Program: M.

Com
Course Title: Financial Markets and Services
Course Code: M19MC3270
Course Type: Soft Core
Course Presenter: Dr. Thamotharan A
Course Mentor: NA
Semester: & Section: III Semester
Academic Year: 2020-2021
Course Pre-requisites: Indian financial system, Management of Banks
L T P: 2:1:0
Pedagogy: ICT and Digital support

Unit –II: Merchant Banking:

Concept – Commercial banking Vs merchant banking; Origin and evolution - Scope - Functions
– Merchant Banking Services, Offer document, Pre-issue and post- Issue obligations- SEBI
regulations- intermediaries, Responsibilities of lead managers, – Stock Broking Services –
Underwriting Services. Securitisation, Special purpose vehicle, Pass through certificates.
Custodial service. Pension funds. (Theory only)

Merchant Banking in India

Merchant bank means bank one who underwrites corporate securities and advises on issues like
corporate merger,
It may be in the form of a company, firm, institutions etc. It is basically service banking which
provides non-financial services such as arranging for funds rather providing fund

The first merchant bank was set up in 1969 by Grind Lays Bank. Initially they were issue
mangers looking after the issue of shares and raising capital for the company. But subsequently
they expanded their activities such as working capital management; syndication of project
finance, global loans, mergers, capital restructuring, etc.,
Merchant banker in India was in the form of management of public issue and providing financial
consultancy for foreign banks.

In 1973, SBI started the merchant banking and it was followed by ICICI. SBI capital market was
set up in August 1986 as a fully-fledged merchant banker.

Between 1974 and 1985, the merchant banker has promoted lot of companies. However they were
brought under the control of SEBI in 1992.

1. Recent Developments in Merchant Banking

1. The recent developments in Merchant banking are due to certain contributory

factors in India. They are

 Many new issues. It is expected that 2010 that it is going to be party time for
 Merchant banks, as many new issues are coming up.
 The foreign investors –both in the form of portfolio investment and through foreign
 Direct investments are venturing in Indian Economy. It is increasing the scope of
 Merchant bankers in many ways.
 Disinvestment in the government sector in the country gives a big scope to the
 Merchant banks to function as consultants.
 New financial instruments are introduced in the market time and again. This basically
 Provides more and more opportunity to the merchant banks.
 The mergers and corporate restructuring along with MOU and MOA are giving
 Immense opportunity to the merchant bankers for consultancy jobs. However the
challenges faced by merchant bankers in India are

2. SEBI guideline has restricted their operations to Issue Management and Portfolio Management
to some extent. So, the scope of work is limited.
3. In efficiency of the clients are often blamed on to the merchant banks, so they are into trouble
without any fault of their own.

4. The net worth requirement is very high in categories I and II specially, so many professionally
experienced person/ organizations cannot come into the picture.

5. Poor New issues market in India is drying up the business of the merchant bankers. Thus the
merchant bankers are those financial intermediary involved with the activity of transferring
capital funds to those borrowers who are interested in borrowing. The activities of the merchant
banking in India is very vast in the nature of
 The management of the customers securities
 The management of the portfolio
 The management of projects and counseling as well as appraisal
 The management of underwriting of shares and debentures
 The circumvention of the syndication of loans
 Management of the interest and dividend etc.

COMPARISON COMMERCIAL BANK MERCHANT BANK

Meaning Commercial bank is providing the Merchant bank refers to the financial
basic banking functions i.e. institution, that specializes in
accepting deposits and lending international trade and provide and
money to general public. selection of services to its clients.

Governing Regulated by Banking Regulation Rules and regulations designed by

Act/body Act, 1949. SEBI.

Engaged in General banking business Consultancy type business

Nature of loan Debt-related Equity-related

extended

Exposure to risk Less Comparatively more

Role Financier Financial Advisor

 Caters Needs of general public. Needs of corporate firms.

Functions of Merchant Bankers

1. Corporate Counselling:
Merchant bankers render advise to corporate enterprises from time to time in order to
improve performance and build better image/reputation among investors and to increase the
market value of its equity shares.
 Government’s economic and licensing policies
 Merchant banks make a detailed market analysis
 It helps in reviving the old-line projects and sick units by assessing their requirements
 Provides help in raising loans from the financial institutions and credit facilities from
the banks.
 Helps in getting approval of financial institutions or banks for schemes of
rehabilitation.
 Monitors rehabilitation schemes
 Finds out the possibilities of takeover of sick units and accordingly makes
arrangement for negotiations with financial institutions/banks and other interested
parties
2. Project Counselling:
Project counselling broadly covers the study of the project and providing advisory services on
the project viability and procedural steps to be followed for its implementation.

 Development of an idea of a project or review of the project idea/project profile.

 Preparation of project report after considering its financial, economic and market
 Advising about location of a project,
 preparing a project report,
 conducting feasibility studies,
 making a plan for financing the project,
 finding out sources of finance,
 advising about concessions and incentives from the government.
3. Capital Restructuring Services:
Merchant banks render different capital restructuring services to the corporate units depending
upon the circumstances a particular unit is facing.
 Examination of the capital structure of corporate unit to decide the extent of capitalisation.
 It helps the clients in preparing the Memorandum for Controller of Capital Issue (CCI)
and in obtaining his consent.
 For companies governed by Foreign Exchange Regulation Act (FERA), merchant
bankers suggest an alternative capital structure which is in conformity with the legal
requirements. It also advises company on disinvestment issues to their maximum
advantage.
 Merchant bankers also render advise on mergers, takeovers and amalgamations and help
in their implementation.
 Merchant bankers also identify the areas of diversification of the existing production
systems and suggest various strategies to widen and restructure the capital base
accordingly
4. Portfolio Management:
Merchant banks offer services not only to the companies issuing the securities but also to
the investors. They advise their clients, mostly institutional investors, regarding
investment
decisions as to the quantum of amount of security and the type of security in which to invest.
5. Issue Management:
merchant banker had been mainly confined to the management of new public issues of
corporate securities by the newly formed companies, existing companies (further issues)
and foreign companies in dilution of equity as required under FERA.
The services provided by them include:
 Preparation of the prospectus.
 Preparation of a plan and budget to estimate total expenditure of the issue.
 Preparation of CCI (Controller of Capital Issues) application and
providing assistance in obtaining consent of the CCI.
 Selection of institutional and broker underwriters and underwriting
agreements.
 Appointment of registrars, brokers and bankers to the issue.
 Advertising and arranging publicity agency for post and pre-issue.
 Selection of issue house.
 Compliance of listing requirements of stock exchanges.
 Act as co-ordinator with underwriter’s brokers and bankers to the issue
and stock exchanges.
 Merchant banker advises the client whether to go for
o A fresh issue or
o Additional issue or
o Bonus issue or
o A right issue of equity or preference or both, if both then, in what proportion it is
to be made
6. Loan/Credit Syndication:
Merchant bankers provide specialized services in preparation of project, loan applications for
raising short-term as well as long-term credit from various banks and financial institutions for
financing the project or meeting the working capital requirements. They also manage Euro-
Issues and help in raising funds abroad.

 Estimation of the total costs/expenditure on the project.

 Preparing a financial plan to meet the total cost of the project keeping into consideration
the requirements of the promoters and their collaborators, financial institutions, banks,
government agencies and underwriters.
 Assisting the clients in the preparation of loan applications for financial assistance from
term lenders/financial Institutions/banks and monitoring their progress.
 Making selection of the institutions/banks for participation in financing.
 Follow-up of the term loan application with the financial institutions and banks and
obtaining the satisfaction for their share of participation.
 Merchants banks help in expediting legal documentation formalities listed by the
participating financial institutions and banks and help in completion of formalities also.
 Merchant banks also help in estimating the working capital requirements and assist the
client in negotiating for the sanction of appropriate facilities.
 Arrange bridge finance which could be either as a part of the main loan sanctioned to the
client by the term lenders or it could be amount against the issue of capital or may be
both.

7. Arranging Working Capital Finance

Earlier, working capital finance was not considered to be a merchant bank activity but used to be
a part of the commercial bank’s function. But some banks like Canara Bank, Grindlays Bank and
Central Bank of India have started including working capital finance as one of the merchant
banking service area.
Finance for working capital is provided usually for new ventures or for existing companies
through issue of debentures. Grind lays bank claims to offer expertise for meeting the
requirements for long-term working capital for private placement of secured debentures. Grind
lays Bank helps the
company in obtaining the enhanced cash credit facilities as well as bill discounting facilities for
their customers or suppliers from banks.

 Estimation of working capital requirements.

 Assistance in preparing the application for credit facilities for submission to the bankers
and Reserve Bank of India.
 Assistance in negotiations for sanction of appropriate credit facilities.
 Helps in expediting documentation and other formalities for disbursements.
 Advises the client for issue of debentures for meeting the increased long term working
capital requirements of the client company.
 Central Bank of India (CBI) helps the client companies in the calculation and provisions
of working capital needed for a given project, management of non-convertible debenture
issues, and management of fixed deposit.

8. Bill Discounting and Acceptance Credit:

Bill discounting function is another important area which is recognized as a merchant banking
activity. But in India this facility is not provided to the corporate units by the merchant bankers.

The need for such services was recognized when Banking Commission 1972, in its report had
recommended the establishment of acceptance and discount house in India following the
development of bill market.

A bill of exchange accepted by a house of established reputation automatically becomes

acceptable to the seller of goods and to the lenders of money even though they do not have any
knowledge of the creditworthiness of the drawer of the bill.

Proposed functions of merchant banker would include the following:

 Finding out the reputation and financial standing of the acceptor.
 The existence of a system for collection of information on borrowers.
 Commercial banks can undertake acceptance and discount business because they have the
necessary expertise and broad network of branches.
  But at present only bill discounting facility is available to commercial banks under the
RBI’s formalized scheme for credit accommodations and under refinancing schemes.
Indian merchant bankers have still to formulate the practices and procedure so that
efficient services could be offered in acceptance and bill discounting
9. Lease Finance:
Many merchant bankers also provide leasing and finance facilities to their customers. Leasing is
an arrangement that provides a firm with the use and control over assets without buying and
owning the same. It is a form of renting assets.

Lease is a contract between the owner of the asset (lessor) and the user of the asset called the
lessee, whereby the lessor gives the right to use the asset to the lessee over an agreed period of
time for a consideration called the lease rental.

The lease contract is regulated by the terms and conditions of the agreement. The lessee pays the
lease rent periodically to the lessor as regular fixed payments over a period of time. The rentals
may be payable at the beginning or end of a month, quarter, half-year or year.

The lease rentals can also be agreed both in terms of amount and timing as per the profits and
cash flow position of the lessee. At the expiry of the lease period, the asset reverts back to the
lessor who is the legal owner of the asset. However, in long-term lease contracts, the lessee is
generally given an option to buy or renew the lease.

Merchant bankers assist their clients by providing finance for the acquisition of asset taken on
lease.

10. Venture Capital:

Many merchant bankers maintain venture capital funds to assist the entrepreneurs who lack
capital to be risked. Capital funds may be provided for unproven ideas, products technology-
oriented or start-up funds. Venture capital has emerged as a new merchant banking activity. It is
a form of equity financing especially designed for funding high risk and high reward projects.

11. Public Deposits:

Merchant bankers also help companies in raising finance by way of public deposits.
12. Specialized Services:
Merchant banks also provide corporate advisory services on issues like mergers and
amalgamation, takeovers, tax matters, recruitment of executives and cost and management audit
etc. Many merchant bankers have also started making of bought out deals of shares and
debentures.

The activities of the merchant bankers are increasing with the change in the money market.
These specialized services which all the merchant banks in India have not been able to render
excepting the ICICI, Canara Bank and Grindlays Bank and Punjab National Bank (PNB).

Grindlays Bank renders this specialized service in accordance with the individual requirements
of the client.

These services include:

 Advice and assistance in negotiating terms and conditions of acquisitions and mergers;
 Expert advice on valuation of the amount of purchase consideration and its nature;
 Help in expediting legal documentation process and obtaining official approval;
 Carry out management audits to identify areas of strength and weaknesses of a corporate
unit;
 Assist in formulating guidelines and plans for future growth.

Specialized services in relation to merger and amalgamation:

 Determining the strengths and weaknesses and their financial implications.
 Deciding suitable form of organization.
 Assist the client company in preparation of the proposal draft, legal documentation.
 (Assistance in obtaining approval from various authorities.
 Co-ordinating the activities of solicitors, accountants, valuators & other professionals
involved in merger and Amalgamation.
 Assessing pros and cons of proposals for financial reconstruction, merger amalgamation.
 Assistance in preparation and formulation of scheme of financial restructuring
 Obtaining consent from shareholders, depositors, creditors, government and other
authorities
 Monitoring implementation of schemes of merger and amalgamation
 Services provided by merchant bankers

The services provided by Merchant Bankers include:

i. Project counseling
ii. Market survey and forecasting
iii. Estimating the amount of funds required.
iv. Raising funds from capital market.
v. Raising of funds through new instruments.
vi. Bought out deals.
vii. OTC market operations.
viii. Mergers and amalgamations.
ix. Loan syndication.
x. Technology tie-ups.
xi. Working Capital Finance.
xii. Venture Capital.
xiii. Lease Finance.
xiv. Fixed deposit management.
xv. Factoring
xvi. Portfolio management of mutual funds.
xvii. Rehabilitation of sick units.

Regulation of Merchant Bankers

Merchant banking activity in India is regulated by the SEBI (Merchant Bankers) Rules, 1992. The
Rules provide that:

a. no person shall carry on any activity as a merchant banker unless he holds a certificate granted
by SEBI.

b. SEBI would grant the certificate:

i. on payment of the registration fee.

ii. on condition that the merchant banker would redress investor grievances within I month of
investors complaint and would inform SEBI of all such complaints received.
 iii. only if the applicant has the necessary infrastructure and manpower to carry out the
functions as a merchant banker.
iv. a minimum of two persons who have the experience to conduct the business of merchant
banking should be under the employment of the applicant.
v. the applicant fulfills the capital adequacy requirements. The capital adequacy requirement
should not be less than the net worth of the applicant and the minimum shall be
Rs.1,00,00,000 for category I merchant banking, Rs.50,00,000 for category II and
Rs.20,00,000 for category III.
vi. the applicant should be professionally qualified in law, business or management.
vii. the applicant should not have been involved in any litigation involving the securities market.
the applicant should not have been convicted of any offense involving moral turpitude.

SEBI Regulations on merchant bankers:

SEBI has brought about a effective regulative measures for the purpose of disciplining the
functioning of the merchant bankers in India. The objective is to ensure an era of regulated
financial markets and thus streamline the development of the capital market in India. The
measures were introduced by the SEBI in the year 1992. The measures were revised by SEBI in
1997. The salient features of the regulative framework of merchant banking in India are
discussed below.

Registration of Merchant Bankers Application for Grant of Certificate

An application by a person for grant of a certificate shall be made to the Board in Form A. The
application shall be made for any one of the following categories of the merchant banker namely:
Category I-
To carry on any activity of the issue management, which will inter alliance consist of preparation
of prospectus
Other information relating
to the issue, determining financial structure, tie-up of financiers and final allotment and refund of
the subscription; 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, consultant to an issue.
Category IV
To act only as adviser or consultant to an issue.With effect from 9th December, 1997, an
application can be made only for carrying on the activities mentioned in category I.
An applicant can carry on the activity as underwriter only if he contains separate certificate of
registration under the provisions of Securities and Exchange Board of India (Underwriters)
Regulations, 1993, and as portfolio manager only if he obtains separate certificate of registration
under the provisions of Securities and Exchange Board of India (Portfolio Manager) Regulations,
1993.
Conformance to Requirements
Subject to the provisions of the regulations, any application, which not complete in all respects
and does not conform to the instructions specified in the form, shall be rejected. However, before
rejecting any such application, the applicant will be given an opportunity to remove within the
time specified such objections and may be indicated by the board.
Furnishing of Information, The Board may require the applicant to furnish further information
or clarification regarding matter relevant to the activity of a merchant banker for the purpose of
disposal of the application. The applicant or its principal officer shall, if so required, appear
before the Board for personal representation.

Consideration of Application: The Board shall take into account for considering the grant of a
certificate, all matters, which are relevant to the activities relating to merchant banker and in
particular whether the applicant complies with the following requirements;
That the applicant shall be a body corporate other than a non-banking financial company as
defined by the Reserve Bank of India Act, 1934.
 That the merchant banker who has been granted registration by the Reserve Bank of India
to act as Primary or Satellite Dealer may carry on such activity subject to the condition
that it shall not accept or hold public deposit.
 That the applicant has the necessary infrastructure like adequate office space,
equipments, and manpower to effectively discharge his activities.
 That the applicant has in his employment minimum of two persons who have the
experience to conduct the business of the merchant banker.
 That a person (any person being an associate, subsidiary, inter-connected or group
Company of the applicant in case of the applicant being a body corporate) directly or
indirectly connected with the applicant has not been granted registration by the Board.
 That the applicant fulfils the capital adequacy as specified.
 That the applicant, his partner, director or principal officer is not involved in any
litigation connected with the securities market which has an adverse bearing on the
business of the applicant.
  That the applicant, his director, partner or principal officer has not at any time been
convicted for any offence involving moral turpitude or has been found guilty of any
economic offence.

 That the applicant has the professional qualification from an institution recognized by the
Government in finance, law or business management.
 That the applicant is a fit and proper person. 11. That the grant of certificate to the
applicant is in the interest of investors.
Capital Adequacy Requirement According to the regulations, the capital adequacy requirement
shall not be less than the net worth of the person making the application for grant of registration.
For this purpose, the net worth shall be as follows:
Category Minimum Amount
Category I Rs.5, 00, 00,000
Category II Rs.50, 00,000
Category III Rs.20, 00,000
Category IV Nil

For the purpose of this regulation ‗net worth means in the partnership firm or a body corporate,
the value of the capital contributed to the business of such firm or the paid up capital of such
body corporate plus free reserves as the case may be at the time of making application.
Procedure for Registration The Board on being satisfied that the applicant is eligible shall
grant a certificate in Form B. On the grant of a certificate the applicant shall be liable to pay the
fees in accordance with Schedule II.
Renewal of Certificate Three months before expiry of the period of certificate, the merchant
banker, may if he so desired, make an application for renewal in Form A. The application for
renewal shall be dealt with in the same manner as if it were a fresh application for grant of a
certificate. In case of an application for renewal of certificate of registration, the provisions of
clause (a) of regulation 6 shall not be applicable up to June 30th, 1998. The Board on being
satisfied that the applicant is eligible for renewal of certificate shall grant a certificate in form B
and send intimation to the applicant. On the grant of a certificate the applicant shall be liable to
pay the fees in accordance with Schedule II.

Procedure where Registration is not granted:

Where an application for grant of a certificate under regulation 3 or of renewal under regulation
9, does not satisfy the criteria set out in regulation 6, the Board may reject the application after
giving
an opportunity of being heard. The refusal to grant registration shall be communicated by the
Board within thirty days of such refusal to the applicant stating therein the grounds on which the
application has been rejected. Any applicant may, being aggrieved by the decision of the Board,
under sub regulation (1), apply within a period of thirty days from the date of receipt of such
intimation to the Board for reconsideration for its decision. The Board shall reconsider an
application made under sub-regulation (3) and communicate its decision as soon as possible in
writing to the applicant.

Effect of Refusal to Grant Certificate:

Any merchant banker whose application for a certificate has been refused by the Board shall on
and from the date of the receipt of the communication under sub-regulation (2) of regulation 10
cease to carry on any activity as merchant banker.

Payment of Fees Every applicant eligible for grant of a certificate shall pay such fees in such
manner and within the period specified in Schedule II. Where a merchant banker fails to any
annual fees as provided in sub-regulation (1), read with Schedule II, the Board may suspend the
registration certificate, whereupon the merchant banker shall cease to carry on any activity as a
merchant banker for the period during which the suspension subsists

Obligations of Merchant Banker

The merchant banker must fulfill the pre-issue and post issue obligations as provided under the
act. The following are the pre-issue and post-issue obligations:

Pre-Issue Obligations

Documents to be submitted along with Offer Document by the Merchant Banker:

 MOU
 Inter-se Allocation of Responsibilities
 Due-Diligence Certificate
 Certificates signed by Company Secretary or Chartered Accountant.
 List of Promoters’ Group & other details.
  Promoter’s individual shareholding.
 Stock exchanges on which securities proposed to be listed, Permanent A/c No., Bank A/c
No. & passport No. of promoters.
 Merchant Banker should not lead manage the issue, if he is a promoter or a director of
issuer company.
 Merchant Banker should not lead manage the issue, if he is an associate of the issuer
company or is involved in marketing of the issue.
 The lead merchant banker shall satisfy themselves about the ability of the underwriters to
discharge their underwriting obligations.
 The issuer company must appoint authorized collection agents in consultation with the
lead merchant banker, subject to necessary disclosures including the names and addresses
of such agents are made in the offer document.
 The merchant banker must ensure that the issuer company has entered into agreement
with the depositories before opening the issue.
Once all the pre-issue obligations are fulfilled the issuer company can open its offer to the public.
But it can only be done after getting the approval of the nodal securities authority. After opening
the issue to the public, the merchant banker must ensure that it is fully subscribed. After the
subscription of the securities the lead merchant banker must fulfill the post-issue obligations.
They are discussed under:

POST-ISSUE OBLIGATIONS

 The post issue lead merchant banker shall ensure the submission of the post issue
monitoring reports.
 Due diligence certificate has to be submitted with the final post issue monitoring report.
The post-issue lead merchant banker shall file a due diligence certificate in the format
specified along with the final post issue monitoring report.
 The post-issue lead merchant banker shall maintain close coordination with the Registrars
to the Issue. Any act of omission or commission on the part of intermediaries shall be
reported to the securities agency.
  Post- issue lead merchant banker shall ensure that in all issues, advertisement giving
details relating to over-subscription, basis on allotment, number, value and percentage of
application received etc. is released within 10 days.
 In a public issue of securities, the managing director along with the lead merchant banker
and the registrar to the issue, shall ensure that basis of allotments is finalized in a fair and
proper manner
Role of Lead Managers
The role of the lead manager starts with ascertaining the fund requirements of a client and
continues till full subscription is received. If it is a book building process, the lead manager also
helps determine the price band; in such cases, they are also called Book Running Lead
Managers. Post issue activities, like intimation of allotments and refunds, are their responsibility
as well.

The Lead Manager coordinates with the Registrar and ensures:

a. Collection of applications from collecting branches.

b. Processing of applications.
c. Fixing the terms of allotment and finalization of allotment.
d. Security of certificates dispatched.
e. Refund orders are sent within time.
f. Securities are listed.
Lead Managers in India
Some of the prominent lead managers in India are:

 Enam Financial
 ICICI Securities
 IL&FS Investsmart
 SBI Capital
 Anand Rathi Securities
 Karvy Investor Services
 DSP Merrill Lynch
 JM Financial
 Centrum Capital
Stockbroking

Stockbroking is a service which gives retail and institutional investors the opportunity to buy
and sell equities. Stockbrokers will trade shares both on exchange and over-the-counter,
dependent on where they can find the best price and liquidity.

There are several different services a stockbroker can provide:

 Execution-only stockbrokers will complete orders on your behalf, but do not offer
any advice
 Advisory stockbrokers will offer advice on where to trade, but only trade on
orders submitted by you
 Discretionary stockbrokers will trade on your behalf, executing trades without your
input

Let us look at the services a stockbroker traditionally provides to its clients in greater detail.

1. Stockbrokers give accurate advice on buying and selling stocks and other securities.
Since they know the markets, they can advise a client on what stocks to buy and sell
and when to buy or sell them. They thoroughly research securities before making such
recommendations
2. Stockbrokers buy and sell shares on behalf of their clients and handle the associated
paperwork. They also act as a record keeper and keep records of all transactions,
statements and so on

3. Stockbrokers manage the client’s investment portfolio and provide regular updates to
their clients about their portfolios. They also answer investment questions that a client
may have
4. Stockbrokers inform their client about any new investment opportunity in the
stock market
5. Stockbroker also helps a client to make changes in investment strategies depending
on the market conditions

There are two main types of stockbrokers:

1. Discount Brokers
2. Traditional Brokers

Discount Brokers

The Discount Brokers usually charge much less, while full-service brokers or the traditional
brokers can be very expensive; however, they provide customized service. We advise investors
and traders to go through both discount and traditional brokers and get awareness of each of
these types of brokers before opening an account.

Here is the brief explanation that can help you in understanding the types of stock brokers.

Traditional Brokers

Traditional stock brokers or full-service stock brokers offer a wide array of services and
products, including financial and retirement planning, investing and tax advice, regular portfolio
updates, and margins to purchase investment products on credit which will be subjected to
necessary terms and conditions.

Since the traditional brokers offer personalized investment or trading recommendations and
services, brokerages charges can be expensive. Take a look at some of the leading Traditional
Brokerage firms that let customers invest and trade in stocks, futures, options, currencies, and
bonds in the Indian Stock Market.

Other types

1. Floor brokers
They execute orders for members (brokers) and receive a share in the brokerage commission
that a commission broker charges to his client.

2. Commission brokers

They execute orders of their customers by buying and selling securities on the exchange. They
charge a specified commission on the purchase or sale value. A commission broker does not buy
or sell securities in his own name. They deal with many clients and consequently with many
securities.

3. Jobbers

They are professional independent brokers engaged in buying and selling of specified
securities in their own name. Jobbers cannot deal on behalf of the public and are barred from
taking the commission. They deal with brokers who in turn transact on behalf of the public. A
jobber deals in a limited number of securities which he tracks regularly.

Jobbers generally quote two prices, one at which he is prepared to purchase and the other at
which he is prepared to sell a security. This two-way price is known as ‘double-barreled price
‘. The difference between the two prices is known as the ‘Jobbers turn ‘. For e.g. a Jobber may
quote the shares of XYZ at Rs.500-501.

This implies that the jobber is prepared to purchase the shares at Rs. 500 each and sell at Rs.501
each. The difference between the two prices is the jobbers' turn.

4. Tarawaniwalas

A tarawaniwala can act both as a broker and jobber. The tarawaniwala might act against
interests of investors by purchasing securities from them in his own name at a lower price and
sell the same securities to them at higher prices. To prevent this, the Securities Contract
(Regulation) Act of 1956 provides that a member of a stock exchange can act as a principal only
for a member of a recognized stock exchange.

5. Odd Lot dealers

They specialize in buying and selling of securities in odd lots. They buy odd lot of units at a
lesser price.
Underwriting

Underwriting is an act of guarantee by an organization for the sale of certain minimum amount of
shares and debentures issued by a Public Limited company.

According to the Companies Act, when a person agrees to take up shares specified in the
underwriting agreement when the public or others failed to subscribe for them, it is called
underwriting agreement. For this purpose, the underwriter who guarantees for the sale of shares,
is given a commission.

Importance of Underwriting
 The persons responsible for issuing shares in the company, known as issuers, have the
option of deciding for the underwriting of shares.
 If the issue is not underwritten, there is a possibility of the issue exiting under subscribed
and even if 90% of minimum subscription is not received, the money has to be refunded
in full.
 Hence, there is an urgent need on the part of the issuer, to seek the assistance of
 underwriters for a successful completion of issue of shares.

SEBI’s Guidelines for Underwriting

According to SEBI, the number of underwriters should be decided well in advance by the issuer
and he must obtain prior permission from SEBI. Permission will be granted by SEBI only after
finding out the net worth of the underwriters and their outstanding commitments.

The Stock Exchange, where the security is going to be listed must also be informed about the
arrangements made with the underwriters. 25% of each class of securities must be offered to the
public and in the remaining 75%, the following method of firm allotment could be adopted.

SEBI has instructed companies to allot to three major categories of allotted, namely,

 QIB
 HNI
 Retailers
QIB refers to qualified institutional bidders ( Mutual Funds, banks, etc.).
HNI refers to high net worth individuals, investing more than Rs. 1 lakh in a single company
security.
Retailers are individuals who are investing less than Rs. one lakh.

Types of Underwriters
There are two types of underwriters.

1. Institutional underwriters – IDBI, IFCI, UTI, SBI Capital Market

2. Non-Institutional underwriters – Any NBFC.
Institutional underwriting in India helps companies to raise capital in their early stages. In fact,
many companies which may not come to the notice of the public were promoted due to the
support given by institutional underwriters.

Many institutional underwriters were responsible for the promotion of infrastructure companies in
the area of steel, chemicals, fertilizer, etc.

Responsibilities of Underwriters
 An underwriter, not only has to underwrite the securities but has to subscribe within 45
days that part of shares which remain unsubscribed by the public.
  His underwriting obligations should not exceed, at any time, 20 times of his net worth.

 The underwriter cannot derive any other benefit except the underwriting commission
which is 5% for shares and 2½% for debentures.

Merits of Underwriting
 Underwriting ensures success of the proposed issue of shares since it provides an
insurance against the risk.
 Underwriting enables a company to get the required minimum subscription. Even if
the public fail to subscribe, the underwriters will fulfill their commitments.
 The reputation of the underwriter acts as a confidence to investors. The underwriters
who are called the lead managers provide financial recognition to the company, whose
shares are issued to the public. Thus, the reputation of the issuing company also improves
because of the reputation of underwriters.

Benefits due to professional underwriters

 Large issues could be undertaken successfully.
 Companies with a long gestation period cannot raise capital without support of
professional underwriters.
 Technocrats could promote companies with their poor financial knowledge.
 New projects in the market could be taken boldly.
 Companies could be promoted in backward areas.
 Certain projects which are not financially viable in the initial stages, especially in priority
sector (agriculture, small scale industry, export-oriented units) could be promoted with
the support of institutional underwriters

Non-Banking financial companies (NBFCs)

THEINTACTFRONT5 DEC 2018 5 COMMENTS

A Non – Banking Financial Corporation is a company incorporated under the Companies Act
2013 or 1956 which is engaged in the business of Loans and Advances, Acquisition of stocks,
equities, debt etc issued by the government or any local authority. The main objective of this
type of a company is to accept deposits under any scheme or manner.
According to section 451(c) of the RBI Act, a Non – Banking Company carrying on the business
of a financial institution will be an NBFC. It is governed by the Ministry of Corporate Affairs as
well as the Reserve Bank of India.

The following NBFC’s are not required to obtain any registration with the Reserve Bank of
India: Core Investment Companies – (assets are less than 100 crore or public funds not taken)

 Merchant Banking Companies

 Companies which are engaged in the business of stock-broking
 Housing Finance Companies
 Companies engaged in the business of Venture Capital.
 Insurance companies holding a certificate of registration issued by IRDA.
 Chit Fund Companies as defined in the Sec 2 clause (b) of the Chit Fund Act, 1982
 Nidhi Companies

Incorporate an NBFC

 A company should first be registered under the Companies Act 2013 or under Companies
Act 1956.
 The minimum net owned funds of the Company should be Rs. 2 Crore.
 There should be a minimum of 1 Director from the same background or a Senior Banker
as a full-time director in the Company.
 The CIBIL records of the Company should be clean
 After all of the above conditions have been satisfied the online application on the website
of RBI should be filled and submitted along with the requisite documents.
 A CARN Number will be generated.
 A Hard copy of the application also has to be sent to the regional branch of the Reserve
Bank of India.
 After the application is properly scrutinized, the License will be given to the Company.

NBFC Guidelines

The Company once it gets it license has to adhere to the following guidelines:
  They cannot receive deposits which are payable on demand.
 The public Deposits which the company can take should be for a minimum time period of
12 months and a maximum time period of 60 months.
 The interest charged by the Company cannot be more than the ceiling prescribed by the
Reserve Bank of India.
 The repayment of any amount so taken by the Company will not be guaranteed by the
Reserve Bank of India.
 All the information about the company as well as any change in the composition of the
Company has to be furnished to the Reserve Bank of India.
 The deposits taken by the Public will be unsecured.
 The Company has to submit its audited balance sheet every year.
 A statutory return on the deposits taken by the company has to be furnished in the form
NBS – 1 every year.
 A Quarterly Return on the liquid assets of the company has to be furnished.

 A certificate from the auditors had to be taken stating that the company is in a position to
pay back all the deposits or money taken from the Public.
 A half-yearly ALM return has to be given by the company which has a Public Deposit of
Rs. 20 Crore and above or has assets worth Rs. 100 Crore and above.
 The credit rating has to be taken every 6 months and submitted to the RBI.
 A minimum level of 15% of the Public Deposits has to be maintained by the Company in
Liquid Assets.
 If the NBFC defaults in the payment of any amount taken, the consumer can go to the
National Company Law Tribunal or the Consumer Forum to file a suit against the
Company

Securitization

Securitization is the method of converting the receivables of the financial institutions, i.e., loans
and advances, into bonds which are then sold to the investors.

In simple terms, it is the means of turning the illiquid assets into liquid assets to free up the
blocked capital.
Securitization is a financial arrangement that consists of issuing securities that are backed by a
pool of assets, in most cases debt.

The underlying assets are “transformed” into securities, hence the expression “securitization.”
The holder of the security receives income from the products of the underlying assets, and this
has given rise to the generic term ABS (Asset-Backed Securities).

Here are a few examples of assets that can be securitized:

 Residential mortgage loans; this category includesthe infamous “subprime mortgages,”

which are home loans issued to individualswith a low credit rating
 Commercial mortgage loans
 Bank loans to businesses
 Commercial debt
 Student loans (mainly in the US)
 Credit-card debt: in this case, the maturity of the security issued will typically be longer
than that of the underlying debt; the assets portfolio will have to be “topped up” several
times in order to ensure the promised cash flows. Therefore, some of the securitized
debt does not exist yet at the time when the security is created. This is referred to as
“securitization of future cash flows.”
 Automobile loans
 Etc.

Securitization Process

Securitization is a complex and lengthy process since it is the conversion of the receivables into
bonds; it involves multiple parties.
Origination Function: The borrower approaches a bank or other financial institution
(originator) for a loan. The respective financial institution allows a certain sum as debts in
exchange for any collateral.

Pooling Function: The originator then sells off its receivables through pledge receipts to the
special purpose vehicle.

Securitization: The SPV transforms these receivables into marketable securities, i.e., either Pay
Through Certificate or PTC (Pass-Through Certificate). These instruments are then forwarded to
the merchant banks for selling it to the investors. The investors buy these instruments to benefit
in the long run.

Since the investors extend the loan, they are liable to receive a return on investment. The
borrowers are unaware of this securitization and pay timely instalments.
The originator receives a lump sum amount, though at a discounted value from the SPV. The
merchant bank charges fees for its services.

Types of Securitization

The different kinds of receivables determine the type of securitization it requires. Given below
are some of the most common types of securitization:

1. Asset-Backed Securities (ABS)

The bonds which are supported by underlying financial assets. The receivables which are
converted into ABS include credit card debts, student loans, home-equity loans, auto loans, etc.
 2. Residential Mortgage-Backed Securities (MBS)

These bonds comprise of various mortgages like of property, land, house, jewellery and other
valuables.

3. Commercial Mortgage-Backed Securities (CMBS)

The bonds that are formed by bundling different commercial assets mortgage such as office
building, industrial land, plant, factory, etc.

4. Collateralized Debt Obligations (CDO)

The CDOs are the bonds designed by re-bundling the personal debts, to be marketed in the
secondary market for prospective investors.

Advantages of Securitization

In the securitization process, the multiple parties involved are borrowers, originator, special
purpose vehicle, merchant bank and investors.

Thus, each one these parties benefit from the process, where the originator and the investor have
multiple advantages as discussed below

1. To the Originator

The originator derives maximum benefit from securitization since the purpose is to get the
blocked funds released to take up other alluring opportunities. Let us discuss each one of these:

a. Unblocks Capital: Through securitization, the originator can recover the amount lent,
much earlier than the prescribed period.

b. Provides Liquidity: The illiquid assets, such as the receivables on loans sanctioned by
the bank, are converted into liquid assets.
 c. Lowers Funding Cost: With the help of securitization, even the BB grade companies
can benefit by availing AAA rates if it has an AAA-rated cash flow.

d. Risk Management: The financial institution lending the funds can transfer the risk of
bad debts by securitizing its receivables.

e. Overcoming Profit Uncertainty: When the recovery of debts is uncertain, its

profitability, in the long run, is equally doubtful. Thus, securitization of such obligations
is a suitable option to avoid loss.

f. Reduces Need for Financial Leverage: Securitization releases the blocked capital to
maintain liquidity; therefore, the originator need not seek to financial leverage in case of
any immediate requirement.

To the Investor

The investor’s aim is to accelerate the return on investment. Following are the different ways in
which securitization is worth investing:

a. Quality Investment: The purchase of MBS and ABS are considered to be a wise
investment option due to their feasibility and reliability.

b. Less Credit Risk: The securitized assets have higher creditworthiness since these are
treated separately from their parent entity.

c. Better Returns: Securitization is a means of making a superior return on their

investment; however, it depends more on the investor’s risk-taking ability.

d. Diversified Portfolio: The investor can attain a well-diversified portfolio on including

the securitized bonds; since these are very different from other instruments.

e. Benefit Small Investors: The investors having minimal capital for investment can
also make a profit out of securitized bonds.
Disadvantages of Securitization

Securitization requires proper analysis and expertise; otherwise, it may prove to be quite unsound
to the investors. Let us now discuss its various drawbacks:

 Lack of Transparency: The SPV may not disclose the complete information about the
assets included in a securitized bond to the investors.
 Complex to Handle: The whole process of securitization is quite complicated involving
multiple parties; also, the assets need to be blended wisely.
 Quite Expensive: When compared to share flotation, the cost of a securitized bond is
usually high, including underwriting, legal, administration and rating charges.
 Investor Bears Risk: The non-repayment of debts by the borrower would ultimately end
up as a loss to the investors. Therefore, the investor is the sole risk-bearer in the process.
 Inaccurate Risk Assessment: Sometimes, even the originator fails to identify the value of
underlying assets or the associated credit risk.
 Loss from Prepayment: If the borrower pays off the sum earlier than the defined period,
the investors will not make superior gains on their investment value

Purpose Vehicle (SPV)

A Special Purpose Vehicle (SPV) is a separate legal entity created by an organization. The SPV
is a distinct company with its own assets and liabilities, as well as its own legal status.
Usually, they are created for a specific objective, often to isolate financial risk. As it is a separate
legal entity, if the parent company goes bankrupt, the special purpose vehicle can carry on.
Reason for creating SPVs:

1. Risk sharing

A corporation’s project may entail significant risks. Creating an SPV enables the corporation to
legally isolate the risks of the project and then share this risk with other investors.

2. Securitization

Securitization of loans is a common reason to create an SPV. For example, when

issuing mortgage-backed securities from a pool of mortgages, a bank can separate the loans from
its other obligations by creating an SPV. The SPV allows investors in the mortgage-backed
securities to receive payments for these loans before other creditors of the bank.

3. Asset transfer

Certain types of assets can be hard to transfer. Thus, a company may create an SPV to own these
assets. When they want to transfer the assets, they can simply sell the SPV as part of a merger
and acquisition (M&A) process.
 4. Property sale

If the taxes on property sales are higher than the capital gain realized from the sale, a company
may create an SPV that will own the properties for sale. It can then sell the SPV instead of the
properties and pay tax on the capital gain from the sale instead of having to pay the property
sales tax.

Benefits:

 Isolated financial risk

 Direct ownership of a specific asset
 Tax savings, if the vehicle is created in a tax haven such as the Cayman Islands
 Easy to create and set up the vehicle

Risks:

 Lower access to capital at the vehicle level (since it doesn’t have the same credit as the
sponsor)
 Mark to Market accounting rules could be triggered if an asset is sold, significantly
impacting the sponsor’s balance sheet
 Regulatory changes could cause serious problems for companies using these vehicles
 The optics surrounding SPVs are sometimes negative

SPV work Mechanism

SPV which will purchase some assets or loans owned by such company. Once these assets are
purchased, they will be grouped into tranches and sold to meet the credit risk of various investors
to raise funds, by issuing debts in the form of bonds or other securities.

The main logic behind this SPV creation lies in ensuring that such SPV is insolvency remote and
treated separately from the parent company. To this end, some steps need to be taken, such as:
 Ensuring the SPV is a new entity with very limited operating history
  Ensuring the SPV is a distinct legal entity capable of holding assets
 Appointing directors that are independent from the parent company
 Restricting the activities of the SPV to reduce the risk of liabilities created outside those
related to securitisation
 Corporate activities of the SPV are kept separate from those of other transaction parties
 The SPV has not given any security for the obligations of another company

PTC

A pass through certificate (PTC) is a certificate that is given to an investor against certain
mortgaged-backed securities that lie with the issuer. The certificate can be compared to securities
(like bonds and debentures) that may be issued by banks and other companies to investors.

The only difference being that they are issued against underlying securities. The interest that is
paid to the issuer on these securities comes to the investor in the form of a fixed income.
Investors in such instruments are usually financial institutions like banks, mutual funds and
insurance companies. However, to understand this better, you need to delve a little deeper into
how exactly the assets are securitized.

Important PTCs

All the PTCs in the market are rated by agencies like Crisil or Fitch ratings, among others. The
ratings tell the investor about the quality of the underlying securities. However, PTCs have
recently been in the news after Crisil downgraded the ratings of PTCs issued by Wockhardt. The
main reason given for this is that Wockhardt defaulted on the interest payment on its PTCs.

Pension plans

Pension plans are also known as retirement plans. In this, you may invest some portion of your
income into the designated plan. The main objective behind a pension plan is to have a regular
income post-retirement. Considering the ever-growing inflation, investing in these plans has
become necessary. Even if you have considerable savings in your bank account, still you may
need one. It is because savings usually get spent in meeting contingent needs. So, the best
pension plan will support you when all other income streams cease to exist.

In India, pension plans have two stages – the accumulation stage and the vesting stage. In the
former, the investors pay annual premiums until they attain the age of retirement. On reaching
the retirement age; the second stage, the vesting stage begins. During this stage of the pension
plan, the retiree will start receiving annuities until their death or the death of their nominee.

Various plans classified

The classification of pension funds can be based on the following:

a. National Pension Scheme

The Government of India introduced a new Pension Scheme for people who wanted to build up
their pension amount. With the scheme, your savings will be invested in debt and equity market,
based on your preference. It allows you to withdraw 60% of the funds at the time of retirement
and the remaining 40% is used for the purchase of the annuity. The maturity amount is tax-free.

b. Deferred Annuity

With the deferred annuity plan, you can accumulate a corpus through a single premium or
regular premiums over the term of the policy. The pension begins once the policy term gets over.
This deferred annuity plan has tax benefits wherein no tax is charged on the money invested until
you plan to withdraw it. This scheme can be bought by either making regular contributions, or by
a one-time payment. This way, it works for you whether you want to invest the entire amount at
one time or want to invest systematically.

c. Pension Funds

The government body, Pension Fund Regulatory and Development Authority (PFRDA), has
authorized six companies to operate as fund managers. These plans offer comparatively better
returns at the time of maturity and remain in force for a substantial amount of time.
d. Immediate Annuity

In this type of scheme, the pension begins right away. As soon as you deposit a lump sum
amount, your pension starts. This is based on the amount the policyholder invests. You can
choose from a range of annuity options. Under the Income Tax Act of 1961, the premiums of the
immediate annuity plans are tax exempt. Post the death of the policyholder, and it is the nominee
who is entitled to the money.

e. Guaranteed Period Annuity

Regardless of whether the holder survives the duration, this annuity option is given for periods
such as five years, ten, fifteen, and twenty years.

f. Pension Plans with and without cover

Pension plans with cover include life cover, which means that at the death of the policyholder,
the family members are paid a lump sum amount. This amount may not be considerable. The
without-cover plan as the name suggests does not have life cover. If the policyholder passes
away, then the nominee gets the corpus. At present, the immediate annuity plans are without
protection, while the deferred plans are with cover.

g. Annuity certain

In this scheme, the annuitant is paid the annuity for a certain number of years. The annuitant can
pick this period, and in case of their death, the beneficiary receives the annuity.

h. Life Annuity

The life annuity scheme pays the annuity amount to the annuitant until the time of death. If the
annuitant dies and they had chosen the option ‘with spouse’, then the spouse receives the pension
amount.

Advantages of pension plans

Some of the advantages of investing in Pension Plans are listed below:

a. Option in Investment

Pension funds give investors the option to invest in either the safe government securities or take
some risk and invest in debt and equity investments depending on their risk profile. The risk is
balanced by the prospect of higher returns that are generated by the investment.

b. Long-term savings

These plans serve as a long-term savings scheme regardless of whether you opt for a lump sum
payments or multiple payments of small amounts, the savings is assured. Pension plans create an
annuity which can be invested further and give rise to a steady flow of cash post your retirement.

c. Choose how you want to get paid

Depending on your age or what your plans are, you can either invest a lump sum amount and get
annuity payments right away, or choose a deferred annuity plan which will let your corpus earn
more interest until the payouts begin.

d. Works as a life insurance cover

There are pension plans that offer the investor a lump sum amount when they retire or in case of
the death of the individual, whichever scenario occurs earlier. This means that your pension
policy also serves as a life insurance cover.

e. Negates the effect of Inflation

It is an excellent way of negating the effect of inflation by investing in pension plans. These
plans pay a lump sum during your retirement, which amounts to a maximum of one-third of the
accumulated corpus and the remaining two-thirds of the corpus is used in generating a steady
cash flow.

f. Access a lump sum amount during an emergency

You are allowed to make adjustments to your pension policy to access a lump sum payout in
case of an emergency. This can be done to cover one’s long-term health care.
Disadvantages of pension plans

a. Limited amount of deduction allowed

Though pension plans qualify you to a tax deduction, the maximum allowed deduction on life
insurance premiums is Rs 1.5 lakh under the Income Tax Act, 1961.

b. Taxation on the annuity

When you receive the annuity after your retirement, it is taxable as on that date.

c. High returns require high-risk taking

To make sure that the payout at the time of your retirement is adequate, you may have to seek
high-risk options to obtain higher returns. The traditional non-risky investment options may not
be enough to override the effects of inflation.

d. Best suited for early investors

If you are not an early investor, then this investment option may be a little late for you. As the
returns earned by someone who invests at age 21 as opposed to someone aged 30 or 35 years,
will get a substantially more significant return