Merchant Banking

Merchant Banking

Dr K Ramesha

Professor

MERCHANT BANKING HISTORY

• In late 17th and early 18th century Europe, the largest companies of the world were merchant adventurers. Supported by wealthy groups of people and a network of overseas trading posts, the collected large amounts of money to finance trade across parts of the world. For example, The East India Trading Company secured a Royal Warrant from England, providing the firm with official rights to lucrative trading activities in India. This company was the forerunner in developing the crown jewel of the English Empire. The English colony was started by what we would today call merchant bankers, because of the firm's involvement in financing, negotiating, and implementing trade transactions

MERCHANT BANKING HISTORY• The colonies of other European countries were started in the same

manner. For example, the Dutch merchant adventurers were active in what is now Indonesia; the French and Portuguese acted similarly in their respective colonies. The American colonies also represent the product of merchant banking, as evidenced by the activities of the famous Hudson Bay Company. One does not typically look at these countries' economic development as having been fueled by merchant bank adventurers. However, the colonies and their progress stem from the business of merchant banks, according to today's accepted sense of the word.

• The colonies of other European countries were started in the same manner. For example, the Dutch merchant adventurers were active in what is now Indonesia; the French and Portuguese acted similarly in their respective colonies. The American colonies also represent the product of merchant banking, as evidenced by the activities of the famous Hudson Bay Company. One does not typically look at these countries' economic development as having been fueled by merchant bank adventurers. However, the colonies and their progress stem from the business of merchant banks, according to today's accepted sense of the word.

THE HISTORICAL MERCHANT BANK

• Merchant Banking, as the term has evolved in Europe from the 18th century to today, pertained to an individual or a banking house whose primary function was to facilitate the business process between a product and the financial requirements for its development. Merchant banking services span from the earliest negotiations from a transaction to its actual consummation between buyer and seller.

• In particular, the merchant banker acted as a capital sources whose primary activity was directed towards a commodity trader/cargo owner who was involved in the buying, selling, and shipping of goods. The role of the merchant banker, who had the expertise to understand a particular transaction, was to arrange the necessary capital and ensure that the transaction would ultimately produce "collectable" profits. Often, the merchant banker also became involved in the actual negotiations between a buyer and seller in a transaction

THE MODERN MERCHANT BANK

• During the 20th century, however, European merchant banks expanded their services. They became increasingly involved in the actual running of the business for whom the transaction was conducted. Today, merchant banks actually own and run businesses for 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 day skills. These skills include those inherent in an entrepreneur, a management advisor, a commercial and/or investment banker plus that of a transaction broker. Today a merchant banker is who has the ability to merchandise -- that is, create or expand a need -- and fulfill capital requirements. The modern European merchant bank, in many ways, reflects the early activities and breadth of services of the colonial trading companies

THE MODERN MERCHANT BANK

• Most companies that come to a U.S. merchant bank are looking to increase their financial stability or satisfy a particular, immediate capital need.

• Professional merchant bankers must have: 1) an understanding of the product, its industry and operational management; 2) an ability to raise capital which might or might not be one's own (originally merchant bankers supplied their own capital and thereby took an equity interest in the transaction); 3) and most importantly, effective skills in concluding a transaction - the actual sale of the product and the collection of profit. Some people might question whether or not there are many individuals or organizations who have the abilities to fulfill all three areas of expertise

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

Merchant Banking - Britain

• Merchant banking in Britain developed partly as a result of the operation of historical factors and partly in response to the requirements of trade and industry for their short and long term needs. Though merchant banks themselves collect deposits and grant credit to a limited extent, they act mainly as intermediaries– In channelling short term credit from commercial banks through

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

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


• In addition, MBs render a variety of advisory services to individuals and corporate bodies including such financial institutions as investment trust and unit trusts, of which they are the promoters and managers. MBs therefore from an integral part of the complex of financial institutions like commercial banks, discount houses, long-term financial institutions and capital markets and have therefore established intimate business relationships with them through daily contacts and advisory services.

Merchant Banking - Britain• The prominent MBs do acceptance of business; many of them act as

issuing houses, some are financial bankers, some do foreign exchange business, some are engaged in bullion business, a few undertake merchanting. All of them do banking in some form by keeping money in current or other accounts for their customers at home or abroad. This type of banking activity ancillary to other services, but the keeping of current account on which their customers draw by cheque is a substantial business for many of them. Allied with this is the keeping of securities in safe custody including the accounts of customers and making and realizing investments on their behalf. This has led in many cases to giving advise to customers on their investments as well as on the management of pension funds, college endowments and other funds of a similar nature. Some of them have an active trustee business which either a department or a separate subsidiary company handles. They also act as registrars and transfer agents for industrial companies. Many MBs have promoted and are managers of investment trusts and unit trusts. By developing unit-linked insurance business, they have set up their own life insurance companies, or have established business connections with the existing life insurance offices.


• 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 medium term export credit

– Advise a growing number of industrial companies not only on how and when to raise capital but also on their financial affairs generally

– Engaged in foreign security business, placing American shares in Europe and vice versa, running European and off-shore trusts thus concerning themselves with foreign loan business

Merchant Banking - USA

• In US, investment bankers are mainly engaged in marketing corporate and other obligations. Investment banking firm forms and manages any syndicate to market public offerings of the issue made by a client corporation. The investment banker is a good judge of the timing of the issue, secondly, he is adept in formulating the terms and conditions which are acceptable to investors in the prevailing conditions. The investment banking firms are, therefore, mainly engaged in investment advisory services bearing on domestic issues of capital as well as in arranging consortia for the issue of capital on behalf of foreign governments and foreign corporate enterprises


• It is important to bear in mind that these institutions have grown and functioned over the years in the environment of freedom wherein they have diversified their activities in tune with the changing circumstances. They have developed qualities of integrity, financial expertise, high management stability, loyalty and close relationship with clients. Many of them have substantial resources of their own and command additional resources through access to commercial banks, financial institutions and the stock market with which they have established intimate relations and enjoy a high creditworthy status


• In the post war period, new trends have emerged in the work frame of commercial banks in the European countries which indicate that banks are now prepared to offer multiple services including merchant banking services, to their individual and corporate clients. Taking advantage of this several banks (in US and UK) set up either subsidiary companies or separate divisions in their own organizations to offer these services. Commercial banks have thus been competing with the old established merchant banks (IB)

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 merchant banker does. In this situation, let us try to settle for a workable definition of this term.


• 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 banker means 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 services in relation to such issue management”

Merchant Banks - Concept• Merchant Banker

– Should be engaged in the business of issue management

– 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 such issue management

• ‘engaging 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 services to such issue management’


• 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, of the deposits of money from the public, repayable on demand or otherwise 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 company to internal underwriting support and to manage any issue. It reads “the effecting, insuring, guaranteeing, underwriting, participating in managing and carrying out of any issue, public or private of state, municipal or other loans or shares, stock, debentures or debenture stock of any company, corporation or association and the lending of money for the purpose of any such issue”

– A bank can undertake merchant banking business, but an MB can not undertake banking business


• 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 in securities are not performed by MB


• Merchant Banking Vs Management Consultancy• Institute of Chartered Accountants of India –

management consultancy does not include the functions of statutory periodical audits, tax representation or advice concerning matters or acting as liquidator, trustee, executor, administrator, arbitrator or receiver, but shall include…….

• The scope of management consultancy is much wider than MB

Merchant Banking in India

• Till early 1960s there was no merchant banking in the Indian banking system. It was the Grindlays Bank which started merchant banking services as far back as 1967 in India. Others to follow were Citibank (1970), SBI (1972)

• The boom in the capital market in mid 1970s with the introduction of FERA – 1973 encouraged other banks and financial institutions to set up MB divisions.

• Private financial brokers also started private MB organizations

Merchant Banking in India

Merchant Banking Divisions

ForeignBanks

IndianBanks

FinancialInstitutions

PrivateMerchantBankers

SubsidiaryDivision in

Bank

Merchant Banking and Corporates

Objectives ofMerchantBanking

Guidance

Project Formulations

Implementation

Modernization

Diversification

Mobilizing Resources

Raising Working Capital

Activities of Merchant Bankers

• Wide range of activities – broadly classified under two heads - counseling and procuring finance

• 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


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

• Aid in applying to financial institutions, banks and other sources of finance

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

• Consultation about alternative sources of finance, debt-equity ratios, etc

• Liaison with government departments, financial institutions, banks etc

• Advise and assistance for modernization, expansion and diversification

Activities of Merchant Bankers• Some of the important functions of a MB are

– Issue management• Deciding on the size and timing of a public issue in the light of

market conditions• Preparing the base of successful issue marketing from initial

documentation, 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 like

brokers, portfolio managers and financial press for pre-selling and media coverage

• Preparation of draft prospectus and other documents• Wide coverage throughout the country for collection of

applications• advertisement


• 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

Merchant Banking

Documents

Transcript of Merchant Banking