NISM Series IX Merchant Banking: Chapter 2 – Introduction to Merchant Banking (Short Notes)

Chapter 2 of the NISM Series IX syllabus introduces you to the concept, history, and evolution of merchant banking — both globally and in India. It also covers the regulatory framework that governs merchant bankers in India. This is one of the most important chapters for the NISM Merchant Banking Certification Examination.

Also Read: Chapter 1 – Introduction to Capital Markets | NISM Series IX Free Mock Test What is Merchant Banking?

The primary activity of Merchant Banks is to provide fee-based advisory and issue management services to corporates and governments. Unlike commercial banks, merchant banks do not accept deposits from the public. Instead, they earn income through fees and commissions for services rendered.

Modern merchant banks perform a wide variety of activities including:

Financing foreign trade
Underwriting of equity issues
Portfolio management
Foreign security business and foreign loan business
Project appraisal
Advisory on mergers, acquisitions, and takeovers

Key difference: Merchant banks are fee-driven institutions, while commercial banks are deposit-driven and earn interest income.

Evolution of International Merchant Banking Origin in Europe (17th–19th Century)

Merchant banking originated in Italy and spread to France in the 17th–18th centuries, where wealthy merchants began engaging in banking using their accumulated profits from trade. Unlike money changers, these merchants dealt in bills of exchange and speculated on exchange rates — a practice that formed the basis of modern merchant banking.

In the United Kingdom, merchant banks grew prominently during the 18th–19th centuries, primarily by accepting commercial bills linked to domestic and international trade. These institutions were the forerunners of today's investment banks.

Evolution in the United States

In the US, investment banks evolved as the key players in capital markets, assisting companies in issuing and trading securities. Major legislative milestones include:

Glass-Steagall Act (1933): Separated commercial banking from investment banking in the US, prohibiting the same institution from engaging in both activities. This was a response to the Great Depression.
Relaxation in 1997 and Repeal in 1999: Deregulation allowed increased consolidation between commercial and investment banking — leading to the formation of financial conglomerates.
Dodd-Frank Act (2010): Passed after the 2008 global financial crisis, this Act reintroduced regulation of the financial sector, including the Volcker Rule, which restricts banks from proprietary trading with their own funds.

UK vs US: Key Differences

UK Merchant Banks: Primarily offer advisory services, fund management, and trade financing. Focus on earning fee-based income.
US Investment Banks: Perform similar roles but also engage in proprietary trading and profit-seeking through their own capital. Subject to stricter regulatory oversight than commercial banks.

History of Merchant Banking in India

The development of merchant banking in India can be traced through distinct phases:

Phase 1: Foreign Banks Pioneer (1967–1972)

Merchant banking in India began with foreign banks:

Grindlays Bank (1967) – One of the first to offer merchant banking services in India, providing loan syndication and equity-raising services.
Citibank (1970) – Another early entrant offering similar services to large Indian corporates.

Phase 2: Public Sector Banks Enter (1972 onwards)

The 1972 Banking Commission Report recommended separating merchant banking from commercial banking. Following this, public sector banks set up dedicated merchant banking divisions:

SBI, Bank of India, and Canara Bank established merchant banking divisions
ICICI was the first financial institution to set up a merchant banking division in 1973
IFCI and IDBI followed later

Phase 3: Post-1991 Liberalisation

After the economic liberalisation of 1991, merchant banking expanded beyond issue management into broader capital market services. Key developments:

SBI Capital Markets (1986) – Dedicated merchant banking subsidiary of SBI
ICICI Securities (1995) – Full-service investment banking arm of ICICI
Leading players like SBI, ICICI, and Kotak now offer full-spectrum investment banking services
Merchant banks today are also active in M&A advisory, asset valuation, investment management, and trust promotion

Regulatory Framework for Merchant Bankers in India

Merchant bankers in India operate under a comprehensive regulatory framework. The regulations are divided into Core Regulations and Support Regulations.

Core Regulations 1. SEBI Act, 1992

SEBI (Securities and Exchange Board of India) was established on April 12, 1992 under the SEBI Act. SEBI is empowered to:

Protect the interests of investors
Promote development of the securities market
Regulate the securities market

SEBI can impose penalties for violations including:

Failure to furnish information or returns
Failure to enter into agreements with clients
Failure to redress investor grievances
Insider trading
Non-disclosure of shareholding/takeovers
Fraudulent and unfair trade practices

The Securities Appellate Tribunal (SAT) is set up under the SEBI Act to hear appeals against SEBI orders.

2. Securities Contracts (Regulation) Act, 1956 (SCRA)

SCRA provides the legal definition of "securities" and regulates virtually all aspects of securities trading. It also provides for the setting up of clearing corporations by stock exchanges and gives SEBI explicit powers to make or amend by-laws of any stock exchange.

3. Securities Contracts (Regulation) Rules, 1957 (SCRR)

SCRR provides procedures for recognition of stock exchanges and lays down conditions for listing of securities, including the minimum public float requirements. SCRR must be read in conjunction with SCRA.

4. SEBI (Merchant Bankers) Regulations, 1992

This is the primary regulation governing merchant bankers. It covers:

Criteria for registration as a merchant banker
Capital adequacy requirements
General obligations and responsibilities
Conditions of registration, grant, and renewal of certificate

5. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR)

SEBI ICDR is the most important regulation for issue management. It covers:

General conditions for public issues, rights issues, QIPs, preferential issues
Eligibility requirements for issuers
Obligations of issuers and intermediaries
Disclosure requirements for listed and unlisted companies seeking listing

6. SEBI Listing Obligations and Disclosure Requirements (LODR) Regulations, 2015

LODR governs companies that have listed their securities on stock exchanges. "Designated securities" include equity shares, NCDs, preference shares, IDRs, mutual fund units, and other SEBI-specified instruments.

7. SEBI (Prohibition of Insider Trading) Regulations, 2015

These regulations prevent trading based on Unpublished Price Sensitive Information (UPSI). Key provisions:

Insiders include directors, employees, relatives, intermediaries, or anyone with access to UPSI
UPSI includes financial results, dividends, mergers, management changes — any non-public information that could impact share prices
Trading plans must follow strict rules including a 120-day cooling-off period
Companies must implement Chinese Wall procedures to restrict UPSI access
Compliance officers oversee adherence to the Code of Fair Disclosure and Conduct

8. SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SAST)

Also known as the Takeover Code, SAST deals with:

Initial and continual disclosures of shareholding and control
Substantial acquisition of shares or voting rights
Bailout takeovers
Investigation and action by SEBI

9. SEBI (Delisting of Equity Shares) Regulations, 2021

These regulations deal with the process of removing equity shares from a stock exchange's trading platform. Two types of delisting:

Voluntary Delisting – Company chooses to exit the exchange
Compulsory Delisting – Exchange or SEBI forces delisting due to non-compliance

These regulations do not apply to securities listed on the Institutional Trading Platform without a public issue.

10. SEBI (Buy-Back of Securities) Regulations, 2018

Listed companies can buy back their own securities under these regulations. Key aspects covered:

Conditions of buy-back
Procedure for buy-back through tender offer
Procedure for buy-back from open market
Obligations of the merchant banker

Support Regulations Foreign Exchange Management Act (FEMA), 1999

FEMA aims to facilitate external trade, payments, and orderly development of the forex market in India. Inbound Foreign Investment Routes under FEMA:

FDI Route (Foreign Direct Investment)
FPI Route (Foreign Portfolio Investment)
FVCI Route (Foreign Venture Capital Investment)

Competition Act, 2002

Prohibits anti-competitive agreements and abuse of dominant position. Regulates combinations (acquisitions and M&A) that may cause an "appreciable adverse effect on competition" in India. Relevant provisions were notified on May 20, 2009.

Companies Act, 2013

Most operational aspects of a company are administered under the Companies Act, 2013. Several sections directly impact the issue process — including those relating to prospectus preparation, allotment, share capital, and board governance.

Prevention of Money Laundering Act (PMLA), 2002

PMLA was enacted to prevent black money generation and money laundering. It brings RBI, SEBI, and IRDA under its purview and applies to all financial institutions, banks, insurance companies, mutual funds, and their intermediaries. The Act came into force from July 1, 2005.

SEBI (Bankers to an Issue) Regulations, 1994

Governs Bankers to an Issue (BTI), whose functions include:

Acceptance of application and application monies
Acceptance of allotment or call monies
Refund of application monies
Payment of dividend or interest warrants

SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993

Covers registration and code of conduct for RTAs. They handle pre-issue work, issue work, and post-issue work including maintaining records of applications and processing allotments and refunds.

SEBI (Intermediaries) Regulations, 2008

All SEBI-registered intermediaries must comply with this regulation, which prescribes the procedure for registration, general obligations, and criteria for determining a "fit and proper person." Merchant bankers must comply with this in addition to the SEBI (Merchant Bankers) Regulations.

SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021

Listed companies can issue shares to employees through schemes like ESOS, ESPS, SARS, GEBS, and RBS. Regulation 12 mandates the appointment of a registered merchant banker for scheme implementation and compliance.

SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021

Applies to public issues of debt securities and NCRPs, private placement of non-convertible securities, and listing of commercial paper issued as per RBI guidelines.

SEBI (Real Estate Investment Trust) Regulations, 2014

A REIT is a trust registered under these regulations. The REIT manager, in consultation with the trustee, must appoint a merchant banker for managing assets and for the offer and listing of units.

SEBI (Infrastructure Investment Trust) Regulations, 2014

InvITs are trusts registered under these regulations for investing in infrastructure projects. The manager has specific regulatory responsibilities.

The Depositories Act, 1996

Enables setting up of multiple depositories (NSDL and CDSL) in India. Ushered in an era of efficient capital market infrastructure with dematerialised securities.

SEBI (Foreign Portfolio Investors) Regulations, 2019

Defines Foreign Portfolio Investors (FPIs) — persons satisfying prescribed eligibility criteria. All existing FIIs and QFIs were merged into the single FPI category under this regulation (issued on September 23, 2019).

SEBI (Alternative Investment Funds) Regulations, 2012

AIFs are privately pooled investment vehicles for sophisticated investors. Angel Funds are a sub-category of Venture Capital Funds under Category I – AIF, that raise funds from angel investors.

SEBI (Research Analyst) Regulations, 2014

Defines and regulates research analysts. Specifies limitations on trading, internal policies for dealing, restrictions on publication of research reports, and public appearance norms.

SEBI (Investment Adviser) Regulations, 2013

An Investment Adviser is any person who, for consideration, provides investment advice to clients. This regulation governs their registration, conduct, and compliance requirements.

Quick Revision Table – Key Regulations for NISM Series IX

Regulation	Year	Key Focus
SEBI Act	1992	Establishment and powers of SEBI
SCRA	1956	Definition of securities, stock exchange oversight
SEBI MB Regulations	1992	Registration and conduct of merchant bankers
SEBI ICDR	2018	Capital market issuances (IPO, FPO, Rights, QIP)
SEBI LODR	2015	Continuous listing obligations
Insider Trading	2015	Prevention of UPSI-based trading
SEBI SAST	2011	Takeovers and substantial acquisitions
Delisting Regs	2021	Voluntary and compulsory delisting
Buy-Back Regulations	2018	Buy-back by listed companies
FEMA	1999	Foreign exchange management and FDI/FPI
PMLA	2002	Anti-money laundering (effective July 1, 2005)
Competition Act	2002	Anti-competitive agreements and M&A regulation

Frequently Asked Questions – NISM Series IX Chapter 2 When was SEBI established?

SEBI was established on April 12, 1992, under the SEBI Act, 1992.

What is the Glass-Steagall Act?

The Glass-Steagall Act (1933) was a US law that separated commercial banking from investment banking. It was relaxed in 1997 and fully repealed in 1999, leading to the rise of large financial conglomerates.

Which was the first financial institution to set up merchant banking in India?

ICICI was the first financial institution to set up a merchant banking division in India in 1973.

What is UPSI in insider trading regulations?

UPSI stands for Unpublished Price Sensitive Information — any non-public information that, if disclosed, could materially affect the price of a company's securities. Examples include financial results, dividends, mergers, and management changes.

What is the Volcker Rule?

The Volcker Rule, introduced under the Dodd-Frank Act (2010) in the US, restricts commercial banks from engaging in proprietary trading using their own funds. It was introduced following the 2008 financial crisis.

Practice Makes Perfect! Try our Free NISM Series IX Mock Test to test your understanding of Chapter 2. Also explore our NISM Study Material section for complete exam preparation.

Next Chapter: Chapter 3 – Registration, Code of Conduct & General Obligations