SEBI Regulations for Merchant Bankers

Merchant banking activities in India are strictly regulated by the Securities and Exchange Board of India (SEBI) to protect investors and maintain market integrity. The primary regulatory framework is the SEBI (Merchant Bankers) Regulations, 1992, which has been amended over time (notably a significant amendment effective 2026).
These regulations cover the registration, capital adequacy, code of conduct, and responsibilities of merchant bankers. Below is an overview of key regulatory provisions:

Registration with SEBI

Any person or institution desiring to act as a Merchant Banker in India must register with SEBI and obtain a merchant banker’s certificate of registration. Without SEBI registration, one cannot carry out issue management or other merchant banking activities.

• Eligibility criteria include being set up as a body corporate (or certain allowed entities like banks), having necessary infrastructure and manpower, and fulfilling capital adequacy norms.
• Earlier, four categories (I, II, III, IV) of merchant bankers existed:
  • Category I: could act as issue manager (lead manager), underwrite, and provide all merchant banking services. (Net worth requirement was ₹5 crore, raised from ₹1 crore in 1995).
  • Category II: could act as co-manager in issues (not lead), advisor or consultant in issues, underwrite, etc. (Net worth requirement was ₹50 lakh earlier).
  • Category III: could underwrite up to a certain limit, and act only as advisor (Net worth maybe ₹20 lakh).
  • Category IV: could only act as adviser/consultant (no underwriting, no issue management) with no minimum net worth specified.
• Over time, these distinctions became less relevant as most active merchant bankers registered as Category I to provide full services. Many Category II/III either upgraded or exited.

New Two-Tier Category System (from 2026)

SEBI revamped the categorization to just two categories with much higher capital requirements:

• Category I Merchant Banker: Must have a minimum net worth of ₹50 Crore (to be achieved in phases by 2028; interim ₹25 Crore by 2027). Category I MBs are allowed to undertake all merchant banking activities, including managing public issues on the main board (main stock exchanges).
• Category II Merchant Banker: Must have a minimum net worth of ₹10 Crore (phased, interim ₹7.5 Crore by 2027). Category II MBs can undertake all merchant banking activities except acting as lead manager for main board equity IPOs. They can manage smaller issues like SME exchange IPOs, rights issues, open offers, buybacks, etc., but not large main-market IPOs.

This increase in net worth requirements is aimed at ensuring that only well-capitalized, serious players handle large public issues, thereby improving due diligence quality and the capacity to underwrite.

Liquid Net Worth Requirement

Out of the net worth, 25% must be in liquid assets (like cash, treasury bills, etc.) at all times. That means a Category I MB needs at least ₹12.5 Crore in highly liquid form. This ensures that if an underwritten issue devolves, the merchant banker has ready funds to cover it.

Registration is granted initially for a particular period (earlier 3 years) and is renewable. Now effectively, as long as compliance is maintained and fees are paid, the registration continues. SEBI charges fees for registration and renewal.

Capital Adequacy & Prudential Norms

Apart from net worth, SEBI’s updated norms cap the Underwriting commitments

• Total underwriting obligations of a merchant banker should not exceed 20 times its net worth (liquid capital). This prudential limit prevents over-leveraging. For example, if a merchant banker has liquid net worth of ₹10 Crore, it can underwrite issues up to ₹200 Crore in total at any point.
• Revenue Requirements: SEBI introduced a clause that a Category I merchant banker must generate at least ₹25 Crore of revenue over a rolling 3-year period from merchant banking activities (for Cat II, ₹5 Crore over 3 years). This is to discourage dormant license-holders and ensure only active players retain their registration. Failing to meet this threshold could result in cancellation of registration if not rectified.

These changes reflect SEBI’s move towards risk-based supervision, ensuring merchant bankers have “skin in the game” and operational capability.

Permitted Activities and Separation of Businesses

SEBI stipulates that merchant bankers shall undertake only permitted activities related to the securities market. Permitted activities include issue management, underwriting, advisory, portfolio management, etc. If a merchant banker (especially a non-bank entity) wants to do other financial activities (like lending, stock broking, asset management), those should be carried out through a separate entity or division with separate registration.

• By regulation, a merchant banker cannot carry on any business other than those connected with securities market without SEBI’s prior approval. This means their focus must remain on merchant banking and related capital market services; if they want to diversify, they must form subsidiaries or separate companies for those.
• Recent amendments require merchant bankers to hive off any non-permitted activities into a separate entity within a given timeframe, to avoid conflicts of interest and reduce risk contamination.

Code of Conduct

SEBI’s regulations include a detailed Code of Conduct that merchant bankers must follow. Key principles include:

• High Standards of Integrity and Fairness: They should act in an ethical manner, not manipulate or mislead issuers or investors.
• Due Diligence: They are expected to exercise due diligence, ensure proper care and professional judgment in all their operations – particularly in verifying information in issue prospectuses and in M&A deals.
• Transparency and Disclosure: All relevant information should be disclosed to investors. They must avoid misrepresentation or hiding material facts in offer documents.
• Investor Interest Paramount: Merchant bankers should place the interest of investors and the securities market above their own immediate interests or the interest of their issuer clients, in case of any conflict.
• Avoid Conflict of Interest: If there is any potential conflict (e.g., the merchant banker’s group company is investing in the issuer), it must be disclosed and handled in a fair manner. One new rule, for instance: a merchant banker cannot lead-manage an issue if its own directors or close relatives hold above a minimal stake (more than 0.1% or ₹10 lakh in value) in the issuer – to avoid conflict.
• Confidentiality: They should maintain confidentiality of client information and not misuse it for personal gain (no insider trading on information obtained through their advisory roles).
• Professional Quality: They should employ qualified and competent staff (SEBI now mandates that principal officers have at least 5 years of relevant experience and certain staff must pass specific NISM certification exams to ensure knowledge of regulations).

Responsibilities and Obligations

Lead Manager Limits

SEBI at times prescribes how many issues a lead manager can handle simultaneously, based on their manpower and track record. (Historically, there was a guideline that one merchant banker should not manage more than 5 issues at a time to ensure focus, especially if issues are large. Now with net worth criteria, emphasis is on capital rather than number of issues, but SEBI still monitors if a merchant banker is handling too many mandates beyond their capability).

Underwriting & Escrow

If acting as an underwriter, they must ensure arrangement of funds if needed. In takeover open offers, merchant bankers ensure the acquirer deposits required amount in escrow (around 25% of the consideration if fully underwritten, etc.) before the offer.

Issue Procedure Compliance

Merchant bankers must submit due diligence certificates to SEBI at various stages of an issue (e.g., certifying that all disclosures are true, that they have verified all material aspects, etc.). They also file post-issue compliance reports.

Redressal of Investor Grievances

They are responsible for ensuring that investor grievances related to issues (like refund delays, allotment issues) are resolved. SEBI holds lead managers accountable to follow up with the company or registrars to sort these out.

Reporting to SEBI

Merchant bankers have to submit periodic reports to SEBI – such as half-yearly statements of net worth compliance and activities, and immediate intimations of any material changes (like change in key personnel, any penalty or litigation against them, etc.). The new rules about half-yearly CA certification of net worth and limits are part of this enhanced oversight.

Compliance officer

Every merchant banker must appoint a Compliance officer who independently oversees adherence to rules and investor grievance handling. SEBI has stressed that this officer should be senior and not involved in business decisions to ensure independence.

Disciplinary Measures

SEBI can suspend or cancel the registration of a merchant banker for misconduct, rule violations, or not meeting the financial requirements. There is a defined procedure (including show-cause notices, hearings, and appeals potentially to the Securities Appellate Tribunal).

If a merchant banker is found to have caused losses to investors by wrongful act, SEBI can also impose penalties or direct them to make good the losses, etc. Extreme cases could even lead to barring individuals from the securities market.