NISM-Series-IX Merchant Banking Certification Workbook PDF May 2023

IX Merchant Banking NISM-Series-IX: Merchant Banking Certification Examination Workbook for NISM-Series-IX: Merchant Banking Certification Examination National Institute of Securities Markets www.nism.ac.in 1 NISM-Series-IX: Merchant Banking Certification Examination This workbook has been developed to assist candidates in preparing for the National Institute of Securities Markets (NISM) Certification Examination for Merchant Banking. Workbook Version: May 2023 Published by: National Institute of Securities Markets © National Institute of Securities Markets, 2023 5th Floor, NCL Co-operative Society, Plot No. C-6 E-Block, Bandra Kurla Complex, Bandra East Mumbai – 400 051, India National Institute of Securities Markets Patalganga Campus Plot IS-1 & IS-2, Patalganga Industrial Area Village Mohopada (Wasambe) Taluka-Khalapur District Raigad-410222 All rights reserved. Reproduction of this publication in any form without prior permission of the publishers is strictly prohibited. 2 NISM-Series-IX: Merchant Banking Certification Examination Foreword NISM is a leading provider of high end professional education, certifications, training and research in financial markets. NISM engages in capacity building among stakeholders in the securities markets through professional education, financial literacy, enhancing governance standards and fostering policy research. NISM works closely with all financial sector regulators in the area of financial education. NISM Certification programs aim to enhance the quality and standards of professionals employed in various segments of the financial services sector. NISM’s School for Certification of Intermediaries (SCI) develops and conducts certification examinations and Continuing Professional Education (CPE) programs that aim to ensure that professionals meet the defined minimum common knowledge benchmark for various critical market functions. NISM certification examinations and educational programs cater to different segments of intermediaries focusing on varied product lines and functional areas. NISM Certifications have established knowledge benchmarks for various market products and functions such as Equities, Mutual Funds, Derivatives, Compliance, Operations, Advisory and Research. NISM certification examinations and training programs provide a structured learning plan and career path to students and job aspirants who wish to make a professional career in the Securities markets. Till March 2023, NISM has certified nearly 17 lakh individuals through its Certification Examinations and CPE Programs. NISM supports candidates by providing lucid and focused workbooks that assist them in understanding the subject and preparing for NISM Examinations. This book covers all important aspects of the functioning of the Merchant Bankers. These include the basic understanding of the Indian securities markets; various terminologies used in the issue management process; the process of issue management and underwriting; general obligations and due diligence to be taken care of during the issue management process; the role of merchant bankers in acquisitions, takeovers, buyback of securities, disinvestment etc. This book will be immensely useful to all those who want to learn about the various functional aspect of Merchant Bankers. Dr. C.K.G. Nair Director 3 NISM-Series-IX: Merchant Banking Certification Examination Acknowledgement This version of the workbook has been reviewed by the Certification Team of National Institute of Securities Markets. NISM gratefully acknowledges the contribution of Association of Investment Bankers of India (AIBI) and all the Examination Committee for NISM-Series-IX: Merchant Banking Certification Examination consisting of nominated representatives from the AIBI. About the Certification Examination for Merchant Banking In order to create a common minimum knowledge benchmark for employees working with SEBI registered Merchant Bankers and performing various SEBI regulated functions such as those relating to IPO, FPO, Open offer, Buy-back, Delisting etc., and are involved in, or deal with any of the following:  The investors, issuers or clients of intermediaries  Assets or funds of investors or clients  Redressal of investor grievances  Internal control or risk management  Activities having a bearing on operational risk  Maintain books and records pertaining to above activities. The exam will further seek to ensure basic understanding of various aspects of capital market functions, the processes involved in various functions of registered Merchant Bankers and the regulatory environment in which it operates. Examination Objectives The examination aims to enable a better understanding of various regulations in the Merchant Banking Domain. The examination also covers knowledge competencies related to the understanding of the financial structure in India and the importance of the different rules and regulations governing the Indian securities market. On successful completion of the examination the candidate should:  Know the basics of the Merchant Banking in India.  Understand the functioning of Merchant Bankers related to Issue Management Process, Substantial Acquisition of Equity Shares, Buyback of Equity Shares and Delisting of Shares.  Know the regulatory environment in which the Merchant Bankers operates in India. Assessment Structure The examination consists of 100 questions of 1 mark each and should be completed in 2 hours. The passing score on the examination is 60%. There shall be negative marking of 25% of the marks assigned to a question. 4 NISM-Series-IX: Merchant Banking Certification Examination How to register and take the examination To find out more and register for the examination please visit www.nism.ac.in 5 NISM-Series-IX: Merchant Banking Certification Examination Table of Contents Chapter 1- Introduction to Capital Market................................................................................. 8 1.1 Introduction to Capital Market..................................................................................... 8 1.1.1 Capital Market....................................................................................................... 8 1.1.2 Products in Indian Securities Market.................................................................... 9 1.1.3 Participants in Indian Securities Market............................................................. 12 1.1.4 Regulators in Indian Securities Market............................................................... 14 1.1.5 Role of Investment Banker in Private Equity...................................................... 15 Chapter 2 Introduction to the Merchant Banking.................................................................... 18 2.1 Concept and Evolution of Merchant Banking............................................................. 18 2.2 Merchant Banking in India.......................................................................................... 20 2.3 Regulatory Framework for Merchant Bankers in India.............................................. 21 Chapter 3 - Registration, Code of Conduct & General Obligations of Merchant Bankers in India................................................................................................................................................... 71 3.1 Introduction................................................................................................................ 71 3.2 Registration of Merchant Bankers.............................................................................. 72 3.3 Code of Conduct for Merchant Bankers..................................................................... 75 3.4 General obligations and Responsibilities................................................................... 79 3.5 Redressal of Investor Grievances and SCORES........................................................... 83 Chapter 4: Issue Management – Important Terms................................................................... 85 4.1 Understand the various terms related to Offering.................................................... 85 Chapter 5: Issue Management - Process and Underwriting................................................... 100 5.1 Issue Management................................................................................................... 100 5.2 Obligations Relating to Issues................................................................................... 110 5.3 Pricing of Issue.......................................................................................................... 124 5.4 Underwriting............................................................................................................. 125 5.5 Issuance Conditions and Procedures........................................................................ 127 5.6 Minimum Subscription............................................................................................. 128 5.7 Allotment, Refund and Payment of Interest............................................................ 128 6 NISM-Series-IX: Merchant Banking Certification Examination 5.8 Post Issue Functions, Reporting and Compliance.................................................... 130 Chapter 6: Issue Management - General Obligations of Merchant Bankers and Due Diligence................................................................................................................................................. 133 6.1 General Obligations of Merchant Bankers with regards to Issue Management...... 133 6.2 Preferential Issue...................................................................................................... 152 6.3 Qualified Institutional Placement............................................................................. 158 6.4 Rights issue............................................................................................................... 161 6.5 Indian Depository Receipts....................................................................................... 164 Chapter 7: Other Merchant Banking Activities - Mergers, Acquisitions & Takeovers............ 173 7.1 Mergers, Acquisitions & Takeovers.......................................................................... 173 7.2 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011............ 175 Chapter 8: Other Merchant Banking Activities - Disinvestment, Buyback of Equity Shares.. 204 8.1 Disinvestment........................................................................................................... 204 8.2 Role of Merchant Banker in Buy back of Equity Shares........................................... 205 8.3 Role of Merchant Banker in Delisting of Shares....................................................... 210 8.4 Role of Merchant Bankers in Issue and Listing of Debt Securities........................... 211 8.5 Role of Merchant Banker in Share Based Employee Benefits.................................. 215 8.6 Role of Merchant Banker in cases where exit opportunity is required to be given to dissenting shareholders....................................................................................................... 215 8.7 Role of Merchant Banker in Issue of Securities by Small and Medium Enterprises (SME) 216 8.8 Role of Merchant Banker in Alternative Investment Funds..................................... 219 7 NISM-Series-IX: Merchant Banking Certification Examination Chapter 1- Introduction to Capital Market LEARNING OBJECTIVES: After studying this chapter, you should know about the:  Structure of the capital market  Products available in the Indian securities market  Participants in the Indian securities market  Role of different regulators of the market In this chapter, the structure of the Indian Capital Market, the different products available in the securities market, various participants and the role of different regulators of the market will be discussed in brief to give an overview of the capital market in India. Introduction to Capital Market Capital Markets play a very important role in the development of the economy. It helps in allocating the unutilized resources i.e. transfer of funds from savers to its efficient users. It provides channels for allocation of savings to investments. They consist of investors, who are the backbone of the economy, issuers, regulatory bodies and intermediaries. The movement of capital in the economy from the savings pool to the investment pool is performed by two main platforms of institutional intervention – (a) Financial institution and banking framework and (b) the capital market framework. The capital market plays the primary role of a facilitator and an intermediary in raising capital and deployment of the same in the economy. Capital Market Capital Market provides a platform for the issuers and the investors to come together. It helps the issuers to raise capital for productive deployment in creating economic wealth. At the same time, the capital market offers investment avenues to investors with appetite for higher risks and returns as compared to savings in bank deposits. Capital Market is further divided into the Primary Market and Secondary Market whereas Money Market is classified into Organized Money Market and Unorganized Money Market. Primary Market is the new issue market, which provides opportunity to issuers of securities, Government as well as corporates, to raise resources to meet their requirements of investments and/or discharge some obligation. If securities are allotted to the public for the first time for the purpose of listing, it is called Initial Public Offer (IPO). Once the securities are listed on the Stock Exchanges, the same shares traded will be on the secondary market, between investors themselves. If securities are already listed and the issuer company wants to issue further class of securities to the investors again, it is called Further Public Offer (FPO). 8 NISM-Series-IX: Merchant Banking Certification Examination Secondary Market helps in providing liquidity to the securities which has already been issued in the primary market. In this market, an investor liquidates his own investments. Since the securities are traded on the stock exchange and the transactions are between two investors, the issuer does not come into picture. Secondary Markets operate through two mediums, namely, the Over-The-Counter (OTC) market and the Exchange Traded Market. OTC markets are the informal type of markets where trades are negotiated. In this type of market, the securities are traded and settled bilaterally over the counter. The other option of trading is through the stock exchange route, where trading and settlement is done through the stock exchanges and the buyers and sellers may not be in touch with each other. The transaction is carried out through SEBI registered stock brokers and/or authorised persons. Money market is a market for financial assets that are close substitutes for money. It is typically a market for short term funds. The money market deals primarily in securities, such as banker’s acceptances, negotiable certificates of deposit (CDs), repos and Treasury Bills (T-bills), call/notice money market and commercial paper. Products in Indian Securities Market Indian securities markets cover a wide range of products depending upon the risk appetite of the investors. For example, if an investor wants to invest in risky products he has the option to invest in products of the equity market, whereas a risk-averse investor can invest in bond markets which are comparatively less risky. Product portfolio of Indian securities markets can be broadly classified into 3 categories: a) Equity Market Products b) Derivative Market Products c) Debt Market Products a) Equity Market Products: The equity segment of the stock exchange allows trading in equity shares, convertibles, warrants, mutual funds and exchange traded funds (ETFs). Equity Shares represent a form of fractional ownership in a business venture. Equity shareholders collectively own the company and also bear the risk and enjoy the rewards of ownership. Preference Shares represent economic interest that has a superior right as compared to equity shares. Preference shareholders have first preference to receive dividends and return of their capital. Preference shares are therefore paid a fixed rate of dividend and are redeemable within a time period not exceeding 20 years. Convertibles are instruments that can be converted into equity shares of the issuer company. Convertibles can be issued in the form of debt instruments such as fully or partly convertible debentures or bonds. The conversion can also be structured as mandatory or at the option of the investor. Depending on the conversion features, these instruments are known as Fully Convertible Debentures (FCDs), OFCDs (optional FCDs) 9 NISM-Series-IX: Merchant Banking Certification Examination and PCDs (Partly Convertible Debentures). Convertibles can also be structured through preference shares in which case they would be known as CPS (Convertible Preference Share) or CCPS (Cumulative CPS including dividend payable). Warrants entitle an investor to buy equity shares after a specified time period at a given price. Warrants provide the right but not the obligation to purchase shares or other securities in the company. If the warrant is not exercised, the investor stands to lose the amount paid on acquisition of the warrant. Mutual Funds pools money from numerous investors who wish to save or make investments having similar investment objective. The Mutual Fund invests in different types of funds in consonance with the investment objectives. A mutual fund company pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments, depending on the objectives of the fund. There are funds which invest in equities, better known as equity MF schemes which are considered riskier than debt mutual funds. Exchange Traded Fund is a fund that can invest in either all of the securities or a representative sample of securities included in the index. Importantly, the ETFs offer a one-stop exposure to a diversified basket of securities that can be traded in real time like individual stock example gold exchange traded fund. b) Derivative Market Products: Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. The derivatives segment in India allows trading in the equities, currency and commodities. There are two types of derivatives instruments viz., Futures and Options that are traded on the Indian stock exchanges. Index/Stock Future is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Futures contracts are available on certain specified stocks and indices. Index/Stock Options are of two types - calls and puts. Calls give the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the seller the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date. Currency Derivatives trading was introduced in the Indian financial markets with the launch of currency futures trading in the USD-INR pair on the National Stock Exchange of India Limited (NSEIL) on August 29, 2008. Few more currency pairs have also been introduced thereafter. Currently in India, currency futures contracts are traded on four INR pairs i.e., USDINR, EURINR, GBPINR and JPYINR and on three cross currency pairs i.e., EURUSD, GBPUSD and USDJPY on the recognized stock exchanges. 10 NISM-Series-IX: Merchant Banking Certification Examination Commodity Derivatives markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold on the basis of standardized contracts for a specified future date. Commodity markets facilitate the trading of commodities such as gold, silver and various agricultural goods. Interest Rate Futures trading is based on notional 10-year coupon bearing Government of India (GOI) security. These contracts are settled by physical delivery of deliverable grade securities using electronic book entry system of the existing depository’s viz., NSDL and CDSL and the Public Debt Office of the Reserve Bank unlike the cash settlement of the other derivative products. c) Debt Market Products: Debt market consists of Bond markets, which provide financing through the issuance of debentures and bonds, and enable the subsequent trading thereof. These instruments can be traded in OTC or Exchange traded markets. In India, the debt market is broadly divided into government securities (G-Sec) market and the corporate bond market. Government Securities Market: The Government needs enormous amount of money and one of the important sources of borrowing funds is the government securities market. The government raises short term and long term funds by issuing securities. These securities do not carry default risk as the government guarantees the payment of interest and the repayment of principal. They are therefore referred to as gilt edged securities. Government securities are issued by the central government, state government and semi- government authorities. The major investors in this market are banks, insurance companies, provident funds, state governments, FPIs. Government securities are of two types- treasury bills and government dated securities. Corporate Bond Market: Corporate bonds are bonds issued by firms, corporate and are issued to meet needs for expansion, modernization, restructuring operations, mergers and acquisitions. The corporate bond/debt market is a market wherein debt securities of corporates are issued and traded therein. The investors in this market are banks, financial institutions, insurance companies, mutual funds, FPIs etc. Corporates adopt either the public offering route or the private placement route for issuing debentures/bonds. Debentures and bonds are pure debt instruments that carry a periodic interest payment (called ‘coupon’) or a cumulated terminal payment without any periodic interest (called ‘zero coupon’). These instruments are redeemed by repayment of the principal amount as per stated terms of issue. Since these instruments need to be repaid by the issuer company, these are usually secured against assets of the company or other collaterals. They are also rated by one or more independent credit rating agencies, especially if they are issued through public offers. Some of the other instruments available for trading in the debt segment are money market instruments such as Treasury Bills, Commercial Papers and Certificate of Deposits. 11 NISM-Series-IX: Merchant Banking Certification Examination Participants in Indian Securities Market There are different participants who play an important role in the securities market. Entities develop, issue, register and sell securities for the purpose of financing their operations. There are people who invest in these securities and there are some entities that provide the service of intermediation. Some of them are discussed here: i. Issuer means any company/corporate making an offer of securities. They are the persons who actually approach the market stating their specific objectives and collect funds from the general public by offering securities. ii. Investors are the persons who actually invest their funds in the securities offered by the issuer. They are broadly categorised as Retail Investors, Institutional Investors and Non- Institutional Investors. Investors investing upto Rs. Two lakh in a single public issue transaction is termed as Retail investors, whereas institutional investors comprise of domestic financial institution, mutual funds, FPIs etc commonly known as Qualified Institutional Buyers (QIBs).1 iii. Intermediaries: There are many intermediaries in the Indian securities market. As per the SEBI Act, 1992, intermediaries include stock brokers, share transfer agents, bankers to an issue, self-certified syndicate bank (SCSBs), trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, mutual funds and such other intermediaries who may be associated with securities markets in any manner, depositories, depository participants, custodians of securities, credit rating agencies and such other intermediaries as SEBI may, by notification, specify in this behalf. Some of them are discussed below:  Stock Brokers: Stock brokers have been defined as a member of a stock exchange. Stock Brokers are the members of the Stock Exchange and can either be individuals or corporate. They give their advice and recommendations relating to investment opportunities to their clients. Their clients may be retail investors or institutional clients and they execute the trade on their client’s behalf on the exchange. Further, SEBI has discontinued the category of sub-broker as a market intermediary and they have been migrated to a category known as Authorized Person and/or Trading member. Authorised Person or “AP” means a person –individual, partnership firm, LLP or body corporate – who is appointed by a stock broker (including trading member) and who provides access to trading platform of a stock exchange as an agent of the stock broker.  Custodians: mean any person who carries on or proposes to carry on the business of providing custodial services. Custodial services include safekeeping of the securities. A 1 CBDT vide Notification No. 59/2015 dated 6th July, 2015 has stated that for the purpose of issue of tax-free, secured, redeemable, and non-convertible bonds, Retail individual Investors means those individual investors, Hindu Undivided Family (through Karta), and Non Resident Indians (NRIs), on repatriation as well as non-repatriation basis, applying for upto Rupees Ten lakhs in each issue and individual investors investing more than Rupees Ten lakhs shall be classified as High Net Worth Individuals. 12 NISM-Series-IX: Merchant Banking Certification Examination Custodian is an entity that helps safeguard the securities of its clients. Custodians may also be clearing members like Professional Clearing Members (PCMs) but not trading members. They settle trades on behalf of the clients of the trading members, when a particular trade is assigned to them for settlement.  Depositories: means a depository as defined in clause (e) of sub-section (1) of section 2 of the Depositories Act, 1996. Depositories offer various services to their clients, however, the principal function is to provide a facility for investors to hold and transfer securities in dematerialised form. Through a system of paperless securities, depositories have made the going easier to other institutions as well such as Stock Exchanges and its clearing houses, stock broking firms, issuing companies, share transfer agents etc. Currently there are two Depositories in India, Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL).  Depository Participants (DPs): Depository Participant means a person registered as a participant with the SEBI. The Depository provides its services to clients through its agents called depository participants. These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and body corporate engaged in providing financial services provided certain conditions are fulfilled can become DPs.  Merchant Bankers: means any entity who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management. They need to be registered with SEBI to act and perform as Merchant Banker. They perform a variety of activities including managing capital issues, managing individual funds and advising clients on proper valuation of securities and often the underwriting of issues. Other market participants such as money-market dealers, commercial banks and financial institutions, share brokers and investment funds may also obtain separate registration as Merchant Bankers. Merchant Banks are also involved in conducting due diligence in connection with public offers as also being responsible in compliance matters under SEBI Regulations. Merchant Banks are also eligible to conduct valuation of securities and provide independent opinions for regulatory requirements under SEBI Regulations.  Registrars and Transfer Agents: Registrars to an issue are entities, who on behalf of any Body Corporate collect applications from investors in respect of an issue, keep proper record of applications and monies received from investors and assists body corporate to determine basis of allotment, process and despatch allotment letters, refund orders or certificates in respect of an issue. Share transfer agents maintain the record of holders of securities issued by such body corporate and deal with all matters connected with the transfer and redemption of its securities. Share transfer agent can also be a department 13 NISM-Series-IX: Merchant Banking Certification Examination or division (by whatever name called) of a body corporate performing the above activities if, at any time the total number of the holders of securities issued exceed one lakh.  Self - Certified Syndicated Bank (SCSBs): SCSBs are Banker to an Issue registered with the SEBI, which offers the facility of Application Supported by Blocked Amount. In addition to the Self Certified Syndicate Banks (SCSBs), Syndicate Members and Registered Brokers of Stock exchanges, the Registrars to an Issue and share transfer Agents (RTAs) and Depository Participants (DPs) registered with SEBI are also permitted to accept application forms (both physical as well as online) in public issues. Regulators in Indian Securities Market In order to have effective functioning and proper development of the market, there is a need for a regulator. Amongst other tasks, the first and foremost task of the regulator would be to protect the interest of investors and to ensure that there is no violation of rules and regulations. In India, securities markets are regulated by different regulators and hence there may be instances where there is a regulatory overlap. The Securities and Exchange Board of India (SEBI) is the securities market regulator 2. As per SEBI Act 1992, it is “responsible for protecting the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto”. It also regulates the issue of new securities, has the power to make rules for regulating the stock exchange, provides license to dealers and brokers and deals with frauds and inconsistencies in the capital market. The money market which deals with bonds and deposits is regulated by the Reserve Bank of India (RBI). It looks at the macroeconomic conditions and decides the rate of interest to be paid on government securities as well as important factors like the Statutory Lending Ratio (SLR) and the Cash Reserve Ratio (CRR). It works with the Government to balance the growth of the country with factors such as inflation, current account deficits and the exchange rates of the rupee vis-à- vis the global currencies. Ministry of Company Affairs (MCA) through the Registrar of Companies regulates the Corporate Sector. The Ministry is primarily concerned with administration of the Companies Act, 2013, other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the corporate sector in accordance with law. The Ministry is also responsible for administering the Competition Act, 2002 though regulatory orders in individual cases are passed by the Competition Commission of India. Insurance Regulatory and Development Authority of India (IRDAI) is the watchdog for the insurance sector. Its mission is “to protect the interests of the policyholders, to regulate, promote 2 SEBI regulates Commodity derivatives which is included in the definition of derivatives under the Securities Contracts (Regulation) Act, 1956. Commodity derivatives have been defined in the Act. SEBI has also introduced options trading in commodity futures also. 14 NISM-Series-IX: Merchant Banking Certification Examination and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto”. It regulates the insurance and re-insurance business and has the mandate to register new insurance issuers, deal with issues of policyholders and to specify the code of conduct of the insurance business. Pension Fund Regulatory and Development Authority (PFRDA) is mandated to regulate the pension sector in India. It was formed through the PFRDA Act of 2003. It is responsible for carrying out the Government of India’s effort to find a sustainable solution to providing adequate retirement income to the citizens. Since 2008, the pension contributions of the central government employees are being invested by professional pension fund managers in accordance with Government of India guidelines, under the regulation of the PFRDA. Ministry of Finance (MOF) works through the Reserve Bank of India to regulate the securities market to the extent of investments into India by foreign or Non-Resident Indian investors. Foreign Exchange Management Act, 1999 came into force in 2000. The Act along with the Regulations and Rules thereunder specify the conditions to be fulfilled and the compliances to be made for investment into India. All the authorities have an interrelation with each other. For example: If a company is issuing equity shares in the securities market for the first time, the company has to comply with the provisions of the Companies Act which falls within the purview of the MCA and the offices of the Registrar of Companies and the Regional Directors under the MCA. The issue process is regulated under SEBI Regulations. Apart from this, if the issue is subscribed to, by the foreign investors or Non-resident Indians, such investments will be subject to the RBI regulations as well. Further, if a company is a bank or an insurance company, it is primarily regulated by RBI or IRDAI respectively, once the company decides to come with an IPO and lists its shares, thereafter, it also comes within the jurisdiction of SEBI as a listed company. Role of Investment Banker in Private Equity Investment bankers are usually appointed by companies seeking to raise capital through private equity sources such as venture capital funds and later stage private equity funds. Such transactions may also include investors seeking to sell their existing stakes in companies to other private equity investors. In such transactions, investment banker’s role is primarily of an advisory nature to assist the company or the investor from the sell side. The investment banker plays a key role in identifying the buy side investors and thereafter conducting the whole deal process till the transaction is culminated successfully. More specifically, the following aspects of the investment banker’s role are important -  Growth Plan Formulation - Advise the company on the arriving at the growth plan and capital investment required so that the necessary financial forecasts can be furnished to the investors. This would require an extensive study of the company’s past performance, growth opportunity, competitor analysis, market trends and other parameters. 15 NISM-Series-IX: Merchant Banking Certification Examination  Transaction Structuring – To come up with the correct instrument, quantum of capital to be raised and the capital structure of the company pre and post the proposed transaction.  Arriving at Pre-Money Valuation – Investment bankers conduct the valuation of the company for the proposed transaction in order to arrive at the sell side pitch to the investors and arrive at the transaction structure. Valuation should be based on established norms for such transactions and meet necessary regulatory pricing requirements for preferential allotments.  Offer Literature, Data Room Assistance – Investment banks prepare the entire transaction related literature such as the ‘teasers’ or preliminary information memorandum, the detailed information memorandum, financial models for the business forecast and the proposed transaction. They also assist in compilation of the information and documents for preparation of the data room based on which the potential buyers conduct their pre-investment due diligence on the company. The information memorandum should incorporate the necessary corporate disclosures that are required for investors to make an informed investment decision.  Leading the Transaction – Investment banks handhold the entire transaction from the initial stage till the parties execute definitive agreements to bring the transaction to a close. The process includes conducting meetings, leading negotiations for drawing up the term sheet, ensuring fair valuation for the sellers, co-ordination with the sellers, the company’s team and other agencies such as accounting and legal firms for completion of due diligence, audit and necessary certifications, furnishing of disclosure statements, representations and warranties and execution of documents. 16 NISM-Series-IX: Merchant Banking Certification Examination Review Questions: 1. In which market, securities are issued to investors for the first time? (a) Primary Market (b) Secondary Market (c) Repo Market (d) Currency Market 2. Who are the major investors in government securities market in India? (a) Banks and Insurance Companies (b) Provident Funds (c) Pension Funds (d) All of the Above 3. The SLR and CRR rates are decided by which of the following regulatory bodies? (a) Securities and Exchange Board of India (b) Reserve Bank of India (c) Insurance and Regulatory Authority of India (d) Competition Commission of India 4. Derivatives in which of the underlying assets are allowed in the Indian Market? (a) Equities (b) Currency (c) Commodities (d) All of the above 17 NISM-Series-IX: Merchant Banking Certification Examination Chapter 2 Introduction to the Merchant Banking LEARNING OBJECTIVES: After studying this chapter, you should know about the:  Concept and evolution of merchant banking  Merchant banking scenario in Indian and international market  Regulatory framework in which the merchant bankers function in India In the earlier chapter, we have discussed the capital market products and participants in the Indian context. This chapter delves into the evolution of merchant banking, the role of merchant bankers, concept and the regulations governing the activities of merchant banking in Indian context. The merchant banking activities with respect to international markets such as United States and United Kingdom have also been dealt with briefly. Concept and Evolution of Merchant Banking Concept of Merchant Banking The primary activity of Merchant Banks is to provide fee-based advice to corporates and governments on the issue of securities. Merchant banks differ from commercial banks in the sense that they do not take deposits from individuals or businesses. Merchant banks these days perform a variety of other activities such as financing foreign trade, underwriting of equity issues, portfolio management and undertaking foreign security business as well as foreign loan business, project appraisal etc. However, not all merchant banks offer all these services. Since the functions are very similar to those of Investment Bankers, they are often thought to be the same. However, an investment banker will also provide investment advice and deal with securities in secondary market, unlike a pure Merchant Banker. The difference between merchant banking and investment banking has been highlighted in the following section. Difference between Merchant Banking and Investment Banking There is a fine line of distinction between Merchant Banking and Investment Banking, which we try to highlight in this section. ‘Merchant Banking’ as the term suggests, is the function of intermediation in the capital market. It helps issuers to raise capital by placement of securities issued by the issuers with investors. The merchant banker has an onerous responsibility towards the investors who invest in such securities. The regulatory authorities require the merchant banking firms to promote quality issues, maintain integrity and ensure compliance with the law on own account and on behalf of the issuers as well. Therefore, merchant banking is a fee based service for management of public offers, popularly known as ‘issue management’ and for private 18 NISM-Series-IX: Merchant Banking Certification Examination placement of securities in the capital market. In India, the merchant banker leading a public offer is popularly known as the ‘Lead Manager’. On the other hand, the term ‘Investment Banking’ has a much wider connotation and is gradually becoming more of an inclusive term to refer to all types of capital market activity, both fund- based and non-fund based. This development has been driven more by the way the American investment banks have evolved themselves over the past century. Investment banking encompasses not merely merchant banking but other related capital market activities such as stock trading, market making and underwriting, stock broking and asset management as well. Besides the above, investment banks also provide a host of specialized corporate advisory services in the areas of project advisory, business and financial advisory and mergers and acquisitions.3 Evolution of International Merchant Banking Merchant banking originated in Italy then came to France in the seventeenth and eighteenth centuries. In France, a merchant banker was a merchant who added the banking business to his various activities and utilized his accumulated profits better. Merchant bankers’ activities differed from those of any other ‘money changer’ and involved dealing in bills of exchange with correspondents abroad and speculated on the rate of exchange. Merchant banks flourished in the United Kingdom in the late eighteenth and early nineteenth centuries as England became a rich trading nation. Profits from colonial trade were diverted into merchant banking activities and the chief activity was accepting commercial bills for domestic and international trade. Investment banks as are called in the United States are one of the most important participants in the US capital market. They help businesses and governments sell their new security issues in the debt or equity markets to raise capital, through primary market transactions. Once the securities are sold, they also create the secondary markets for these securities as brokers and dealers. The Glass-Steagall Act of 1933 differentiated the activities between the commercial banks and investment banks and prevented depositories from underwriting. The Securities Exchange Act (1934) in the United States sought to correct practices in securities trading with the formation of the Securities Exchange Commission (SEC). However, the relaxation of the rules set out in Glass Steagall Act in 1997, led to a wider consolidation in the investment and commercial banking space. Owing to the growing requirements of globalisation and growth of financial markets, the Glass Steagall Act was repealed in 1999 and replaced with a liberal Financial Modernisation Act 1999. After the exponential growth of investment banks in the US during the period 1990- 2007 and the subsequent global financial crisis in 2008, investment banks were brought under tight regulation again with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. The Act sought to regulate investment advisers, derivative markets, functioning of credit rating agencies etc. Specific to investment banking, the Act sought to regulate them by segregating banking from proprietary trading and asset 3 Reference: Investment Banking – An Odyssey in High Finance by Pratap Subramanyam. 19 NISM-Series-IX: Merchant Banking Certification Examination management (through the Volcker’s Rule’) as well as to provide for regulatory supervision for capital adequacy, quantitative limits and other restrictions. Merchant Banking in the International Scenario In this section we would be discussing the merchant banking activity as it is practiced in the different countries such as United Kingdom and the United States. Merchant Banking in UK The primary role of the merchant bankers was to discount bills and to provide safety in transactions for merchants going from country to country. Later on, merchant banks diversified into capital issue, advisory as well as management of funds. They also continued the business of financing foreign trade as well as managing funds for themselves and other wealthy merchants. They all showed characteristics such as a short chain of command, sophistication in services and high liquidity. Merchant banks are expected to be more focused on fee income rather than profits from investing funds. Merchant Banking in USA In the United States, merchant banks have evolved in to investment banks. Along with all the functions of a merchant bank, investment banks also risk their own capital and aim to earn profits from their proprietary trading activities. In the United States, commercial banks and investment banks have been separated in terms of the sources of capital as well as allowed activities. Merchant Banking in India The forerunners of merchant banking in India were the foreign banks and they have been created in India in a variety of forms. Nationalized banks have created new subsidiaries to carry out merchant banking activities, other domestic financial institutions have created separate divisions and share brokers and consultancies have registered themselves as public limited companies or partnerships or proprietary firms Grindlays Bank began merchant banking operations in 1967 with a license obtained from the RBI followed by Citibank in 1970. These two banks were providing services for syndication of loans and raising of equity apart from other advisory services. In 1972, the Banking Commission Report asserted the need for merchant banking services in India to be provided by public sector banks. Based on the Glass Steagall Act of 1933 passed by the US, the commission recommended a separate structure for merchant banks so as to separate them from commercial banks and financial institutions. Following the recommendation of the Banking Commission Report 4, SBI set up its merchant banking division in 1972. 4 The Banking Commission Report of 1972 has indicated the necessity of merchant banking service in view of the wide industrial base of the Indian economy. The commission was in favour of a separate institution to render merchant banking services. The 20 NISM-Series-IX: Merchant Banking Certification Examination Other banks such as Bank of India, Syndicate Bank, Punjab National Bank, and Canara Bank also followed suit to set up their merchant banking outfits. ICICI was the first financial institution to set up its merchant banking division in 1973. The later entrants were IFCI and IDBI with the latter setting up its merchant banking division in 1992. The post liberalization era (1991 onwards) brought about a marked transformation in the banking arena. The merchant banking industry during those days was mainly driven by the issue management activity which fluctuated with the trends in the primary markets. In order to stabilise their businesses, several of the banks engaged in merchant banking activity diversified to offer a broader spectrum of capital market services. The bigger investment banks now have several group entities in which the core and non-core business segments are distributed. Some of them such as SBI, IDBI, ICICI, IL&FS, Kotak Mahindra etc. offer almost the entire gamut of investment banking services permitted in India. SBI set up SBI Capital markets in 1986 and ICICI spin off ICICI Securities as a subsidiary in 1995. From simply providing issue management and capital raising advisory services, merchant banks have expanded into providing for many other services. The growth of Indian industry has given rise to further opportunities in mergers and acquisitions and takeovers. Merchant banks are also working on asset valuation, investment management and promotion of investment trusts. 2.2.1 Role of Association of Investment Bankers of India (AIBI) in Indian Context The industry body for merchant bankers in India that acts as a self-regulatory organisation is known as the Association of Investment Bankers of India (AIBI). It was founded in 1993 as the Association of Merchant Bankers of India. It was granted recognition by SEBI to set up professional standards, for providing efficient services and to establish standard practices in merchant banking and financial services. AIBI’s primary objective is to ensure that its members render services to all constituents within an agreed framework of ethical principles and practices. AIBI also works towards promoting the interests of the industry and of its members. AIBI is the thought leader and a nodal point for assimilation and dissemination of information relating to the investment banking industry in India. It is also the industry's sole representative to all statutory authorities, and in particular, to SEBI. Regulatory Framework for Merchant Bankers in India There are various acts, regulations and guidelines which govern the different activities of Merchant Banking in India. These have been discussed below in brief in two categories – (1) Core Regulation and (2) Support Regulation: CORE REGULATIONS SEBI Act, 1992 commission suggested that they should offer investment management and advisory services particularly to the medium and small savers (Reference: Merchant Banking, Principles and Practice – H R Machiraju, 3rd ed.). 21 NISM-Series-IX: Merchant Banking Certification Examination The Securities and Exchange Board of India (SEBI) was established on April 12, 1992 in accordance with the provisions of the SEBI Act, 1992. The preamble of the SEBI describes the basic functions of the SEBI as “...to protect the interests of investors in securities and to promote the development of and to regulate the securities market and for matters connected therewith or incidental thereto...” As per Section 11(2) of SEBI Act, SEBI is empowered under the various regulations of the SEBI Act to perform functions, some of which are specified below; a) Regulate the business in stock exchanges and any other securities markets. b) Register and regulate the working of stockbrokers, share transfer agents, bankers to an issue, debenture trustee, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and others associated with the securities market. SEBI’s powers also extend to registering and regulating the working of depositories and depository participants, custodians of securities, foreign portfolio investors, credit rating agencies, and others as may be specified by SEBI. c) Register and regulate the working of venture capital funds and collective investment schemes including mutual funds. d) Promote and regulate SROs. e) Prohibit fraudulent and unfair trade practices relating to the securities market. f) Promote investors’ education and training of intermediaries in the securities market. g) Prohibit insider trading in securities. h) Regulate substantial acquisition of shares and takeover of companies. i) Require disclosure of information, to undertake inspection, to conduct inquiries and audits of stock exchanges, mutual funds, other persons associated with the securities market, intermediaries and SROs in the securities market. The requirement of disclosure of information can apply to any bank or any other authority or board or corporation. j) Perform such functions and to exercise such powers under the Securities Contracts (Regulation) Act, 1956 as may be delegated to it by the Central Government. k) Levy fees or other charges pursuant to implementation of this regulation. l) Conduct research for the above purposes. m) Calling from or furnishing to any such agencies, as may be specified by the Board, such information as may be considered necessary by it for the efficient discharge of its functions. n) Performing such other functions as may be prescribed. According to sub-section 3 of Section 11 of the SEBI Act, notwithstanding anything contained in any other law for the time being in force while exercising the powers, SEBI shall have the same powers as are vested in a civil court under the Code of Civil Procedure, while trying a suit in respect of the following matters; i. The discovery and production of books of account and other documents, at such place and such time as may be specified by the SEBI; ii. Summoning and enforcing the attendance of persons and examining them on oath; 22 NISM-Series-IX: Merchant Banking Certification Examination iii. Inspection of any books, registers and other documents of any person; iv. inspection of any book, or register, or other document or record of the company; v. Issuing commissions for the examination of witnesses or documents. SEBI Act also empowers SEBI to impose penalties and initiate adjudication proceedings against intermediaries who default on the following grounds such as failure to furnish information, return etc. or failure by any person to enter into agreement with clients etc. Some of them have been discussed below: 15A- Penalty for failure to furnish information, return, etc.- SEBI Act provides for maximum penalty amount for each of the non-compliance of provisions as mentioned in the below mentioned sections. Section15A prescribes penalty payable by an intermediary for failing to- a) Furnish any document, return or report to the SEBI. b) File any return or furnish any information, books or other documents within the time specified as in the regulations. c) Maintain books of account or records. 15B- Penalty for failure by any person to enter into agreement with clients- Section 15B prescribes the penalty payable by an intermediary for failing to enter into an agreement with his/her client in violation of such a requirement under the SEBI Act, 1992. 15C-Penalty for failure to redress investors' grievances- Section 15C prescribes the penalty applicable to a listed company or any person who is registered as an intermediary, for failing to redress investors’ grievances after having been directed in writing by SEBI to do so within a specified time period. 15G-Penalty for insider trading - Section 15G prescribes penalties for the following: a) When an insider acting on his/her own behalf or on behalf of another deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price- sensitive information. b) When an insider communicates any unpublished price-sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law. c) When an insider counsels, or procures for any other person to deal in any securities of anybody corporate listed on any stock exchange on the basis of unpublished price- sensitive information. 23 NISM-Series-IX: Merchant Banking Certification Examination Insider shall be liable to a penalty which shall not be less than ten lakh rupees but which may extend to twenty five crore rupees or three times the amount of profits made out of insider trading, whichever is higher. 15H-Penalty for non-disclosure of acquisition of shares and take-overs- Section 15H prescribes penalty for people who fails to: (a) Disclose the aggregate of his shareholding in the body corporate before he acquires any shares of that body corporate; or (b) Make a public announcement to acquire shares at a minimum price, or (c) Make a public offer by sending letter of offer to the shareholders of the concerned company; or (d) Make payment of consideration to the shareholders who sold their shares pursuant to letter of offer. Any person indulging in the above mentioned activities shall be liable to a penalty which shall not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such failure, whichever is higher. 15HA-Penalty for fraudulent and unfair trade practices- Section 15HA prescribes a penalty for people indulging in fraudulent and unfair trade practices relating to securities. Any person indulging in such activities would be liable to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher. 15HB-Penalty for contravention where no separate penalty has been provided- Section 15HB states that whoever fails to comply with any provision of the SEBI Act, the rules or the regulations made or directions issued by SEBI thereunder, for which no separate penalty has been provided, shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one crore rupees. Role of Appellate Authority -Securities Appellate Tribunal (SAT) The Securities Appellate Tribunal (SAT) has been set up under the SEBI Act, which looks into the appeal of any person who has been aggrieved by any order of SEBI. This section elaborates on the different regulations under the SEBI which discusses the establishment and the role of SAT. Section 15K (1) of the SEBI Act, 1992, empowers the Central Government to establish Securities Appellate Tribunal (SAT) to exercise jurisdiction, powers and authority under the said act or any other law in force. A SAT shall consist of a presiding officer and two other members, to be appointed by the Central Government. The qualification for appointment is that the person should be a sitting or retired judge of the Supreme Court or a retired Chief Justice of a High Court. 24 NISM-Series-IX: Merchant Banking Certification Examination Any person aggrieved by the following may appeal to the SAT, provided the aggrieved person had not granted his consent to the order against which the appeal is being made. The appeal must be filed within a period of 45 days from the date on which a copy of the order is received: a. An order of SEBI made on or after the commencement of the Securities Laws (Second Amendment) Act, 1999, under the SEBI Act 1992, or related rules and regulations. OR b. By an order made by an adjudicating officer under the Act. As per Section 15U (1) of the SEBI Act, 1992, the SAT shall not be bound by the procedure laid down by the Code of Civil Procedure, 1908, but shall be guided by the principles of natural justice. Further, subject to other provisions of the SEBI Act, 1992, and other rules, the SAT shall have powers to regulate its own procedure. As per Section 15U (2) of the SEBI Act, 1992, the SAT shall have, for discharging its functions, the same powers as are vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit, in respect of the following matters: a) Summoning and enforcing the attendance of any person and examining him on oath b) Requiring the discovery and production of documents c) Receiving evidence on affidavits d) Issuing commissions for the examination of witnesses or documents e) Reviewing its decisions f) Dismissing an application for default or deciding it ex-parte g) Setting aside any order of dismissal of any application for default or any order passed by it ex-parte h) Any other matter which may be prescribed According to Section 15U (3) of the SEBI Act, 1992, every proceeding before the SAT shall be deemed to be a judicial proceeding and SAT shall be deemed to be a civil court. Section 15V states that the appellant may either appear in person or authorize one or more chartered accountants or company secretaries or cost accountants or legal practitioners or any of its officers to present his or its case before the SAT. Section 15W of the SEBI Act, 1992 states that the provisions of the Limitation Act, 1963 shall apply to an appeal made to a SAT. Section 15Y of the SEBI Act, 1992 specifies that no civil court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which SAT constituted under the SEBI Act is empowered to decide upon. Further, no injunction shall be granted by any court or an authority in respect of any action taken or to be taken in pursuance of any power conferred by or under the SEBI Act. 25 NISM-Series-IX: Merchant Banking Certification Examination Section 15Z of the SEBI Act, 1992 states that any person aggrieved by any decision or order of the SAT may file an appeal to the Supreme Court within 60 days from the date of communication of the decision or order of the SAT to him, on any question of law arising out of the order. Securities Contracts (Regulation) Act, 1956 The Securities Contracts (Regulation) Act, 1956 provides for the definition of “securities” which includes the following: i. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; ii. Derivatives; 5 iii. Units or any other instrument issued by any collective investment scheme to the investors in such schemes; iv. Security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; v. Units or any other such instrument issued to the investors under any mutual fund scheme; vi. Units or any other instrument issued by any pooled investment vehicle; vii. Any certificate or instrument, issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be; viii. Government Securities; ix. Such other instruments as may be declared by the Central Government to be securities; and x. Rights or interest in securities. The Regulations provides for direct and indirect control of virtually all aspects of securities trading and the constitution, recognition and regulatory oversight of stock exchanges. This Act aims to prevent undesirable transactions in securities by regulating the business of dealing therein and by providing for certain other matters connected therewith. It gives the central government the regulatory jurisdiction over (a) stock exchanges through a process of recognition and continued supervision, (b) contracts and options in securities, and (c) listing of securities on stock exchanges. The objective of SCRA is to prevent undesirable speculation and to regulate contracts and transactions in securities. A transaction in securities between two persons is essentially a contract. The law that specifically applies in the case of a securities contracts is the SCRA. The Act also provides for the setting up of clearing corporations by stock exchanges for the purpose of performing the functions of clearing and settlement of various trades conducted on the stock exchange. SEBI has been given explicit powers under the Act to make or amend by-laws of any stock exchange. 5 As per SCRA, derivatives include a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract or differences or any other form of security; a contract which derives its value from the prices, or index prices, of underlying securities; commodity derivatives; and such other instruments as may be declared by the Central Government to be derivatives. [Amended by the Finance Act 2021]. 26 NISM-Series-IX: Merchant Banking Certification Examination Section 17A of the Act stipulated that any issue of securities to the public or listing on a stock exchange shall conform to the regulations prescribed by SEBI. Section 21 and 22 deals with listing of securities, section 21A deals with delisting of securities and sections 23 to 26 provides for the different penalties and procedures to be imposed upon any person / intermediary on non- compliance with any of the provisions given under the various rules and regulations governing the securities market in India. Section 23 specifies the penalties and the procedures for various non-compliances and failures. Some of them are discussed below: Section 23A of SCRA provides that any person, who is required under the SCRA or any Rules made thereunder–  to furnish any information, document, books, returns or report to a recognized stock exchange or to the Board, fails to furnish the same within the specified time or who furnishes false, incorrect or incomplete information, document, books, return or report shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees.  to maintain books of account or records as per the listing agreements, conditions or bye-laws of the stock exchange, fails to maintain the same, shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees. Securities Contracts (Regulation) Rules, 1957 (SCRR) SCRR provides for the actual procedures to be followed by applicants for recognition as a recognised stock exchange and the requirements with respect to listing of securities on a recognised Stock Exchange. It lays down conditions for the percentage of shares which need to be offered to the public in order to get the shares listed and also the percentage of shares which need to remain with public in order to remain listed. SCRR needs to be read in conjunction with SCRA. SCRR are the rules created for compliance of SCRA. Some of the important rules concerning securities issuances are given hereunder:  Rule 19(1) states that any public company desirous of getting its securities listed on a stock exchange shall make an application for such listing along with the prescribed documents.  Rule 19(2)(b) states that the minimum offer and allotment to public in terms of an offer document shall be as per the following sub-rules:  Rule 19 (2)(b)(i) specifies that at least 25% of each class or kind of equity shares or debentures convertible into equity shares issued by the company, if the post issue capital of the company calculated at offer price is less than or equal to one thousand six hundred crore rupees.  Rule 19(2)(b)(ii) specifies that at least such percentage of each class or kind of equity shares or debentures convertible into equity shares issued by the company equivalent to 27 NISM-Series-IX: Merchant Banking Certification Examination the value of four hundred crore rupees, if the post issue capital of the company calculated at offer price is more than one thousand six hundred crore rupees but less than or equal to four thousand crore rupees.  Rule 19(2)(b)(iii) specifies that at least ten percent of each class or kind of equity shares or debentures convertible into equity shares issued by the company, if the post issue capital of the company calculated at offer price is above four thousand crore rupees but less than or equal to one lakh crore rupees.  Rule 19(2)(b)(iv) specifies that at such percent of each class or kind of equity shares or debentures convertible into equity shares issued by the company equivalent to the value of five thousand crore rupees and at least five per cent of each such class or kind of equity shares or debenture convertible into equity shares issued by the company, if the post issue capital of the company calculated at offer price is above one lakh crore rupees. Provided that the company referred to in sub-clause (iv) shall increase its public shareholding to at least ten percent within a period of two years and at least twenty-five percent within a period of five years, from the date of listing of the securities, in the manner specified by SEBI. Provided that the company referred to in sub-clause (ii) or sub-clause (iii) shall increase its public shareholding to at least twenty-five percent within a period of 3 years from the date of listing of the securities in the manner specified by SEBI.  Rule 19 (4) states that an application for listing shall be necessary in respect of the following: (a) all new issues of any class or kind of securities of a company to be offered to the public; (b) all further issues of any class or kind of securities of a company if such class or kind of securities of the company are already listed on a recognised stock exchange.  Rule 19(5) states that a recognised stock exchange may suspend or withdraw admission to dealings in the securities if a company or body corporate either for a breach of or non- compliance with, any of the conditions of admission to dealings or for any other reason, to be recorded in writing which in the opinion of the stock exchange justifies such action. Provided that no such action shall be taken by a stock exchange without affording to the company or body corporate concerned a reasonable opportunity by a notice in writing, stating the reasons, to show cause against the proposed action.  Rule 19(6) states that a recognised stock exchange may, either at its own discretion or shall in accordance with the order of the SAT under sub-rule (5) restore or re-admit to dealings any securities suspended or withdrawn from the list.  Rule 19(7) states that SEBI may at its own discretion or on the recommendations of a recognised stock exchange, waive or relax the strict enforcement of any or all the requirements with respect to listing prescribed by these rules. Rule 19A stipulates that every listed company other than public sector company shall maintain public shareholding of at least twenty-five per cent of its issued capital. Companies whose public 28 NISM-Series-IX: Merchant Banking Certification Examination shareholding falls below this level due to specified reasons are given time to restore the shareholding back to the minimum required under this Rule [Continuous listing requirement]. SEBI (Merchant Bankers) Regulations, 1992 The SEBI (Merchant Bankers) Regulations, 1992 lists out the different criteria for registration of a merchant banker as an intermediary with SEBI. The different on-going compliances such as the capital adequacy requirement, general obligation and responsibilities, conditions of registrations, grant and renewal of certificate etc. which are required to be adhered to by a merchant banker are detailed out in the Regulation. The SEBI (Merchant Bankers) Regulations, 1992 would be discussed in detail in Chapter 3 of this workbook. SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 SEBI (ICDR) Regulations, 2018 requires that an issuer making an issue of securities to public or to QIBs or to its existing shareholders by way of rights issue is required to appoint a Merchant Banker registered with SEBI. Therefore, it would be important to know and understand various provisions of SEBI (ICDR) Regulations which govern the issue process and specifies rights and obligations of various parties involved in the entire process. SEBI (ICDR) Regulations lays down general conditions for capital market issuances like public and rights issuances, Qualified Institutions Placement (QIP) etc.; eligibility requirements; general obligations of the issuer and intermediaries in public and rights issuances; regulations governing preferential issues, qualified institutional placements and bonus issues by listed companies; Issue of IDRs. SEBI (ICDR) also has detailed requirements laid out with respect to disclosure and process requirements for capital market transactions by listed and unlisted companies which are in the process of listing. The different provisions of the SEBI (ICDR) Regulations have been discussed in detail in the Chapter 3 of this workbook. SEBI Listing Obligations and Disclosure Requirements (LODR) Regulations 2015 These regulations govern a company which has listed any of its designated securities on a recognised stock exchange. The designated securities mean specified securities, non-convertible debt securities, non-convertible redeemable preference shares, perpetual debt instrument, perpetual non-cumulative preference shares, Indian depository receipts, securitised debt instruments, security receipts, units issued by mutual funds and any other securities as may be specified by the Board. Regulation 4 lists out the most important disclosure and other compliances required of a listed company in the following areas – a) Preparation and disclosure of financial information as per applicable accounting standards. Compliance with applicable rules and regulations and timely furnishing of information is also a significant part of the requirements. 29 NISM-Series-IX: Merchant Banking Certification Examination b) Compliance with the corporate governance requirements specified in the regulations for the protection of the rights of shareholders ensuring equitable treatment to all shareholders. c) Recognising the role of stakeholders in corporate governance. d) Ensuring timely and accurate disclosure on all material matters including the financial situation, performance, ownership, and governance. e) The board of directors of a listed company have been given significant responsibilities both in terms of ensuring disclosure of information as well as in their core function of leading the company’s strategy, overseeing its performance and operations and ensuring corporate governance. The company shall also have a grievance redressal mechanism to address investor grievance from time to time and shall also have a full time compliance officer for this purpose and for regulatory compliance. Some of the other important clauses of the Listing Regulations which every issuer is required to comply with as per the Listing Agreement are mentioned below: Sr. No. Regulation Number Pertaining to 1. 29 Prior intimations 2. 30 Disclosure of events or information 3. 31 Shareholding Pattern 4. 38 Minimum level of public shareholding 5. 6 Appointment of Compliance officer and his/her obligations 6. 17 to 27, 46(2) (b) to (i) Corporate Governance and para C, D, E of Schedule V 7. 46 Company website SEBI (Prohibition of Insider Trading) Regulations, 2015 Any dealing/trading done by an insider based on information which is not available in public domain, gives an undue advantage to insiders and affects market integrity. This is not in line with the principle of fair and equitable markets. In order to protect integrity of the market, the SEBI (Prohibition of Insider Trading) Regulations have been put in place. The Regulations mainly provide for who can be insiders, what all is prohibited for them and the systemic provisions which need to be laid down and followed by listed company as well as intermediaries. 30 NISM-Series-IX: Merchant Banking Certification Examination Who are Insiders? “Insiders” are defined as any person who is, or was, connected with a company or is deemed to have been connected with the company and who is reasonably expected to have access to unpublished price sensitive information (UPSI) in respect of securities of a company, or who has received or has had access to such unpublished price. “Any person who is or has during the six months prior to the concerned act been associated with a company, directly or indirectly, in any capacity including by reason of frequent communication with its officers or by being in any contractual, fiduciary or employment relationship or by being a director, officer or an employee of the company or holds any position including a professional or business relationship between himself and the company whether temporary or permanent, that allows such person, directly or indirectly, access to unpublished price sensitive information or is reasonably expected to allow such access. Person is deemed to be a connected person, if such person is: (a) an immediate relative of connected persons; or (b) a holding company or associate company or subsidiary company; or (c) an intermediary as specified in section 12 of the SEBI Act or an employee or director thereof; or (d) an investment company, trustee company, asset management company or an employee or director thereof; or (e) an official of a stock exchange or of clearing house or corporation; or (f) a member of board of trustees of a mutual fund or a member of the board of directors of the asset management company of a mutual fund or is an employee thereof; or (g) a member of the board of directors or an employee, of a public financial institution as defined in section 2 (72) of the Companies Act, 2013; or (h) an official or an employee of a self-regulatory organization recognised or authorized by the SEBI; or (i) a banker of the company; or (j) a concern, firm, trust, Hindu undivided family, company or association of persons wherein a director of a company or his immediate relative or banker of the company, has more than ten percent of the holding or interest; It is intended that a connected person is one who has a connection with the company that is expected to put him in possession of unpublished price sensitive information. Immediate relatives and other categories of persons specified above are also presumed to be connected persons but such a presumption is a deeming legal fiction and is rebuttable. This definition is also intended to bring into its ambit persons who may not seemingly occupy any position in a company but are in regular touch with the company and its officers and are involved in the know how of the company’s operations. It is intended to bring within its ambit those who would have access to or could access unpublished price sensitive information about any company or class of companies by virtue of any connection that would put them in possession of unpublished price sensitive information. 31 NISM-Series-IX: Merchant Banking Certification Examination "Generally available information" means information that is accessible to the public on a non- discriminatory basis; Information published on the website of a stock exchange, would ordinarily be considered generally available. The Regulation defines the term ‘immediate relative’ as a spouse of a person, and includes parent, sibling, and child of such person or of the spouse, any of whom is either dependent financially on such person, or consults such person in taking decisions relating to trading in securities. SEBI Insider regulations, defines an ‘insider’ as any person who is: i) a connected person; or ii) in possession of or having access to UPSI; Since “generally available information” is defined, it is intended that anyone in possession of or having access to unpublished price sensitive information should be considered an “insider” regardless of how one came in possession of or had access to such information. Various circumstances are provided for such a person to demonstrate that he has not indulged in insider trading. Therefore, this definition is intended to bring within its reach any person who is in receipt of or has access to unpublished price sensitive information. The onus of showing that a certain person was in possession of or had access to unpublished price sensitive information at the time of trading would, therefore, be on the person leveling the charge after which the person who has traded when in possession of or having access to UPSI may demonstrate that he was not in such possession or that he has not traded or he could not access or that his trading when in possession of such information was squarely covered by the exonerating circumstances. Unpublished price sensitive information is any information, relating to a company or its securities, directly or indirectly, that is not generally available which upon becoming generally available, is likely to materially affect the price of the securities and shall, ordinarily including but not restricted to, information relating to the following: – (i) financial results; (ii) dividends; (iii) change in capital structure; (iv) mergers, de-mergers, acquisitions, delistings, disposals and expansion of business and such other transactions; (v) changes in key managerial personnel. 32 NISM-Series-IX: Merchant Banking Certification Examination What is prohibited under SEBI (Prohibition of Insider Trading) Regulations? Regulation 3(1) is intended to cast an obligation on all insiders who are essentially persons in possession of unpublished price sensitive information to handle such information with care and to deal with the information with them when transacting their business strictly on a need-to- know basis. It is also intended to lead to organisations developing practices based on need-to- know principles for treatment of information in their possession. Regulation 3(2) is intended to impose a prohibition on unlawfully procuring possession of unpublished price sensitive information. Inducement and procurement of unpublished price sensitive information not in furtherance of one’s legitimate duties and discharge of obligations would be illegal under this provision. Regulation 3 states that an insider shall not communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. Regulation 3(2) states that no person shall procure from or cause the communication by any insider of unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, except in furtherance of legitimate purposes, performance of duties or discharge of legal obligations. Regulation 3(3) further states that an unpublished price sensitive information may be communicated, provided, allowed access to or procured, in connection with transactions that would: (i) entail an obligation to make an open offer under the takeover regulations where the board of directors of the company is of informed opinion that the proposed transaction is in the best interests of the company; (ii) not attract the obligation to make an open offer under the takeover regulations but where the board of directors of the listed company is of informed opinion that the proposed transaction is in the best interests of the company and the information that constitutes unpublished price sensitive information is disseminated to be made generally available at least two trading days prior to the proposed transaction being effected in such form as the board of directors may determine. For this purpose Regulation 3(4) states that the board of directors shall require the parties to execute agreements to contract confidentiality and non-disclosure obligations on the part of such parties and such parties shall keep information so received confidential, except for the purpose of sub-regulation (3), and shall not otherwise trade in securities of the company when in possession of unpublished price sensitive information. As per Regulation 4, no insider shall trade in securities that are listed or proposed to be listed on a stock exchange when in possession of unpublished price sensitive information. However, the insider may prove his innocence by demonstrating the circumstances including the following: 33 NISM-Series-IX: Merchant Banking Certification Examination (i) the transaction is an off-market inter-se transfer between insiders who were in possession of the same unpublished price sensitive information without being in breach of regulation 3 and both parties had made a conscious and informed trade decision; Provided that such unpublished price sensitive information was not obtained under sub- regulation (3) of regulation 3 of the SEBI PIT Regulations. Provided further that such off-market trades shall be reported by the insiders to the company within two working days. Every company shall notify the particulars of such trades to the stock exchange on which the securities are listed within two trading days from receipt of the disclosure or from becoming aware of such information. (ii) the transaction was carried out through the block deal window mechanism between persons who were in possession of the unpublished price sensitive information without being in breach of regulation 3 and both parties had made a conscious and informed trade decision; Provided that such unpublished price sensitive information was not obtained by either person under sub-regulation (3) of regulation 3 of the SEBI PIT Regulations. (iii) the transaction in question was carried out pursuant to a statutory or regulatory obligation to carryout a bona fide transaction. (iv) the transaction in question was undertaken pursuant to the exercise of stock options in respect of which the exercise price was pre-determined in compliance with applicable regulations. (v) in the case of non-individual insiders: – (a) the individuals who were in possession of such unpublished price sensitive information were different from the individuals taking trading decisions and such decision-making individuals were not in possession of such unpublished price sensitive information when they took the decision to trade; and (b) appropriate and adequate arrangements were in place to ensure that these regulations are not violated and no unpublished price sensitive information was communicated by the individuals possessing the information to the individuals taking trading decisions and there is no evidence of such arrangements having been breached; (vi) the trades were pursuant to a trading plan set up in accordance with regulation 5. Regulation 5 deals with Trading Plans which can be formulated by an insider and the procedure related. It states as under: (1) An insider shall be entitled to formulate a trading plan and present it to the compliance officer for approval and public disclosure pursuant to which trades may be carried out on his behalf in accordance with such plan. (2) Such trading plan shall: (i) not entail commencement of trading on behalf of the insider earlier than six months from the public disclosure of the plan; (ii) not entail trading for the period between the twentieth trading day prior to the last day of any financial period for which results are required to be announced by the issuer of the securities and the second trading day after the disclosure of such financial results; (iii) entail trading for a period of not less than twelve months; 34 NISM-Series-IX: Merchant Banking Certification Examination (iv) not entail overlap of any period for which another trading plan is already in existence; (v) set out either the value of trades to be effected or the number of securities to be traded along with the nature of the trade and the intervals at, or dates on which such trades shall be effected; (vi) not entail trading in securities for market abuse. (3) The compliance officer shall review the Trading Plan to assess whether the plan would have any potential for violation of these regulations and shall be entitled to seek such express undertakings as may be necessary to enable such assessment and to approve and monitor the implementation of the plan. However, pre-clearance of trades shall not be required for a trade executed as per an approved trading plan. It is further stated that trading window norms and restrictions on contra trade shall not be applicable for trades carried out in accordance with an approved trading plan. (4) The trading plan once approved shall be irrevocable and the insider shall mandatorily have to implement the plan, without being entitled to either deviate from it or to execute any trade in the securities outside the scope of the trading plan. However the implementation of the trading plan shall not be commenced if any unpublished price sensitive information in possession of the insider at the time of formulation of the plan has not become generally available at the time of the commencement of implementation and in such event the compliance officer shall confirm that the commencement ought to be deferred until such unpublished price sensitive information becomes generally available information so as to avoid a violation of sub-regulation (1) of regulation 4. (5) Upon approval of the trading plan, the compliance officer shall notify the plan to the stock exchanges on which the securities are listed. Code of Fair Disclosure Regulation 8 specified that the board of directors of every company, whose securities are listed on a stock exchange, shall formulate and publish on its official website, a code of practices and procedures for fair disclosure of unpublished price sensitive information that it would follow in order to adhere to each of the principles set out in Schedule A to these regulations, without diluting the provisions of these regulations in any manner. Every such code of practices and procedures for fair disclosure of unpublished price sensitive information and every amendment thereto shall be promptly intimated to the stock exchanges where the securities are listed. Code of Conduct (1) The board of directors of every listed company and market intermediary shall formulate a code of conduct to regulate, monitor and report trading by its designated persons and immediate relatives of designated persons towards achieving compliance with these regulations, adopting the minimum standards set out in Schedule B to these regulations, without diluting the provisions of these regulations in any manner. (2) The board of directors or head(s) of the organisation, of every other person who is required to handle unpublished price sensitive information in the course of business operations 35 NISM-Series-IX: Merchant Banking Certification Examination shall formulate a code of conduct to regulate, monitor and report trading by employees and other connected persons towards achieving compliance with these regulations, adopting the minimum standards set out in Schedule B (in case of a listed company) and Schedule C (in case of an intermediary) to these regulations, without diluting the provisions of these regulations in any manner. (3) Every listed company, market intermediary and other persons formulating a code of conduct shall identify and designate a compliance officer to administer the code of conduct and other requirements under these regulations. (4) For the purpose of sub regulation (1) and (2), the board of directors or such other analogous authority shall in consultation with the compliance officer specify the designated persons to be covered by the code of conduct on the basis of their role and function in the organisation and the access that such role and function would provide to unpublished price sensitive information in addition to seniority and professional designation and shall include:- (i) Employees of such listed company, intermediary or fiduciary designated on the basis of their functional role or access to unpublished price sensitive information in the organization by their board of directors or analogous body; (ii) Employees of material subsidiaries of such listed companies designated on the basis of their functional role or access to unpublished price sensitive information in the organization by their board of directors; (iii) All promoters of listed companies and promoters who are individuals or investment companies for intermediaries or fiduciaries; (iv) Chief Executive Officer and employees upto two levels below Chief Executive Officer of such listed company, intermediary, fiduciary and its material subsidiaries irrespective of their functional role in the company or ability to have access to unpublished price sensitive information; (v) Any support staff of listed company, intermediary or fiduciary such as IT staff or secretarial staff who have access to unpublished price sensitive information. SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 deals with issues such as initial and continual disclosures of shareholding and control, substantial acquisition of shares or voting rights, bailout takeovers and investigation and action by SEBI. The regulations begin with an explanation of important terms such as “acquirer”, “control”, “person acting in concert” and “promoter”. The regulations envisage acquisitions for: 36 NISM-Series-IX: Merchant Banking Certification Examination Change in Control of Management Consolidation of Holdings Substantial Acquisition of shares or voting rights (25% or more) Some of the Regulations are discussed below, to illustrate the nature and scope of the regulations. According to Regulation 3(1), no acquirer shall acquire shares or voting rights in a target company which taken together with shares or voting rights, if any, held by him and by persons acting in concert with him in such target company, entitle them to exercise 25% or more

NISM-Series-IX Merchant Banking Certification Workbook PDF May 2023

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