How is merchant banking regulated in India

Merchant banking comprises a wide set of banking activities which involves issues management by trading in securities, underwriting security issuances (e.g. an IPO), undertaking valuation of businesses and setting up and packaging M&A deals. In business parlance, it is distinguished from commercial banking, which largely revolves around accepting deposits and giving loans (nowadays, commercial banks also provide additional services such as bill payments, certificates of deposits etc.).

Securities and Exchange Board of India (SEBI) is the regulatory authority for merchant banking in India. Activities of merchant banks are regulated by the SEBI (Merchant Bankers) Regulations, 1992.

As per RBI’s Master Circular on Para-Banking activities, banks are allowed to undertake merchant banking activities through a separate subsidiary which would be required to comply with SEBI regulations. Banking Institutions performing merchant banking activities are also required to follow the requirements laid down in the prudential exposure norms prescribed by RBI, as well as the statutory limits contained in Section 19(2) & (3) of the Banking Regulation Act, 1949.

Merchant banking can also be pursued by entities other than banks (however, they should not be NBFCs as defined under the RBI Act), provided they are registered with SEBI. In case a bank pursues merchant banking activities, it would need a banking license from RBI (to carry out banking activities) and a SEBI registration under the SEBI Merchant Bankers Regulations to carry out merchant banking business.

It is to be noted that, those banks and merchant banking subsidiaries which are performing any of the activities under Portfolio Management Scheme (or any similar scheme) are also required to comply with the provisions of the SEBI (Portfolio Managers) Rules and Regulations, 1993.

However, RBI exempts a merchant banking company from following requirements:

1. Provisions related to mandatory registration, maintenance of liquid assets and creation of reserve funds under the RBI Act, 1934;
2. Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998; and
3. Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998.

To be eligible for the above exemptions, a merchant banking company would need to fulfil the following criteria:

• It should be registered with SEBI under section 12 of the SEBI Act 1992;
• It should conduct the business of merchant banking in accordance with rules or regulations framed by SEBI;
• It should acquire securities only as part of its merchant banking activities;
• It should not be engaged in any other financial activities as mentioned in section 45I(c) of the RBI Act 1934; and
• It should not accept or hold public deposits.

Provisions related to the registration of a merchant bank are laid down in Chapter-II of SEBI Regulations, which provides for mandatory registration to carry out the business of merchant banking in India. Following are some of the requirements which are taken into consideration for grant of certificate:

• Applicant should be a corporate body other than a Non-Banking Financial Company (as defined under the RBI Act);
• Applicant should not engage in any activity other than those connected to securities market;
• Applicant should have a minimum of two employees having prior experience in merchant banking;
• Applicant must not be related (directly or indirectly) to any other entity which is registered as a merchant banker;
• Applicant has not been found guilty for any economic offence; and
• Applicant should have a minimum capital of 5 crore rupees (for category-I merchant banker).

Many statutes and regulations require certain functions [such as valuation of shares under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000] to be performed by SEBI registered Merchant Bankers, and hence for businesses operating in the financial sector, obtaining a merchant banking license can be a strategic advantage. Examples of some of the important functions that are performed by Merchant Bankers are given below:

1. Corporate Counselling – After conducting a detailed market analysis to evaluate feasibility of corporate policies, merchant bankers render commercial and strategic advice to improve overall efficiency of a company.
2. Project Counselling – Studying the nature and scale of investment in a business project and assisting clients with finance & procedural aspect for the successful implementation of the project.
3. Portfolio Management – Advising clients (such as Institutional Investors and high net worth individuals) on managing their investments in order to earn maximum profit in a time bound manner.
4. Issue Management – Sponsoring of corporate securities (e.g. IPOs) including marketing, compliance of listing requirements, procuring private subscription and offering securities to existing shareholders of the company.

Due to factors such as growth of primary market, increasing need of corporate restructuring and easing of FDI norms, merchant banking has never been more relevant in India. Therefore, it is very much required that the restrictive norms governing merchant banking, especially those related to capital adequacy and registration, should be relaxed in order to allow small players to enter and further expand the exclusive club of merchant bankers in India.