7380585-Merchant-Banking

8/7/2019 7380585-Merchant-Banking

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Merchant Banking

Dr K Ramesha

Professor


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MERCHANT BANKING HISTORY

In late 17th and early 18th century Europe, the largestcompanies of the world were merchant adventurers.Supported by wealthy groups of people and a network ofoverseas trading posts, the collected large amounts of

money to finance trade across parts of the world. Forexample, The East India Trading Company secured aRoyal Warrant from England, providing the firm withofficial rights to lucrative trading activities in India. Thiscompany was the forerunner in developing the crown

jewel of the English Empire. The English colony wasstarted by what we would today call merchant bankers,because of the firm's involvement in financing,negotiating, and implementing trade transactions


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MERCHANT BANKING HISTORY

The colonies of other European countries were started in the samemanner. For example, the Dutch merchant adventurers were active inwhat is now Indonesia; the French and Portuguese acted similarly in theirrespective colonies. The American colonies also represent the product ofmerchant banking, as evidenced by the activities of the famous HudsonBay Company. One does not typically look at these countries' economicdevelopment as having been fueled by merchant bank adventurers.

However, the colonies and their progress stem from the business ofmerchant banks, according to today's accepted sense of the word.

The colonies of other European countries were started in the samemanner. For example, the Dutch merchant adventurers were active inwhat is now Indonesia; the French and Portuguese acted similarly in theirrespective colonies. The American colonies also represent the product ofmerchant banking, as evidenced by the activities of the famous Hudson

Bay Company. One does not typically look at these countries' economicdevelopment as having been fueled by merchant bank adventurers.However, the colonies and their progress stem from the business ofmerchant banks, according to today's accepted sense of the word.


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THE HISTORICAL MERCHANT

BANK

Merchant Banking, as the term has evolved in Europe from the 18thcentury to today, pertained to an individual or a banking housewhose primary function was to facilitate the business processbetween a product and the financial requirements for itsdevelopment. Merchant banking services span from the earliest

negotiations from a transaction to its actual consummation betweenbuyer and seller.

In particular, the merchant banker acted as a capital sources whoseprimary activity was directed towards a commodity trader/cargoowner who was involved in the buying, selling, and shipping ofgoods. The role of the merchant banker, who had the expertise tounderstand a particular transaction, was to arrange the necessary

capital and ensure that the transaction would ultimately produce"collectable" profits. Often, the merchant banker also becameinvolved in the actual negotiations between a buyer and seller in atransaction


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THE MODERN MERCHANT

BANK

During the 20th century, however, European merchant banksexpanded their services. They became increasingly involved in theactual running of the business for whom the transaction wasconducted. Today, merchant banks actually own and run businessesfor their own account, and that of others.

Since the 18th century, the term merchant banker has, therefore,been considerably broadened to include a composite of modern dayskills. These skills include those inherent in an entrepreneur, amanagement advisor, a commercial and/or investment banker plusthat of a transaction broker. Today a merchant banker is who hasthe ability to merchandise -- that is, create or expand a need -- andfulfill capital requirements. The modern European merchant bank, in

many ways, reflects the early activities and breadth of services ofthe colonial trading companies


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THE MODERN MERCHANT

BANK

Most companies that come to a U.S. merchant bankare looking to increase their financial stability orsatisfy a particular, immediate capital need.

Professional merchant bankers must have: 1) an

understanding of the product, its industry and operationalmanagement; 2) an ability to raise capital which might ormight not be one's own (originally merchant bankerssupplied their own capital and thereby took an equityinterest in the transaction); 3) and most importantly,effective skills in concluding a transaction - the actual

sale of the product and the collection of profit. Somepeople might question whether or not there are manyindividuals or organizations who have the abilities tofulfill all three areas of expertise


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Backdrop

Financial system in particular banking system

before 1968

Financial system, in particular financial markets

and banking system during 1968-1991

Developments in the financial system, banking

system and financial markets in the post 1991

period Universal banking concept

Creation of SEBI


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Merchant Banking - Britain

Merchant banking in Britain developed partly as a resultof the operation of historical factors and partly inresponse to the requirements of trade and industry fortheir short and long term needs. Though merchant banks

themselves collect deposits and grant credit to a limitedextent, they act mainly as intermediaries In channelling short term credit from commercial banks through

discount houses to merchants engaged in the import and exporttrade or in the marketing of goods in the domestic market

In channelling medium and long term capital from those whowish to lend to those who are in need of funds


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In addition, MBs render a variety of advisoryservices to individuals and corporate bodiesincluding such financial institutions asinvestment trust and unit trusts, of which they

are the promoters and managers. MBstherefore from an integral part of the complex offinancial institutions like commercial banks,discount houses, long-term financial institutionsand capital markets and have thereforeestablished intimate business relationships withthem through daily contacts and advisoryservices.


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Merchant Banking - Britain The prominent MBs do acceptance of business; many of them act asissuing houses, some are financial bankers, some do foreign exchange

business, some are engaged in bullion business, a few undertakemerchanting. All of them do banking in some form by keeping money incurrent or other accounts for their customers at home or abroad. Thistype of banking activity ancillary to other services, but the keeping ofcurrent account on which their customers draw by cheque is a substantial

business for many of them. Allied with this is the keeping of securities insafe custody including the accounts of customers and making andrealizing investments on their behalf. This has led in many cases to givingadvise to customers on their investments as well as on the managementof pension funds, college endowments and other funds of a similar nature.Some of them have an active trustee business which either a departmentor a separate subsidiary company handles. They also act as registrars

and transfer agents for industrial companies. Many MBs have promotedand are managers of investment trusts and unit trusts. By developing unit-linked insurance business, they have set up their own life insurancecompanies, or have established business connections with the existinglife insurance offices.


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MBs are active in the following Manage individual funds individuals, firms or

charitable trusts on a large scale

Finance foreign trade both in acceptance business

and in the post-war practice of arranging mediumterm export credit

Advise a growing number of industrial companies notonly on how and when to raise capital but also ontheir financial affairs generally

Engaged in foreign security business, placingAmerican shares in Europe and vice versa, runningEuropean and off-shore trusts thus concerningthemselves with foreign loan business


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Merchant Banking - USA

In US, investment bankers are mainly engaged inmarketing corporate and other obligations. Investmentbanking firm forms and manages any syndicate tomarket public offerings of the issue made by a client

corporation. The investment banker is a good judge ofthe timing of the issue, secondly, he is adept informulating the terms and conditions which areacceptable to investors in the prevailing conditions. Theinvestment banking firms are, therefore, mainly engaged

in investment advisory services bearing on domesticissues of capital as well as in arranging consortia for theissue of capital on behalf of foreign governments andforeign corporate enterprises


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It is important to bear in mind that these institutions havegrown and functioned over the years in the environmentof freedom wherein they have diversified their activitiesin tune with the changing circumstances. They have

developed qualities of integrity, financial expertise, highmanagement stability, loyalty and close relationship withclients. Many of them have substantial resources of theirown and command additional resources through accessto commercial banks, financial institutions and the stock

market with which they have established intimaterelations and enjoy a high creditworthy status


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In the post war period, new trends haveemerged in the work frame of commercial banksin the European countries which indicate thatbanks are now prepared to offer multiple

services including merchant banking services, totheir individual and corporate clients. Takingadvantage of this several banks (in US and UK)set up either subsidiary companies or separatedivisions in their own organizations to offer these

services. Commercial banks have thus beencompeting with the old established merchantbanks (IB)


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Merchant Banks - Concept

There is no statutory or any authoritative

definition for the term Merchant Banking.

For many, it just means management of

capital issues of companies. Some

confuse this with investment banking and

an issue house. Yet another group of

persons mean it to what a merchantbanker does. In this situation, let us try to

settle for a workable definition of this term.


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Definition In the Indian context, merchant banking is understood

to be non-fund based and non-banking services

Merchant bankers are neither merchants nor bankers Rule 2(e) of SEBI (merchant bankers) Rules 1992,

defines who a merchant banker is. merchant bankermeans any person who is engaged in the business ofissue management either by making arrangements

regarding selling, buying or subscribing to securitiesas manager-consultant, advisor or renderingcorporate advisory services in relation to such issuemanagement


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Merchant Banks - Concept Merchant Banker

Should be engaged in the business of issuemanagement

Such engagement should be for Making arrangements regarding selling, buying or

subscribing to securities. Should be engaged as a manager,consultant, advisor in the process of selling, buying,subscribing to securities

Rendering corporate advisory services in relation to suchissue management

engaging in the business of issue managementeither by making arrangements regardingselling, buying or subscribing to securities asmanager, consultant, advisor or renderingcorporate advisory services to such issue

management


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Merchant banking Vs Commercial banking Clause (c) of section 5 of BR Act of 1949, the main business of a

bank is to accept, for the purpose of lending or investment, ofthe deposits of money from the public, repayable on demand orotherwise and withdrawable by cheques, drafts, orders or

otherwise Sub-section of (1) of section 6 deals with the permissible

business. Clause (d) of this section enables a banking companyto internal underwriting support and to manage any issue. Itreads the effecting, insuring, guaranteeing, underwriting,participating in managing and carrying out of any issue, public orprivate of state, municipal or other loans or shares, stock,

debentures or debenture stock of any company, corporation orassociation and the lending of money for the purpose of anysuch issue

A bank can undertake merchant banking business, but an MBcan not undertake banking business


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Merchant Banking Vs Investment Banking There is a thin difference between these two

An investment banker does the following Selling issues of securities of companies

Underwriting functions Helps in mergers and acquisitions

Investment advises

Finding buyers for private placement

Dealing in securities

Hence, similarities between MB and IB.Generally, investment advises and dealing insecurities are not performed by MB


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Merchant Banking Vs Management Consultancy

Institute of Chartered Accountants ofIndia management consultancy does not include the

functions of statutory periodical audits, taxrepresentation or advice concerning matters oracting as liquidator, trustee, executor,administrator, arbitrator or receiver, but shallinclude.

The scope of management consultancy is muchwider than MB


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Merchant Banking in India

Till early 1960s there was no merchant bankingin the Indian banking system. It was theGrindlays Bank which started merchant banking

services as far back as 1967 inIndia. Others tofollow were Citibank (1970), SBI (1972)

The boom in the capital market in mid 1970swith the introduction of FERA 1973encouraged other banks and financialinstitutions to set up MB divisions.

Private financial brokers also started private MBorganizations


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Merchant Banking in India

Merchant Banking Divisions

Foreign

Banks

Indian

BanksFinancial

Institutions

Private

Merchant

Bankers

Subsidiary Division inBank


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Merchant Banking and Corporates

Objectives of

Merchant

Banking

Guidance

Project Formulations

Implementation

Modernization

Diversification

Mobilizing Resources

Raising Working Capital


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Activities of Merchant Bankers

Wide range of activities broadly classifiedunder two heads - counseling and procuringfinance

Some of the important functions of a MB are Project counseling or reinvestment studies for

investors Identify promising projects

Prepare feasibility studies economic and financial

Prepare in-depth project reports

Assist investors in obtaining licenses Do precise capital structuring

Arrange and negotiate foreign collaborations

Give guidance on amalgamations, mergers and takeovers


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Some of the important functions of a MB are Syndication of loans and project finance

Aid in applying to financial institutions, banks and othersources of finance

Expert advise on government policies, demand-supply gaps,raw material availability, product-mix, plan capacityutilization, requirements of plant and machinery etc

Consultation about alternative sources of finance, debt-equityratios, etc

Liaison with government departments, financial institutions,banks etc

Advise and assistance for modernization, expansion anddiversification


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Some of the important functions of a MB are Issue management

Deciding on the size and timing of a public issue in the light ofmarket conditions

Preparing the base of successful issue marketing from initialdocumentation, liaison with SEBI to the preparation of actual

launch Optimum underwriting support

Appointment of bankers and brokers as well as issue houses

Issue management

Professional liaison with share market functionaries likebrokers, portfolio managers and financial press for pre-sellingand media coverage

Preparation of draft prospectus and other documents

Wide coverage throughout the country for collection ofapplications

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Some of the important functions of a MB are

Provision of working capital

Arrangement with banks

Merchant banking is a part of the banking system Sometimes, syndication is arranged by MB

Foreign Currency Loans

Arranges foreign currency loans

Portfolio Management Basically advisory in nature regarding purchase and sale of

securities, handling transactions, safe custody of documents,

collection of dividend etc

7380585-Merchant-Banking

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