[Anshika Agarwal and Dhawni Sharda are third-year law students at National Law University, Odisha]
Introduction
On 29th November 2024, the Securities and Exchange Board of India (“SEBI”) released an amendment titled ‘The Securities and Exchange Board of India(Merchant Bankers)(Amendment) Regulations, 2024’ which followed the release of a consultation paper ‘Review of Securities and Exchange of India(Merchant Bankers) Regulations 1992’. The consultation paper aimed to create a regulatory framework for the operations and ‘permitted activities’ of Merchant Bankers (“MBs”). Furthermore, it established a stringent mechanism in comparison to the earlier MBs Regulations.
The consultation paper further aimed to provide clarity on the permitted activities of these intermediaries and bring them under a defined regulation, however, these regulatory measures could prove to be a deterrent in simplifying and easing the financial and regulatory reforms.
This article critically analyses the consultation paper in alignment with the amended regulations and delves into the regulatory gaps present within this framework. It further explores plausible solutions through which these gaps can be mitigated to the extent possible.
Background
MBs are financial institutions that cater to large business houses and high-net-worth individuals. These institutions are primarily responsible for issue management, portfolio management, and underwriting services. They also provide financial advisory services and help manage investment portfolios.
The introduction of the Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 established a comprehensive legal framework for these intermediaries. However, the rapid growth in the Indian financial markets became the cause to reconsider the role of the market intermediaries, i.e. MBs. Moreover, MBs have recently come under the scrutiny of the market watchdog due to alleged instances of lapses in due diligence. By introducing such a consultation paper, the SEBI aimed to keep a strict vigil on the performance and market penetration of MBs so as to avoid any future irregularities.
Key Recommendations
While the position before the release of the consultation paper provided for for the registration of the Category I bankers, having a minimum net worth of five crore rupees, the updated proposal raised the limit to fifty crores limiting their participation to two categories. Such a two-tier categorization barred the entry of newcomers to the markets. This would go against its own directive of ease of doing business wherein the regulator has been promising and inviting potential entrants to the markets
To further substantiate this, Regulation 13A of the MB Regulations, initially restricted the MBs to undertake any business outside the purview of the securities market without making a segregation. Now, the consultation paper has further added another burden by proposing changes to the valuation activities that won't be done unless specifically provided by the SEBI. While they cannot take on any new valuation assignments after a date decided by SEBI, they will be allowed a transition period of 6 months to complete any existing valuation projects.
This can be further analysed through the compliances, disclosures required, and strict penalties imposed for non-performance. For instance, the deadline for MBs to submit transaction details of securities acquisitions of body corporates was proposed to be extended from 15 days to 6 months as a part of the due diligence required. Furthermore, the penal provision i.e. Regulation 12(2) of MB regulations provides for the suspension of the certificate of registration in case of failure to pay the renewal fees prescribed by the SEBI within the stipulated time. Aggravating these concerns, the proposal provided a penal interest at 15% p.a. for each month of delay or part thereof or interim suspension of business activities for the same failure. It had to be further ensured that merchant bankers do not get multiple registrations and take the veil of other body corporates to carry out their operations when their license gets revoked as an individual entity.
Notably, these proposals have not been addressed in the recent amendment of the Merchant Bankers Regulations, 1992.
Ripple Effect on the Industry
Though the proposal would bring a complete overhaul in the MB regulations after 1992, however, certain proposals could become a lacuna in the performance of these intermediaries. The increase in the net worth requirements as outlined in the proposal could seriously impede the competitiveness of the market. Setting such a high threshold for the net worth would come down heavily on the niche players or small MBs, facing liquidity crunch. Creating such barriers will not provide a level playing field for the ones who do not fit in the said criteria. This would further stifle competition and innovation, favouring the large players.
Still, the capital requirements are just one aspect of the regulatory overhaul. Since merchant bankers look after a host of activities, it becomes imperative to reconsider the restrictions imposed on their engagement in the ancillary activities. Such activities broaden their portfolio for providing comprehensive solutions and inviting more potential clients. While drawing a line is an appreciated endeavor, this should not come at the cost of operational expansion. Instead of placing blanket restrictions, a more nuanced approach with industry consultation would be more effective. This further extends to consideration of penal provisions for non-payment of renewal fees. While this would promote timely compliance, it might also disrupt ongoing dealings with the clients. This, in turn, would create a ripple effect in the market. Such regulations would inadvertently discourage the smaller MBs from continuing their operations, creating a situation of market centralisation.
Further, the proposal provided for the six-month time period for reporting any acquisition made. While this may facilitate the ease of doing business for the MBs, it can also prove to be a dilatory tactic by MBs in releasing the reports. This delay would impede the identification of potential violations and hinder disclosure requirements which would result in reduced market transparency.
Lastly, the significant risks might rise for the regulators having concurrent jurisdiction, resulting in an overlap. In case of its existence, this can be complied with by segregating and sourcing out these activities to third parties. Therefore, an attempt can be made to clearly define the scope of activities
Concluding Remarks
To align with SEBI's objectives and harmonize regulatory oversight with financial sector reforms, it is crucial to distinguish between creating a regulatory framework and regulatory overreach. If such regulations are formulated without due consideration to the market realities, then they remain a dead letter. A more nuanced approach would involve devising a bifurcated strategy that considers the size and financial resources of the MBs rather than adopting a ‘one size fits all’ approach. SEBI can further consider real-time reporting systems but the intervals of such reports must be structured in a manner that allows the potential stakeholder to get an overview of the market operations of MBs consistently.
Furthermore, the amendments to the regulations should be in place to streamline the regulatory framework, fostering an ease of doing business environment. While the recent amendments fail to fulfill the intended purpose to be served, there still remains an additional burden on SEBI to channelise these frameworks. The recent amendments have fallen short of their intent. It also becomes necessary to reassess these amendments and relook at the SEBI’s proposed revisions to MB Regulations to foster transparency and streamline the regulatory regime. While the intent behind a stricter regulatory framework was to establish market integrity, a more nuanced approach is to fundamentally allow the small entrants and avoid market concentration.
Therefore, initiatives like a structured regulatory framework, and real-time reporting systems may be undertaken to balance the regulatory checks with the market realities to foster both market growth and integrity. In order to fetch the best outcomes of such initiatives the viable proposals of the consultation paper can be incorporated prudently in the revised amendments.
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