Amendment To The Merchant Banker Rules By SEBI

Introduction

The notification of the Securities and Exchange Board of India (Merchant Bankers) (Amendment) Regulations, 2025¹ ('the Amendments') represents a watershed moment in the history of Indian capital market regulation. For over three decades, the merchant banking industry in India operated under the foundational framework established by the Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992² ('the 1992 Regulation'). While this framework facilitated the liberalization of India's economy and the initial growth of its equity markets, the sheer velocity, complexity, and scale of the market in 2025 rendered the 1992 architecture increasingly obsolete.

The Amendments, effective from January 3, 2026, constitute a fundamental philosophical shift in how the regulator views the role of the "gatekeeper" in the primary market. The transition is from a regime of registration and compliance to one of risk-based supervision and capital resilience.

Related: Regulatory and Compliance Law Firms

The Previous Regime

To understand the gravity of the Amendments, the previous regime must be contextualized. The 1992 Regulations were drafted when India's market capitalization was a fraction of its current size, and the average Initial Public Offering ('IPO') size was modest.

Under the 1992 Regulations, a Merchant Banker ('MB') could obtain a Category I license with a net worth of merely ₹5 Crores. By 2024, this sum was insufficient to cover even the basic operational costs of a compliance-heavy financial firm in Mumbai, let alone support the underwriting risks of mainboard IPOs often exceeding ₹1,000 Crores.

Further, the low barrier to entry led to a proliferation of licenses. A significant number of registered MBs were operationally dormant, generating no revenue from core merchant banking activities. These entities often utilized the Securities and Exchanges Board of India ('SEBI') registration as a "badge of credibility" to sell unregulated services or, worse, "rented" their licenses to unregistered advisors for a fee, creating a shadow banking ecosystem with high regulatory opacity.

To add to it, the explosion of the Small and Medium Enterprises ('SME') IPO market between 2020-2025 exposed cracks in the due diligence process. Smaller, ill-capitalized MBs were bringing companies to market with questionable fundamentals, driven by volume rather than quality³.

The New Capital Architecture

The core pillar of the Amendments is the restructuring of capital adequacy norms. SEBI has abandoned the unitary model in favour of a tiered, risk-weighted capital framework. This acknowledges the bifurcation of the Indian primary market into the mainboard (large-cap/mid-cap) and the SME Platform/Private Markets.

a. The Two-Tier Categorization System

The newly inserted Regulation 7A⁴, along with Regulation 7⁵, introduce a bifurcated classification for MBs, creating distinct ecosystems for large and small intermediaries.

• Category I: The Mainboard Heavyweights It permits MBs with a minimum net worth of INR 50 Crores, to undertake all activities specified in Regulation 13A, including the lead management of mainboard IPOs. This represents a 1000% increase from the previous INR 5 Crores threshold. This dramatic hike acts as a formidable entry barrier, effectively reserving the mainboard IPO market for institutional players capable of absorbing significant financial shock.

• Category II: The SME and Boutique Specialists It permits MBs with a minimum net worth of INR 10 Crores to undertake all activities except the management of mainboard equity IPOs. Their primary domain includes SME IPOs, rights issues, buybacks, open offers, and private placements. This category prevents the complete annihilation of the boutique investment banking sector. It allows smaller players to continue serving the MSME ecosystem, albeit with a doubled capital requirement (up from ₹5 Crores to ₹10 Crores).

B. Mandate of "Liquid Net Worth"

Perhaps the most sophisticated change in the 2025 regulations is the move from "Net Worth" to "Liquid Net Worth" ('LNW'). LNW is defined as net worth deployed in unencumbered liquid assets such as cash, fixed deposits, treasury bills, government securities, and money market instruments.

The Amendments mandate that MBs must maintain a minimum LNW at all times. For Category I, MBs must maintain a LNW of minimum INR 12.5 Crores, and for Category II, a minimum ₹2.5 Crores must be maintained.

This requirement fundamentally alters the treasury management of MBs. Historically, many MBs invested their surplus capital in high-yield but illiquid instruments (like inter-corporate deposits or real estate). The new regulation forces a reallocation of capital into low-yield, high-safety liquid assets. While this reduces the return on equity for the MB on their own proprietary book, it drastically enhances the safety of the settlement system. It ensures that in the event of an underwriting devolution, the money is physically available in the bank and not locked in a property dispute.

c. Transition Roadmap and Compliance Timelines

Recognizing the disruptive nature of these capital hikes, SEBI has provided a calibrated transition window, with the capital buildup progressing over two years.

Table 1: Transition Timeline for Capital Adequacy

Existing MBs who fail to meet these milestones are barred from undertaking fresh mandates, to prevent a rush of risky issuances by non-compliant entities trying to make quick revenue before exiting.

Reforms in Underwriting Rules

The 1992 Regulations had a fatal flaw; wherein underwriting obligations were not strictly linked to liquid capital. An MB could theoretically underwrite an issue size far exceeding their ability to pay, relying on the assumption that the issue would be fully subscribed by the public. The Amendments close this regulatory arbitrage by introducing a Leverage Cap.

Under the new regime, underwriting exposure is explicitly pegged to Liquid Net Worth (LNW). The maximum underwriting obligation is set to be not more than 20 times Liquid Net Worth.

This change also aligns the with the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018⁷. The previous minimum underwriting obligation (5% or ₹25 lakh) has been rationalized to ensure consistency across regulations, removing legacy contradictions that confused market participants.

Operational Scope: The "Positive List" and Segregation

Regulation 13A⁸ has been rewritten to transform the merchant banking license from a general "financial consultancy" permit into a specialized "securities market" authorization. This is achieved through a positive list approach, where it says that if an activity is not listed, it is prohibited unless structured through a Separate Business Unit ('SBU').

a. The List of Permitted Activities

Regulation 13A⁹ explicitly delineates what an MB can do. This list focuses exclusively on the securities market lifecycle.

Core Permitted Activities:

1. Primary Market Issuance: Managing public issues (IPOs), Rights Issues, and Qualified Institutional Placements (QIPs).
2. Corporate Actions: Managing Open Offers (Takeovers), Buybacks, and Delisting offers.
3. Advisory: Corporate advisory services incidental to the above (e.g., advising on the pricing of an IPO).
4. Private Markets: Private placement of listed or "proposed to be listed" securities.
5. International: Managing GDR/ADR issuances.
6. AIF Services: Filing placement memoranda for Alternative Investment Funds.
7. Market Making: Acting as market makers (crucial for the SME segment).
8. Opinions: Issuing Fairness Opinions on valuations/mergers.

However, the SEBI has made a critical omission from this list, which is valuation. Historically, MBs were the primary valuers for various corporate transactions. The Amendments explicitly remove valuation from the MB's direct scope to prevent conflict of interest. Valuations now must be conducted by independent Registered Valuers which would be regulated by Insolvency and Bankruptcy Board of India.

b. The SBU Compromise

In SEBI's 2024 Consultation Paper¹⁰, it proposed a hard "hive-off", forcing MBs to spin off non-core activities into separate legal entities. This met with fierce industry resistance due to tax and operational costs. In a pragmatic compromise, the Amendments now allow non-core activities to be retained within the same legal entity, but only through an SBU. These activities include operations regulated by other financial regulators, and fee-based, non-fund-based financial activities.

The "Ring-Fencing" Protocol lays down that to operate an SBU, the MB must demonstrate "In-Substance Segregation". This will come with capital restrictions (the aforementioned INR 50 Crores threshold MBs cannot be leveraged for the SBUs), and operational segregation with distinct teams, reporting lines; to prevent information leakage.

The "Active Player" Doctrine: Minimum Revenue Thresholds

For the first time, SEBI has introduced performance-based criteria for license retention. Herein, a license is a privilege for active participants, not a dormant asset. Regulation 9C¹¹ introduces minimum revenue thresholds. A MB must generate minimum cumulative revenue from permitted activities over a rolling block of three financial years.

The minimum revenue requirements are INR 25 Crores for Category I MBs, and INR 5 Crores for Category II MBs (the revenue is a cumulative of three years). However, the rule does not apply to MBs who deal exclusively in the issuance of non-convertible debt securities, securitized debt, real estate investment trust, or infrastructure investment trusts. This exemption protects specialized debt arrangers who may have lumpy deal flows compared to equity bankers.

Conclusion

The Amendments by SEBI bring some well-needed changes. They impose short-term pain, higher costs, forced consolidation, and stricter compliance, in exchange for long-term systemic stability. By raising the floor for capital, liquidity, and governance, SEBI has signalled that the Indian primary market is no longer a playground for the under-capitalized. It is a mature ecosystem demanding intermediaries who are not just "registered," but resilient, liquid, and rigorously professional.

Appendix A: Comparative Analysis of 1992 vs. 2025 Regulations

Footnotes

1. Securities and Exchange Board of India, Merchant Bankers Amendment Regulations, 2025, F. No. SEBI/LAD-NRO/GN/2025/282 (Issued on December 3, 2025).

2. Securities and Exchange Board of India, Merchant Bankers Regulations, 1992, No. LE/11112/92 (Issued on December 22, 1992).

3. Vivek Singla, SME IPOs: A New Dawn for India's Small Businesses, National Institute for Micro, Small and Medium Enterprises, https://www.nimsme.gov.in/news-article/sme-ipos-a-new-dawn-for-india-s-small-businesses.

4. Regulation 7A of the Amendments.

5. Regulation 7 of the Amendments.

6. Regulation 13A of the Amendments.

7.Securities and Exchange Board of India, Issue of Capital and Disclosure Requirements Regulations, 2018, No. SEBI/LAD-NRO/GN/2018/31 (Issued on September 11, 2018).

8. Regulation 13A of the Amendments.

9. Regulation 13A of the Amendments.

10. Securities and Exchange Board of India, Consultation Paper titled Review of Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 (August 28, 2024).

11. Regulation 9C of the Amendments.