SEBI considers all matters relevant/relating to the underwriting and in particular.

Fee: Underwriters, had to, for grant or renewal of registration, pay a fee to the SEBI from the date of initial grant of certificate, Rs. 2 lakhs for the first and second years and Rs.1 lakh for the third year. A fee of Rs.20,000 was payable every year to keep the certificate in force or for its renewal. Since 1999, the registration fee has been raised to Rs.5 lakhs. To keep the registration in force, renewal fee of Rs.2 lakhs every three years from the fourth year from the date of initial registration is payable. Failure to pay the fee would result in the suspension of the certificate of registration.

Agreement with Clients: Every underwriter has to enter into an agreement with the issuing company. The agreement, among others, provides for the period during which the agreement is in force, the amount of underwriting obligations, the period within which the underwriter has to be subscribe to the issue after being intimated by/on behalf of the issuer, the amount of commission/brokerage, and details of arrangements, if any, made by the underwriter for fulfilling the underwriting obligations.

Inspection and Disciplinary Proceedings: The framework of the SEBI‘s right to undertake the inspection of the books of accounts, other records and documents of the underwriters, the procedure for inspection and obligations of the underwriters is broadly on the same pattern as applicable to the lead managers.

SEBI’s General Obligations and Responsibilities Code of Conduct for Underwriters:1) Make all efforts to protect the interests of its clients.2) Maintain high standards of integrity, dignity and fairness in the conduct of its

business.

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3) Ensure that it and its personnel will act in an ethical manner in all its dealings with a body corporate making an issue of securities (i.e. the issuer).

4) Endeavour to ensure all professional dealings are effected in a prompt, efficient and effective manner.

5) At all times render high standards of service, exercise due diligence, ensure proper care and exercise independent professional judgment.

6) Not make any statement, either oral or written, which would misrepresent (a) the services that the underwriter is capable of performing for its client, or has rendered to any other issuer company; (b) his underwriting commitment.

7) Avoid conflict of interest and make adequate disclosure of his interest.8) Put in place a mechanism to resolve any conflict of interest situation that may

arise in the conduct of its business or where any conflict of interest arises, should take reasonable steps to resolve the same in any equitable manner.

9) Make appropriate disclosure to the client of its possible source or potential in areas of conflict of duties and interest while acting as underwriter.

10) Not discriminate amongst its clients, save and except on ethical and commercial considerations.

Action in Case of Default: The liability for action in case of default arising out ofi. non-compliance with any conditions subject to which registration was granted.

ii. contravention of any provision of the SEBI Act/rules/regulations, by an underwriter involves the suspension/cancellation of registration, the effect of suspension/ cancellation are on the lines followed by the SEBI in case of lead managers.

PORTFOLIO MANAGEMENT SERVICES

Preserving and growing capital is as hard as earning it. Knowing what one want is as important as achieving those goals. Assessing one‘s risk profile and aligning potential returns for the risk assumed from various investment options is the crucial task. In today‘s fluid environment, that has become a hard task to achieve. As the investor‘s net worth increases, financial complexity expands exponentially and the investment needs and options multiply. And equities offer one of the best options for investments. Mutual funds as an investment vehicle are structured to reduce risks as far as possible, as they cater to thousands of investors.

Portfolio and Management Services: A list of all those services and facilities that are provided by a portfolio manager to its clients, relating to the management and administration of portfolio of securities or the funds of the client, is referred to as portfolio management services. The term portfolio means the total holdings of securities belonging to any person.

Portfolio Manager: According to SEBI, Portfolio Manager means any person who pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management or administration of a portfolio of securities or the funds of the client, as the case may be.

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Discretionary Portfolio Manager: According to SEBI, discretionary portfolio manager means a portfolio manager who exercises or may, under a contract relating to portfolio management, exercises any degree of discretion as to the investments or management of the portfolio of securities or the funds of the client, as the case may be.

Objectives of Portfolio Management Provide long term capital appreciation with lower volatility, compared to the

broad equity markets. Takes long positions in the cash market and short positions in the index futures

markets. Invests in the model portfolios thus downside the risk by selling index futures

in the derivatives market.

Functions of Portfolio and Management: The objective of portfolio management is to

develop a portfolio that has a maximum return at whatever level of risk the investor deems

appropriate.

Risk Diversification An essential function of portfolio management is spread risk akin to

investment of assets. Diversification could take place across different securities and across

different industries. Is an effective way of diversifying the risk in an investment. Simple

diversification reduces risk within categories of stocks that all have the same quality rating.

Asset Allocation An important function of portfolio management is asset allocation. It deals

with attaining the operational proportions of investments from asset categories. Portfolio

managers basically aim of stock-bond mix. For this purpose, equally weighted categories of

assets are used.

Bets Estimation Another important function of a portfolio manager is to make an estimate of

best coefficient. It measurers and ranks the systematic risk of different assets. Best coefficient

is an index of the systematic risk. This is useful in making ultimate selection of securities for

investment by investment by a portfolio manager.

E-Balancing Portfolios Rebalancing of portfolios involves the process of periodically

adjusting the portfolios to maintain the original conditions of the portfolio. The adjustment

may be made either by way of ‗Constant proportion portfolio or by way of Constant best

portfolio‗. In

Constant proportion portfolio, adjustments are made in such a way as to maintain the relative

weighing in portfolio components according to the change in prices. Under the constant beta

portfolio, adjustments are made to accommodate the values of component betas in the

portfolio.

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Strategies A portfolio manager may adopt any of the following strategies an part of an

efficient portfolio management.

Buy and Hold Strategy Under the buy and hold‘ strategy, the portfolio manager builds a

portfolio of stock which is not disturbed at all for a long period of time. This practice is

common in the case of perpetual securities such as common stock.

Indexing Another strategy employed by portfolio managers is indexing‗. Indexing involves

an attempt to replicate the investment characteristics of a popular measure of the bond

market. Securities that are held in best-known bond indexes are basically high grade issues.

Laddered Portfolio Under the laddered portfolio, bonds are selected in such a way as that

their maturities are spread uniformly over a long period of time. This way a portfolio

manager aims at distributing the funds throughout the yield curve.

Barbell Portfolio Under the laddered portfolio, bonds are selected in such a way as that their

maturities are spread uniformly over a long period of time. This way a portfolio manager

aims at distributing the funds throughout the yield curve can also benefit from lower

transaction costs because of better liquidity.

1SEBI Guidelines

Following are the guidelines pertaining to the issue of bonus shares by a listed

corporate enterprise:

Reservation In respect of FCDs and PCDs, bonus shares must be reserved in

proportion to such convertible part of FCDs and PCDs. The shares so reserved may be issued

at the time of conversion(s) of such debentures on the same terms on which the bonus issues

were made.

Reserves The bonus issue shall be made out of free reserves built out of the

genuine profits or share premium collected in cash only. Reserves created by revaluation of

fixed assets are not capitalized.

Dividend mode The declaration of bonus issue, in lieu of dividend, is not made

Fully paid The bonus issue is not made unless the partly paid shares, if any are

made fully paid-up.

No default The Company has not defaulted in payment of interest or principal in

respect of fixed deposits and interest on existing debentures or principal on redemption

thereof and has sufficient reason to believe that it has not defaulted in respect of the payment

of statutory dues of the employees such as contribution to provident fund, gratuity, bonus etc.

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Implementation A company that announces its bonus issue after the approval of

the Board of Directors must implement the proposal within a period of 6 months from the

date of such approval and shall not have the option of changing the decision.

The articles The articles of Association of the company shall contain a provision

for capitalization of reserves, etc. If there is no such provision in the Articles, the company

shall pass a resolution at its general body meeting making provisions in the Articles of

Associations for capitalization.

Resolution Consequent to the issue of bonus shares if the subscribed and paid-up

capital exceeds the authorized share capital, the company at its general body meeting for

increasing the authorized capital shall pass a resolution.

PRICING OF THE ISSUE Preferential Issue of Shares:

The issue of shares on a preferential basis can be made at a price not less than the higher

of the following:

a. The average of the weekly high and low of the closing prices of the related shares quoted

on the stock exchange during the six months preceding the relevant date (thirty days prior to

the date on which the meeting of general body of shareholders is held in terms of Section

81(1A) of the Companies Act, 1956 to consider the proposed issue) (or)

b. The average of the weekly high and low of the closing prices of the related shares quoted

on a stock exchange (any of the recognized stock exchanges in which the shares are listed and

in which the highest trading volume in respect of the shares of the company has been

recorded during the preceding 6 months prior to the relevant date) during the two weeks

preceding the relevant date.

Pricing of Shares arising out of warrants, etc

Where warrants are issued on a preferential basis with an option to apply for and be

allotted shares, the issuer company shall determine the price of the resultant shares. The

relevant date for the above purpose may, at the option of the issuer be either the one referred

to above or a date 30 days prior to the date on which the holder of the warrants becomes

entitled to apply for the said shares. The resolution to be passed in terms of section 81(1A)

shall clearly specify the relevant date on the basis of which price of the resultant shares shall

be calculated. An amount equivalent to at least ten percent of the price fixed in terms of the

above shall become payable for the warrants on the date of their allotment. The amount

referred to above shall be adjusted against the price payable subsequently for acquiring the

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shares by exercising an option for the purpose. The amount so referred to above shall be

forfeited if the option to acquire shares is not exercised.

Pricing of shares on conversion:

Where PCDs/FCDs/other convertible instruments, are issued on a preferential basis,

providing for the issuer to allot shares at a future date, the issuer shall determine the price at

which the shares could be allotted in the same manner as specified for pricing of shares

allotted in lieu of warrants as indicated above.

RAISING INTER CORPORATE LOANS AND FIXED DEPOSITS:

Loan syndication - the sources of funds

Loan syndication in the case of domestic borrowings is undertaken with the institutional

lenders and the banks. Amongst institutional lenders , the following institutions are the main

suppliers of long and medium term funds with which the merchant bankers contact liaison

and arrange loans , working for and on behalf of the clients.

A. Some of the All India Financial Institutions  include:

i)       Industrial Finance Corporation of India (IFCI)

ii)      Industrial Development Bank of India (IDBI)

iii)    Industrial Credit and Investment Corp. of India (ICICI)

iv)    Industrial Reconstruction Bank of India (IRBI)

B. State financial institutions like :

i)       state financial Corporations(SFCs)

ii)      State industrial development corporations(SIDCs)

iii)    State Industrial and Investment Corp. (SIICs)

are also approached by the merchant bankers

C. All India level investment institutions also help in the process . They include ;

i)       Life Insurance Corp. of India

ii)      Unit Trust of India

iii)    General Insurance Corp. of India an its subsidiaries.

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D. Commercial Banks

Commercial banks join consortium financing with All India financial institutions to provide medium term loans to industrial projects , otherwise they cater to the needs of working capital requirements .

Loan Syndication - the instruments

There are several main groups of instruments on offer in the syndicated loan market :

•Term loan : This type of loan is fully drawn and is either repaid in full at maturity (bullet payment) or repayments may start before the final maturity (staged repayment). The borrower has a right to call all or part of the loan at any time without paying penalty, but it cannot redraw any part it has canceled.

•Revolving credit facility : A revolving credit facility gives the borrower more flexibility about how much principal can be outstanding during the loan’s life.

•Evergreen facility : A loan that can be extended after pre-set periods. For example, a five year evergreen loan could be extendible every year for another five years.

•Back-stop facility : A back-stop facility protects a company against liquidity crunch; it is a loan designed to be drawn only as the last resort. Many borrowers regard back-stop as an insurance policy in case they suffer temporary shortfalls in funds or a failure of one of their normal funding sources. Most back-stops also include a swingline facility, which gives the borrowers the "same day money".

Loan syndication - the advantages

•Cost of funds :

This mode of financing is cheaper than their average cost of funds raised through a series of bilateral loans. The cost saved increases as the amount required increases.

•Maturity Profile :

These facilities have a wide maturity range starting from an year to 20 years.

•Diversity of credit risk :

 Banks are also prepared to lend to non-investment grade companies, to borrowers not rated and to borrowers who are starting operations. Another advantage is that the banks will consider and price a range of credit enhancements, such as security over assets, off-balance sheet structures, security over property and using offshore vehicles to channel cash flows; which reduces funding costs for non-investment grade borrowers.

•Confidentiality :

 Confidentiality of the process can be ensured.

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•Size :

 Funds larger than $1 billion have been raised by syndicated loan market. A case in point is the Hanbo Steel Company of S.Korea which raised close to $5.8 billion through syndicated loans to finance its expansion and modernisation.

•Speed and certainty :

Once a borrower has mandated a group of banks to underwrite a loan it can be certain that it will have the funds it requires and on the terms it needs.

•Flexibility :

Unlike highly standardised debt markets, banks are willing to price a wide range of transactions incorporating non-standard cash flow. A borrower can incorporate a variety of instruments like multi-currency options, risk management techniques and pre-payment of the loan in advance without paying a fee.

•Currency :

 Most bank lenders, provide freely convertible currencies while international bank markets change their positions regularly and are generally reluctant to buy bonds in a currency that is weakening.

•Renegotiation :

Renegotiation may be possible under certain situations.  

LOAN SYNDICATION FOR DOMESTIC BORROWINGS -  THE CURRENT SCENARIO

The Reserve Bank of India announced, in April 1997, a series of measures to free banks from the shackles of norms and other restrictive rules large advances. One of the measures was to remove the requirement of consortium lending and, as further gratuitous, it said, ``as an alternative to sole/multiple banking/consortium, banks are free to adopt the syndication route irrespective of quantum of credit involved, if the arrangement suits the borrower and financing banks''.

Syndicated lending for working capital, as advised by RBI, has not yet made its debut in India, although 15 months have elapsed since it made the suggestion. Some of the reasons for this are as follows.

Dispute over Interest Rate setting :

The vast majority of such loans the world- over carry a uniform interest rate, viz., the borrower pays the same interest to all the banks participating in a syndicated loan. Under Indian conditions, this could prove to be a major stumbling block. Different banks have different prime lending rates (PLR) and prime term lending rates (PTLR), with big public sector banks having the lowest PLR/PTLR and private sector/foreign banks having the highest PLR/PTLR. . If a blue chip borrower were to seek a syndicated loan at the PLR of a

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big public sector bank, all the smaller private/foreign banks would be shut out of the loan; they cannot obviously lend below their PLR, which would be higher than the rate paid by the borrower. The one possibility is to treat such loans as being outside the purview of PLR. But then, the very sanctity of PLR would be lost.  

Dispute over Overall Responsibility :

Secondly, the syndicated form of lending pre-supposes that the main bank or the leader bank assumes the overall responsibility for the appraisal and supervision of the loan. Currently, in multiple or consortium lending, all member banks individually appraise the loan and are also supposed to monitor the end-use, value of security, the general health of the borrower etc., periodically. In syndicated lending, it is unlikely that the Government and RBI officers sitting on the boards of various public sector banks would permit the officers of the member banks in a syndicated loan to rely solely or even primarily on the leader bank for regular appraisal and monitoring of the loan. They would expect these officers to do a complete due diligence exercise for the loan, as if it is solely granted by the member bank. This would defeat the purpose behind syndication.

Lack of Marketing Skills :

Last of the peripheral reasons is that syndicated lending calls for active, if not aggressive marketing by the leader bank. Indian banks, primarily in the public sector, do not possess this skill or if they did possess the skill, it has been kept under wraps for so long as to be ineffective.

The main reason, of course, is that nowhere in the world has anybody attempted syndicated lending for working capital (short- term) advances.

 Two of the prerequisites for a syndicated loan are that the period of the loan is for a few years and the security is a fixed charge on the assets of the borrower, unless it is on an unsecured basis.          Both these are not met in a short-term working capital advance. The period of such an advance is contractually short, not exceeding one year. The security for working capital loans is invariably a floating charge on assets created with the loan, i.e., current assets on hypothecation basis. The value the security comprising current assets will be constantly changing and this kind of security is totally unsuited for a syndicated loan. Therefore, syndicated loans are not for short-term working capital advances, for which RBI had recommended that system to all   banks.

Examples

1 . Crompton Greaves Ltd. raises Rs.45 cr

CROMPTON Greaves Ltd (CGL) has raised Rs. 45 crores from the domestic market by way of loan syndication.  The transaction, which is the first of its kind in the country, was arranged by ANZ Investment Bank. Typically, in a offshore term-loan syndication, an arranger bank places the specified amount with a number of other non-consortium banks. The transaction is structured on a uniform pricing basis, with fee sharing indicated upfront and with common loan and security documentation.

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In CGL's case, the total facility of Rs. 45 crores was placed with three banks - Vijaya Bank (Rs. 20 crores), Indian Overseas Bank (Rs. 15 crores) and State Bank of Saurashtra (Rs. 10 crores).

The syndicated term-loan, linked to the respective bank prime lending rates (PLRs), has been priced uniformly at 13.5 per cent per annum payable quarterly. The four-year loan, repayable in equal installments at the end of second, third and fourth years, is secured by pari passu first charge on the assets of the company. The loan and security documentation for all three participating banks is common.

CGL plans to utilise the amount for modernisation of its plant and machinery and other capital expenditure programmes. This fund-raising is a part of the company's overall borrowing programme of Rs. 200 crores for the financial year 1998-99.

QUESTION BANK

TWO MARKS1) What do you mean by merchant bank?2) Define merchant banker.3) What is portfolio management?

FIVE MARKS1. What are the objectives of merchant bankers?2. What are the functions of merchant bankers?3. What are the guidelines given to merchant bankers?

TEN MARKS1. What are the regulations issued to merchant bankers from SEBI?2. Describe about the process of merchant banking.3. Explain about the services provided by merchant bankers.

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