Some good, some bad: Experts on Sebi’s plan for tough merchant banking norms

There are 224 merchant bankers (MB) registered with the Securities and Exchange Board of India (Sebi), including prominent ones like 360 ONE WAM Ltd, AK Capital Services Ltd, JM Financial Ltd and Kotak Mahindra Capital Company Ltd.

Sebi’s proposal, set out in a consultation paper, is based on recommendations of the regulator’s Primary Market Advisory Committee (PMAC) and is open for public comments till 18 September.

Sebi noted that even though merchant bankers were not permitted to do business other than in securities, some were participating in activities outside of securities markets.

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“It has been observed that merchant bankers are engaged in private placement activities pertaining to unlisted companies, advisory services for projects and syndication of rupee term loans, which are outside the domain of SEBI," the paper said.

Arguing that such activities pose significant regulatory and systemic risks, the regulator proposed an overhaul of its regulations governing merchant bankers. 

Sebi’s paper clarified that merchant bankers—excluding banks and public financial institutions—will undertake only those activities that are related to the securities market and fall under Sebi’s jurisdiction.

Merchant bankers engaged in activities other than the permissible ones will segregate those within two years from a date which the board will specify, the paper said.

Sebi clarified that activities that require separate regulatory registration and licence that do not concern the securities market will not be permitted as per the regulations.

While most industry experts appreciated Sebi’s move, stating that such an overhaul was long due to get the right kind of players in the market, some merchant bankers feared it would discourage smaller players.

Anjali Aggarwal, partner and head of capital markets at wealth management firm Corporate Professionals, said the move was crucial to tackle the mushrooming of merchant bankers in the market.

“In the last three years, as per the Sebi website, 27 new merchant bankers have been registered. This influx raised concerns over their quality of due diligence. The proposed changes will be a check on the entire issue management ecosystem", she said.

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At present, merchant bankers are required to keep a minimum net worth of ₹5 crore and Sebi had proposed increasing it to ₹50 crore, as suggested by the Association of Investment Bankers of India (AIBI).

Aggarwal said streamlining permissible activities will bring more clarity on the scope of activities.

“Introduction of categories and minimum net worth requirements were the need of the hour. In the current financial environment, the extant provision of ₹5 crore net worth is not a difficult parameter. Maintaining minimum liquid net worth, will enable merchant bankers to take up better underwriting obligations," she said.

Sebi suggested categorizing merchant bankers by net worth and giving them two years to increase their net worth. For category 1, a merchant banker had to show a net worth of at least ₹50 crore, and for category 2 a minimum of ₹10 crore.

If the merchant bankers failed to earn a revenue of at least 50% of their net worth on a combined basis through permitted activities for three successive years, then Sebi would cancel their registration, it proposed.

Sebi also proposed a minimum liquid net worth requirement from merchant bankers for underwriting and other obligations under Sebi regulations, arguing this would help act as an entry barrier.

Tarun Singh, founder and managing director of investment house Highbrow Securities, said the proposed net worth requirements may unintentionally erect barriers for smaller or newer firms.

“This change risks creating an ecosystem where only the well-established giants thrive, potentially stifling the spirit of innovation and competition that is crucial for a healthy market."

However, the introduction of categories and minimum liquid net worth was a step in the right direction, he said, ensuring merchant bankers are well-equipped to handle market volatility.

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Singh said Sebi ought to ensure that future iterations of these rules do not stifle the contributions of smaller entities. “Sebi’s regulations should aim to balance stringent requirements with an ecosystem that allows smaller players to flourish and contribute meaningfully," he said.

Sebi observed that merchant bankers were using multiple registrations within a group to circumvent regulatory action or enforcement.

To enable institution building and streamline regulatory oversight, Sebi proposed that merchant bankers, other than banks and public financial institutions with their group companies, would have only a single registration within the same group.