Unit 2
Issue Management and Securitisation
Introduction
Issue management refers to management of public issues of companies like shares and debentures. The issue manager makes strategic decisions regarding method of issue of securities, time of issue of securities and price for issue of securities depending on the existing and future market situations. Issue management service is provided by merchant banker with involvement of agencies like underwriters, brokers, bankers, advertising agencies, printers, auditors, legal advisors, register to an issue etc. SEBI has formulated rules and regulations regarding issue management. Issue managers are required to be registered with SEBI and must comply with some requirements for registration-
Merchant bankers
Merchant bankers are non-banking financial companies engaged in providing wide range of financial services like issue management, corporate counselling, portfolio management, mergers and acquisitions etc. to corporate houses. In India, Merchant banking activity was initially started by Grindlays bank in 1967. According to SEBI (Merchant Bankers) Rules 1992, “A merchant banker has been defined as any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant advisor or rendering corporate advisory services in relation to such issue management”. Some examples of merchant bankers are- Bajaj Capital Limited, SBI capital markets, ICICI securities Ltd.
Different functions performed by merchant bankers are-
1. Corporate counselling: Corporate counselling refers to the activities performed to guide the corporate houses for their efficient financial management. Corporate counselling includes the following activities:
2. Project counselling: It involves the following activities:
3. Loan syndication: Merchant bankers facilitates the clients to get syndicated loan from different commercial banks by performing the activities like-
(a) It estimates the total cost of the project.
(b) It prepares financial plan for the project to be submit in banks to get the desired loans.
(d) It identifies institutions and banks for participation in financing.
(e) It arranges bridge finance.
(h) It makes assessment for working capital requirements.
4. Issue management: Issue management refers to management of public issues of companies like shares and debentures. The issue manager/merchant banker makes strategic decisions regarding method of issue of securities, time of issue of securities and price for issue of securities depending on the existing and future market situations. Issue management service is provided by merchant banker with involvement of agencies like underwriters, brokers, bankers, advertising agencies, printers, auditors, legal advisors, register to an issue etc.
6. Underwriting of public issue: In underwriting of public issue the activities performed by merchant bankers are as follows:
(a) It selects brokers for underwriting purpose.
(b) It makes arrangement for publication of the prospectus.
(c) It co-ordinates the activities of underwriters, brokers and bankers to the issue, and the Stock Exchanges.
7. Portfolio management: It refers to managements of investment of clients to get maximum return with minimum cost. It performs the following activities:
8. Merger and acquisition: A merger refers to combination of two or more companies into a single entity whereas in take-over one company acquires the control over another existing company. The merchant bankers act as professional expert in merger and acquisition to safeguard the interest of the shareholders in both the companies.
9. Foreign currency financing: Merchant bankers provide finance for export and import trade. The main activities undertaken under this head are:
(a) Provide assistance to carry out the study of turnkey and construction contract projects.
(b) Makes arrangement for loan syndication, letters of credit, pre-shipment credit, deferred post-shipment credit, bridge loans, and other credit facilities.
(c) Makes arrangement for foreign currency loans.
(e) Guarantees for deferred payment.
10. Working capital finance: Merchant bankers provide working capital finance to its clients to manage their short term capital needs.
11. Venture financing: Another function of a merchant banker is to provide venture finance to projects. It refers to provision of equity finance for funding high-risk and high-reward projects.
12. Lease financing: Merchant bankers provide lease finance to the clients to manage rent for property taken on lease.
Underwriters
Underwriter means a person or an association of person who undertakes the responsibility that securities offered to the public will be subscribed in the market. According to SEBI rules 1993, underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate when existing shareholders of a body corporate or the public do not subscribe to the securities offered to them. Commercial banks and development banks provide underwriting services. SEBI issued guidelines on underwriting of securities such as-
Bankers to an issue
Banker to an issue is the bank responsible for acceptance of application money from investors and refund of excess application money on behalf of the investing company. Section 3 of the SEBI act provides that no person shall carry on any activity as a banker to an issue unless he holds a certificate granted by the Board under the regulations.
Brokers to an issue
Broker to an issue is responsible for procurement of subscription to the issue from the prospective investors. Brokers must register with the SEBI to perform its activities. SEBI divide their activities into categories-
Key takeaways
Stock Broker is member of a stock exchange registered with SEBI to perform the brokering business. Some examples of stock broker are Sharekhan, IHDFC securities, Motilal Oswal etc.
The registration procedure of stock brokers are-
On fulfilment of following conditions, the registrar will provide registration certificate to the stock brokers—
(a) the stock broker holds the membership of any stock exchange;
(b) he shall abide by the rules, regulations and bye-laws of the stock exchange which are applicable to him;
(c) where the stock broker proposes to change his status or constitution, he shall obtain prior approval of the Board for continuing to act as such after the change;
(d) he shall pay fees charged by the Board in the manner provided in these regulations; and
(e) he shall take adequate steps to redress of grievances, of the investors within one month of the date of receipt of the complaint and keep the Board informed about the number, nature and other particulars of the complaints received from such investors.
A stock broker perform the following activities-
1) Stock broker provides a ready market to the investors for continuous buying and selling of securities.
2) Stock brokers safeguard the activities for investors by complying with the rules and regulations provided by the SEBI.
3) Stock broker maintains liquidity in the financial market by continuously buying and selling of securities.
4) Stock broker promotes the habit of saving and investment among the general masses by facilitating them investment avenues.
5) Stock broker promotes capital formation in the economy by mobilising resources from deficit sector to surplus sector.
6) Stock broker provide different quotation of market prices for various securities to the potential investors to make their investment decision.
7) Stock brokers persuade material information to the potential investors that help them to make correct investment decision.
8) Stock broker keep storage and protection of customer data.
Sub-brokers
Sub-broker in a stock exchange is a person appointed by the broker to act as an agent for him. In others words, sub-brokers are agent of brokers to deal with investors on behalf the brokers but they are not the members in stock exchange. Section 2 (gc), “sub-broker means any person not being a member of stock exchange who acts on behalf of a stock broker as an agent or otherwise for assisting the investors in buying, selling or dealing in securities through such stock brokers”. The sub- brokers should apply in “Form B” for registration with SEBI. The registration procedure of sub-brokers are-
1) The application form shall be accompanied by a recommendation from stock broker in “Form C”.
2) The application should be submitted to the same stock exchange where the stock broker is the member.
3) On receipt of application the stock exchange will verify the eligibility of applicant as sub-broker.
4) After satisfactory verification the stock exchange will forward the application to the board within 30 days from the receipt of application.
5) The Board on being satisfied that the sub-broker is eligible, shall grant a certificate in ‘Form E’ to the sub-broker and send the intimation to that effect to the stock exchange or stock exchanges.
Foreign brokers
Foreign brokers of stock exchange are persons who provide platform to investors to access the foreign exchange market. They bring together the buyer and sellers of different countries through a common network.
Trading and clearing/self-clearing members
Trading cum clearing/self-clearing members operates in stock exchanges to clear and settle their own stocks or on behalf of their clients. Section 2(fa) “self-clearing member” means a member of a clearing corporation or clearing house of the derivatives exchange or derivatives segment of a stock exchange who may clear and settle transactions on its own account or on account of its clients only, and shall not clear or settle transactions in securities for any other trading member(s). The registration procedure of trading and clearing members with SEBI is as follows-
(1) An application shall be made in Form AA of Schedule I, through the concerned derivatives exchange or derivative segment of a stock exchange of which he is a member.
(2) The derivatives exchange or segment or clearing house or corporation shall forward the application to the Board within thirty days from the date of its receipt.
(3) The applicant must furnish all material information or clarifications, regarding the trading and settlement in derivatives and matters connected thereto, to consider the application for grant of a certificate.
Stock trading
Stock trading refers to buying and selling of securities in a stock exchange. Trading and settlement procedure in stock market are mentioned below-
In the first step, the potential investor will select a broker/sub-broker and get registered with them. It is because the investors cannot directly access the stock market. The brokers will participate in trading in stock market on behalf of the investors.
2. Opening a Demat account:
In the next step, the investors open a dematerialised (demat) account to keep the securities in electronic mode. Demat account is opened with depositories like NSDL and CDSL.
3. Placing orders:
After opening of demat account, the investors can place orders for buying and selling of securities. The order is placed with the brokers regarding buying or selling of securities.
4. Execution of orders:
On receipt of order, the stock brokers must execute it within 24 hours from the receipt of such order. A contract note issued to the investors which contains information about the transactions, number of shares traded, price, fee, time and date of transaction etc.
5. Clearing and Settlement:
The clearing process takes place once two orders are matched. This process is managed by the clearing houses. Settlement involves the settlement of transactions for the buyers and sellers. In case of spot settlement the rolling principle of T+2 is followed.
Derivative trading
Derivative trading is a contract where the value of the contract is derived from an underlying asset like commodity, currency, security etc. derivative trading is taken place to hedge the risk associated with financial market. Derivative trading may be classified as-
It is an over the counter derivative contract where trading take place through private negotiation without going to an exchange. Transactions are taken place on spot but delivery will be taken at a future date.
2. Future trading:
It is an exchange traded trading where transactions are taken place through stock exchanges. All terms and conditions of the transactions are taken at spot but delivery will take place at a future.
3. Options:
Option is a derivative contract where parties to the contract give the right but not the obligation to buy/sell the underlying asset. It is traded in both OTC market and exchange traded market. It is of two types- call option and put option.
4. Swap trading:
It is s derivative contract where parties to the contract can exchange/swap their future cash flow, interest rate or currency of the contract.
Key takeaways
Securitisation is the process of pooling varieties of contractual debt like residential and commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities. In other words, securitisation process allows financial company to convert assets (mortgages and security against loan) into financial instruments and sell it in the financial market.
Securitisation v/s Factoring
Basis of difference | Securitisation | Factoring |
| It is associated with loans. | it is associated with book debts. |
2. Assets | It deals with loans. | It deals with bills receivables. |
3. Duration | It deals with medium and long term assets. | It deals with short tem assets. |
4. Agency | Collection is done by agency or bank itself. | Collection is done by the factor. |
5. Risk | Risk is absorbed by the bank. | Risk is absorbed by the factor. |
Features of securitisation
The essential features of securitisation is highlighted below-
Pass through certificates
Pass through certificates are issued by banks to the investors of securitisation instruments as evidence of their investment. The certificate entitled to holders that they will receive income generated out of their investments.
Securitisation mechanism
The figure 1 shows the securitisation mechanism/process in stepwise.
Step 1: in the first step, the bank/originator identifies the assets it wants to remove from its balance sheet and then pools them to sell it to the special purpose vehicle (SPV) i.e. the issuing company.
Step 2: In the next step, the issuer/SPV finances the acquisition of the pooled assets by issuing tradable, interest-bearing securities that are sold to capital market investors.
Step 3: The investors purchases such securities from the stock market at market rate. They will provide interest over such investment at fixed rate or market rate.
Fig 1: securitisation mechanism/ process
Special purpose vehicle (SPV)
SPV is a subsidiary company formed by the parent company to isolate and secure its financial risk i.e. securitisation of asset. Creation of SPV allows the companies to assure the investors repayment of debt in case of financial crisis of companies.
Benefits of securitisation
The securitisation of assets provided benefits to both originator and investor. Some of such benefits are highlighted in the following points-
4. It unblocks capital of banks by transforming mortgage assets and other loan assets into financial instruments.
5. It provides liquidity to illiquid assets of banks by converting them into marketable securities.
6. It manages the risk associated with securitisation by creating off special purpose vehicle.
7. It lowers funding cost of the originator by utilising the unused assets for cash flow.
8. It reduces the need for financial leverage by releasing blocked capital of the originator in the financial market for cash flow.
2. To the investor:
New guidelines on securitisation
RBI issued guidelines on securitisation of assets in accordance with the guidelines of BCBS and IFRS. The summary of such guidelines are highlighted in the following points-
Key takeaways
References