Revise Lecture 30 1. Merchant Banking 2 Merchant Banking – An Overview The financial services...

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Revise Lecture 30

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• Merchant Banking

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Merchant Banking – An Overview

• The financial services sector is an important

constituent of the financial system and plays a significant role in the realm of economic development of a country.

• Merchant Banking is a prominent component of the financial sector of our country.

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• Merchant banking, although a non-banking financial activity, resembles banking function.

• The function of merchant banking which originated, and grew in Europe, was enriched by American patronage, and these services are now being provided throughout the world by both banking and non-banking institutions.

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• The word ‘Merchant Banking’ originated among the Dutch and the Scottish traders, and was later on developed and professionalized in Britain.

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• In the U.S., investment bankers cater to the needs of business enterprises carrying out merchant banking functions. The main functions of merchant banking are the following;

1. Corporate counselling2. Project counselling3. Pre-investment studies

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4. Capital restructuring5. Credit syndication and project finance6. Issue management and underwriting7. Portfolio management8. Working capital finance9. Acceptance creat and bill discounting10. Mergers, Amalgamations and takeovers

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11. Venture capital12. Lease financing13. Foreign currency finance14. Fixed deposit broking15. Mutual funds16. Relief to sick industries17. Project appraisal

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•Public Issue Management

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Public Issue Management

• The management of securities of the corporate sector offered to the public on a regular basis, and existing shareholders on a rights basis, is known as ‘public issue management’.

• Issue management is an important function of merchant bankers and lead managers.

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• The management of issues for raising funds through various types of instruments by companies is known as ‘issue management’.

• A fast growing economy like Pakistan offers tremendous scope for issue management and the merchant bankers provide their skills and expertise to companies in the management of capital issues.

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• Categories of Securities Issue

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• Corporate enterprise use several sources for raising funds from the capital market.

• Issue of securities constitutes an important mode of raising such finances.

• Security issues takes the following forms;1. Public issue2. Right issue3. Private placement

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Public issue of securities:• When capital funds are raised through the

issue of a prospectus, it is called ‘public issue of securities’.

• It is the most common method of raising funds in the capital market.

• A security issue may take place either at par, or at a premium or at a discount.

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Public issue of securities:• The prospectus has to disclose all the essential

facts about the company to the prospective purchasers of the shares.

• SECP insists on the adequacy of disclosure of information that should serve as the basis for investors to make a decision about the investment of their money.

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Right issue:• When shares are issued to the existing

shareholding of a company on a privileged basis, it is called as ‘Rights Issue’.

• The existing shareholders have a pre-emptive right to subscribe to the new issue of shares.

• Rights shares are offered as additional issues by corporates to mop up further capital funds.

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Private placement:• When the issuing company sells securities

directly to the investors, especially institutional investors, it takes the form of private placement.

• In this case, no prospectus is issued, since it is presumed that the investors have sufficient knowledge and experience and are capable of evaluating the risks of the investment.

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Public issue of securities:• Private placement covers shares, preference

shares and debentures.• The role of financial intermediary, such as

merchant bankers and lead managers, assumes greater significance in private placement.

• They involve themselves in the task of preparing an offer memorandum and negotiating with investors.

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Public issue of securities:Private placement obviously commands an

advantage over the public issue on the following grounds;

1. Speed and confidentiality of issue2. Access to capital market more quickly than a

public issue which may take 6 months to one year. Time taken by private placement is just 2 to 3 months.

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Public issue of securities:3. Less expensive method of raising capital

because of fewer compliance procedures4. Advantageous to small companies which

cannot afford a public issue because of the expense involved.

5. Ideally suited to companies which need only relatively limited amount of capital funds.

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• Issue Manager

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Issue Manager• Any financial institution / intermediary which

can carry out the activities connected with issue management, is registered with SECP, and can follow its regulations and guidelines, is capable of venturing into issue management.

• Issue management is an important activity for merchant bankers.

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Issue Manager (Requirements)The Issue manager needs to satisfy the following

requirements before being allowed by the SECP to carry out various issue management activities;

1. Adequate and necessary infrastructure such as adequate office space, equipments and manpower to effectively discharge activities.

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Issue Manager (Requirements)2. Minimum number of two persons needed,

who are professionally qualified in Law, Finance or Banking management and have the experience to conduct the business of the merchant banker.

3. Fulfilling the capital adequacy requirements, i.e. a minimum net worth of Rs 5 crores.

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• Categories of Issue managers

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Categories of Issue managers• SECP has classified Issue managers into four

categories as follows;• Merchant banker who is authorized to act as

issue manager, advisor, consultant, underwriter and portfolio manager.

• Merchant banker who is authorized to act only as advisor, consultant, underwriter and portfolio manager.

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Categories of Issue managers

• Merchant banker who is authorized to act as underwriter, advisor to an issue.

• Merchant banker who is authorized to act only as advisor or consultant to an issue.

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• Role of Issue manager

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Role of Issue manager The merchant banker as an issue manager is

helpful is the following ways;1. Easy floatation:• An issue manager acts as an indispensable pilot

facilitating a public / right issue. This is made possible with the help of a repository of special skills possessed by him to execute the management of issue.

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2. Financial consultant:• An issue manager essentially acts as a financial

architect, by providing advice relating to capital structuring, capital gearing and financial planning for the company.

3. Underwriting:• An issue manager allows for underwriting the

issues of securities made by corporate enterprise. This ensures due subscription of the issue.

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4. Market makers:• Merchant bankers, an issue managers often

act as the market makers for the issues lead managed by them.

• They invest, continue to hold and provide, buy and sell quotes for the listed scrips of the company.

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5. Due diligence:• The issue manager has to comply with SECP

guidelines. • The merchant banker will carry out activities

with due diligence and furnish a Due Diligence Certificate to SECP.

• SECP has also prescribed a code of conduct for merchant bankers.

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• Activities involved in public issue management

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Activities involved in public issue management:• There are several activities that have to be

performed by the issue manager in order to raise money from the capital market.

• Adequate planning needs to be done while chalking out an appropriate marketing strategy.

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Activities involved in public issue management:• The various activities involved in raising funds

from the capital markets are the following;Pre-issue Activities:1. Signing of MoU2. Obtaining appraisal note3. Optimum capital structure

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Activities involved in public issue management:4. Convening meeting5. Appointment of financial intermediary6. Preparing documents7. Due diligence certificate8. Submission of offer document9. Finalization of collection centres

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Activities involved in public issue management:10. Filing with RoC.11. Launching the issue12. Promoter’s contribution.13. Issue closure

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Lecture 31

•Marketing of new issues

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Marketing of New Issues

Methods of marketing securities:• Following are the various methods being

adopted by corporate entities for marketing the securities in the New Issues Market;

1. Pure prospectus method2. Offer for sale method3. Private placement method

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Methods of marketing securities:4. Initial public offers (IPOs) method5. Right issue method6. Bonus issue method7. Book-building method8. Stock option method9. Bought-out deals method

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Pure prospectus method:• The method whereby a corporate enterprise

mops up capital funds from the general public by means of an issue of a prospectus, is called ‘pure prospectus method’.

• It is the most popular method of making public issue of securities by corporate enterprises.

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Pure prospectus method:Advantages:• The pure prospectus method of marketing the

securities serves as an excellent mode of disclosure of all the information pertaining to the issue. The method promotes confidence of investors through transparency and non-discriminatory basis of allotment.

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Pure prospectus method:Drawbacks:

1. High issue costs2. Time consuming

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Offer for Sale method:• Where the marketing of securities takes place

through intermediaries, such as issue houses, stockbrokers and others, it is a case of ‘Offer for Sale Method’.

• Under this method, the sale of securities takes place in two stages.

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Offer for Sale method:• First stage, the issuer company makes an en-block

sale of securities to intermediaries such as the issue houses and share brokers at an agreed price.

• Second stage, the securities are re-sold to ultimate investors at a market-related price. The difference between the purchase price and the issue price constitutes ‘profit’ for the intermediaries.

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Offer for Sale method:Advantage:• The biggest advantage of this method is that it saves

the issuing company the hassles involved in selling the shares to the public directly through prospectus.

Drawback:• This method is, however, expensive for the investor

as it involves the offer of securities by issue houses at very high prices.

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Private Placement Method:• A method of marketing of securities whereby

the issuer makes the offer of sale to individuals and institutions privately without the issue of a prospectus is known as ‘Private Placement Method’.

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Private Placement Method:Advantages:1. Less expensive as various types of costs

associated with the issue are borne by the issue houses and other intermediaries.

2. Placement of securities suits the requirements of small companies.

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Private Placement Method:Disadvantages:1. Concentration of securities in a few hands.2. Depriving the common investors of an

opportunity to subscribe to the issue, thus affecting their confidence level.

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Initial Public Offer (IPO) Method:• The public issue made by a corporate entity

for the first time in its life is called ‘Initial Public Offer’ (IPO).

• Under this method of marketing, securities are issued to successful applicants on the basis of the orders placed by them, through their brokers.

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Initial Public Offer (IPO) Method:• The job of selling the stock is entrusted to a

popular intermediary, the underwriter. Advantage:The biggest advantage of this method of

marketing of securities is that there is no need for the investors to part with the money even before the shares are allotted in his favor.

Revise Lecture 30 1. Merchant Banking 2 Merchant Banking – An Overview The financial services...

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