Sebi Overhauls Merchant Banker Rules to Boost Financial Stability and Flexibility

Source: BS

Context:

The Securities and Exchange Board of India (Sebi) has introduced a comprehensive overhaul of merchant banker (MB) regulations, focusing on capital adequacy, net worth, revenue requirements, and operational flexibility. The reforms aim to strengthen financial stability, enhance risk management, and improve ease of doing business in India’s capital markets.

What is a Merchant Banker?

A merchant banker (MB) is a financial intermediary or institution that provides specialized services to corporates, governments, and high-net-worth clients in raising capital and managing financial transactions. Unlike commercial banks, merchant bankers primarily focus on capital market activities, advisory, and corporate finance, rather than deposit-taking.

Key Changes in Merchant Banker Regulations

1. Capital Adequacy Framework
   • Merchant bankers must maintain a minimum net worth based on their activity category:
     • Category 1: Minimum Rs 50 crore net worth; can undertake all permitted activities.
     • Category 2: Minimum Rs 10 crore net worth; can undertake all activities except managing main-board equity issues.
   • Liquid Net Worth Requirement: At least 25% of the minimum net worth must be liquid at all times.
   • Underwriting Limit: Capped at 20 times the merchant banker’s liquid net worth.
2. Revenue Requirements
   • Category 1 MBs: Minimum Rs 12.5 crore cumulative revenue from permitted activities over the last three financial years.
   • Category 2 MBs: Minimum Rs 2.5 crore cumulative revenue.
   • Exemptions: Revenue criteria do not apply to MBs managing only issuance of non-convertible securities, securitized debt instruments, security receipts, municipal debt, commercial papers, REITs, and InvITs.
3. Flexibility to Undertake Non-Regulated Activities
   • MBs can engage in fee-based, non-fund activities in sectors not regulated by Sebi or any other financial sector regulator (FSR), subject to conditions.
   • Initial Sebi plan to hive off non-regulated activities into a separate legal entity was relaxed after market feedback.
4. Enhanced Transparency in ESOP & Sweat Equity Valuation
   • Sebi replaced merchant bankers with independent registered valuers for employee compensation-linked valuations, including ESOPs and sweat equity shares.
   • Aims to strengthen fairness and transparency in employee reward mechanisms.

Rationale Behind the Changes

• Risk Management: Ensure MBs are financially strong to manage underwriting and other market risks.
• Financial Stability: Limit over-leveraging and exposure of MBs to capital market volatility.
• Ease of Doing Business: Allow MBs operational flexibility to diversify into permissible financial services activities.
• Market Confidence: Strengthen investor protection and reliability of ESOP/share-linked valuations.

Implications for Market Participants

• Large MBs (Category 1): Greater autonomy and ability to manage multiple capital market activities.
• Smaller MBs (Category 2): Limited scope for main-board equity issuances but can expand into other permitted activities.
• Investors & Employees: More reliable and transparent valuation of ESOPs and sweat equity.
• Market Dynamics: Expected to encourage consolidation, improved compliance, and stronger financial performance of MBs.