Net Worth Liquid Capital And Chinese Walls Under SEBI's New Merchant Banker Framework

India's merchant banking industry is entering a more demanding regulatory phase in which capital strength, liquid buffers and governance standards will matter as much as deal making credentials. The new regulations which SEBI introduced through its January 2026 circular following the complete revision of the Merchant Bankers Regulations in December 2025, establish new net worth and "liquid net worth" requirements while linking underwriting capacity to actual liquid assets and raising staffing and compliance expectations and creating operational barriers to protect merchant banking activities from other business operations. For issuers, investors and ECM practitioners, these changes will reshape who can lead large capital markets transactions, how syndicates are structured and how conflicts are managed across universal banking and full service securities groups.

A. Why SEBI is resetting merchant banking now

The current situation sees SEBI making changes to its merchant banking regulations because there exists a strong primary market and more retail and institutional investors participate while capital raising procedures become more complicated. The policy commentary about the amendments shows that there exists a problem with undercapitalised intermediaries who manage large public offerings and the different governance and staffing standards that apply to various categories and the potential conflicts that arise when merchant bankers work for diversified financial groups which lack proper information barriers.

The December 2025 amendments to the Merchant Bankers Regulations tightened core definitions and enabled SEBI to prescribe higher capital and governance thresholds, while the 1 January 2026 circular follow on communications lay out phased timelines for implementing those requirements. The combined regulations require lead managers and underwriters to maintain sufficient loss absorption capacity which includes keeping easily sellable assets and operating under governance systems that withstand market volatility and disputed security offerings.

The meaning that can be conveyed is that, Merchant Banking is a core prudential and conduct sensitive activity of itself and not just a less capitalised addition to a larger group.

B. The new capital and liquid net worth norms

1. Higher net worth thresholds and phased timelines

Under the amended framework, SEBI has established new minimum net worth standards for merchant bankers because of the revised regulations which now establish clearer distinctions between full service firms and companies that provide limited advisory services. Reporting indicates that Category I merchant bankers responsible for lead managing public issues and acting as underwriters will need to meet significantly higher net worth thresholds, moving towards figures around ₹50 crore over a phased period while lower thresholds apply to entities carrying out only advisory or non-fund based merchant banking activities.

The scheduled rise in prices will not lead to an immediate market collapse. The registered merchant banks must fulfil their capital requirements through a phased approach which extends across multiple financial years. The SEBI monitoring system needs to check intermediate milestones which allow existing registered merchant bankers to reach their new capital requirements. New applicants, by contrast, are required to meet the revised thresholds upfront, effectively raising the entry bar for fresh entrants that wish to offer full service merchant banking.

Entities that fail to achieve their progress milestones will face supervisory scrutiny, which includes the possibility of new business restrictions and, in severe situations, the prohibition of essential merchant banking operations until they achieve compliance.

2. Liquid net worth and composition of buffers

SEBI assesses the asset performance and funding capabilities of merchant banks through their evaluation of net worth measurements. The circular and related commentary describe "liquid net worth" as that portion of net worth held in specified liquid instruments which financial institutions use to meet underwriting and other obligations after applying haircuts and concentration limits. The standard instruments which people accept as proper include cash and cash equivalents, scheduled commercial bank fixed deposits, government securities, prescribed mutual fund units, and highly liquid listed equity, with market risk and convertibility being measured through haircut deductions.

SEBI has prescribed that a defined percentage reported to be in the region of 25 per cent of the required net worth must be maintained as liquid net worth in these qualifying instruments. Merchant bankers will be required to demonstrate ongoing compliance through periodic reporting, including details of the composition of these liquid buffers, valuation methodology and any encumbrances.

This is intended to ensure that net worth figures are not merely accounting constructs but represent genuine capacity to absorb shocks arising from underwriting, offer failures, indemnity obligations and regulatory penalties. For groups, it also means that capital earmarked for merchant banking cannot be locked up in illiquid holdings elsewhere in the organisation.

3. Implications for smaller and mid-tier merchant bankers

The higher net worth floors together with the liquid asset requirements create capital needs for smaller and mid-tier merchant bankers which require them to either raise funds or modify their business operations or establish strategic alliances. Entities that have historically operated with thin capitalisation while participating in medium sized public offers may find that they must either scale up balance sheet strength to retain full Category I capabilities or reposition themselves as niche advisers without underwriting or lead manager roles.

The ECM practice will experience consolidation when larger IPOs and QIPs process their lead management through better capitalized institutions who will take book responsibility while boutique companies operate as co-managers or syndicate partners based on their financial resources.

Issuers and deal counsel will, in turn, need to incorporate these capital and liquid buffer considerations into their selection and diligence of merchant bankers, as the regulatory capacity of a proposed lead manager becomes as important as its distribution reach and league table credentials. For some mid-tier houses, the path forward may lie in focusing on advisory, delisting and open offer work where underwriting risk is limited, while partnering with larger institutions on big ticket public offerings.

C. Underwriting caps, revenue thresholds and outsourcing bans

1. Linking underwriting exposure to liquid net worth

A key objective of the overhaul is to align the underwriting exposure to match the existing liquid resources which a merchant banker can prove through their demonstration of capacity. The new framework limits underwriting commitments to a specific multiple of liquid net worth according to reports which show that actual exposure will not exceed twenty times the liquid net worth buffer. This seeks to prevent situations where merchants commit to large underwritings relative to their balance sheet and then struggle to absorb devolvement risk if an issue is under subscribed.

In practice, this means that a merchant banker's appetite for hard underwriting on large IPOs or rights issues will be a function not only of its risk appetite but of its ability to demonstrate sufficient liquid net worth at the relevant point in time. For ECM practitioners, syndicate structuring and the allocation of underwriting percentages between lead managers will increasingly reflect these regulatory constraints, rather than being driven solely by commercial bargaining.

2. Minimum revenue from core merchant banking and business mix discipline

The reforms also introduce a focus on revenue composition. SEBI has signalled that registered merchant bankers should derive a minimum proportion of their revenue from core merchant banking activities such as issue management, underwriting, buy back and open offer work rather than from unrelated business lines that happen to sit within the same legal entity.

Entities that generate their main revenue from non-merchant banking services while holding a licensing for occasional capital markets operations will experience classification challenges which force them to either separate their non-essential business activities or convert their merchant banking activities into dedicated business units. The intention of this policy is to establish supervisory oversight and capital requirements and governance standards which will be applied to entities that operate merchant banking as their primary business activity.

3. Restrictions on outsourcing core functions

SEBI's circular also tightens expectations around outsourcing. While merchant bankers may continue to outsource certain support functions, the performance of core merchant banking responsibilities such as due diligence on issuers, drafting and vetting offer documents, pricing recommendations and allocation related decisions cannot be offloaded wholesale to unregulated affiliates or third parties.

This has implications for group structures where much of the substantive work on offers was historically done in shared service units or affiliate entities, with the licensed merchant banker acting more as a sign off entity. Under the new framework, merchant bankers will need to ensure that sufficient in house capability exists to discharge key responsibilities, and that any outsourcing is governed by robust agreements, oversight mechanisms and audit trails that allow SEBI to supervise the true locus of decision making.

D. Governance staffing and Chinese walls

1. Strengthened governance and senior management requirements

The new framework establishes higher standards for governance and senior management and compliance capacity requirements. The circulars and commentary establish mandatory staffing requirements which include experienced principal officers and senior dedicated compliance officers and board members who must oversee risk and regulatory activities.SEBI also emphasises the need for documented policies on conflicts of interest, allocation of mandates, research independence and interactions with sales and trading functions within wider groups.

Merchant bankers whose governance frameworks used to operate with minimal board supervision which handled only standard approvals and viewed compliance as a secondary office duty and which operated risk management through separate business units now need to establish more structured governance systems. That may include dedicated risk and compliance committees, formalised escalation protocols and more frequent board engagement on regulatory themes, particularly in the context of high risk or politically sensitive offerings.

2. Ring fencing and information barriers within financial groups

The "Chinese walls" dimension is particularly relevant for merchant bankers that are part of larger banking or financial services conglomerates. SEBI's materials underscore the expectation that merchant banking operations should be ring fenced from other proprietary and client facing businesses, with clear information barrier policies, restricted list practices and surveillance over flows of deal related information.

For universal banks and diversified broker dealers, this will require a re-examination of how merchant banking sits alongside lending, trading, research, private banking and wealth management activities. The organization needs to implement physical and system-based team separation and control access to deal and data rooms and establish pre-clearance procedures for staff personal trading who handle confidential information and define rules for sharing specific insights about issuers which result from due diligence processes.

3. Consequences of weak governance and conflict management

The enforcement risk around weak governance has been rising steadily. Under the new framework, failures in conflict management or breakdowns in information barriers such as trading based on offer related information, preferential allocation patterns or misuse of issuer data for cross selling are likely to attract more severe regulatory responses, not only for individuals but for the merchant banking entity as a whole.

From a practice standpoint, this increases the premium on well documented conflict management decisions, especially in situations where the merchant banker, its affiliates or their lending books have multiple touchpoints with the issuer or its promoters. Boards will need to be comfortable that Chinese walls are not just policy documents but are embedded in day to day behaviour, supported by surveillance tools and periodic testing.

E. What this means for deals and ECM practice

1. Impact on IPO and QIP execution and syndicate design

For capital markets practitioners, the most visible impact will be on how IPOs, FPOs and QIPs are structured and executed. As underwriting capacity becomes a function of liquid net worth and as SEBI scrutinises capital buffers more closely, issuers may find that the pool of merchant bankers able to anchor large offerings shrinks to a smaller set of well capitalised houses. Smaller firms may continue to play roles as co-book runners or lead managers for specific investor segments, but the days of thinly capitalised entities leading sizeable, fully underwritten deals are likely numbered.

The composition of syndicates will undergo alterations. Lead managers with stronger balance sheets may take on larger underwriting percentages in exchange for correspondingly higher economics while boutiques will focus on marketing and distribution to defined investor niches. The issuers will experience more concentrated negotiating counterparties because they need to establish a direct link between a lead manager's risk taking capacity and its regulatory profile.

2. Implications for mid-tier and boutique merchant bankers

Mid-tier and boutique merchant bankers will need to think strategically about positioning. Some may choose to raise capital and build liquid buffers to retain full service capabilities, especially if they specialise in particular sectors or issuer profiles where they enjoy comparative advantage. Others may pivot towards advisory only models focusing on valuations, fairness opinions, delistings, open offers and buy backs while consciously stepping back from underwriting heavy mandates that strain their capital.

Partnership models are also likely to evolve. It may become more common for boutiques to originate and structure deals, while roping in larger merchant bankers for underwriting and regulatory front ending, with economics shared accordingly. For ECM lawyers, term sheets and engagement letters will need to capture these roles clearly, including how liability, diligence responsibilities and regulatory interactions are split between syndicate members.

3. Effects on issuers' selection and negotiation of lead managers

Issuers and their boards will need to incorporate the new framework into how they select and negotiate with merchant bankers. Beyond track record and distribution reach, due diligence on a proposed lead manager's capital strength, liquid net worth position, governance arrangements and outsourcing practices will become more important.

The engagement letters will now require parties to provide ongoing proof of their compliance with SEBI capital and governance standards until the end of their contractual obligations, which will include rights that enable issuers to evaluate their syndicate members when a merchant banker fails to meet required regulatory criteria. The increased capital and compliance expenses which merchant bankers incur will directly affect fee negotiations especially in cases that require hard underwriting or custom structuring solutions.

F. Transition timelines and what market participants should do now

1. Key dates and implementation phases

The circular from SEBI establishes a sequential execution process for existing merchant bankers who will adopt the new system through their assessment of capital and liquid net worth requirements which will be evaluated at specific dates during the assessment period. New registrants, on the other hand, are expected to comply with the revised norms from day one.

The market reports show that the period between 2026 and 2028 represents a vital time frame which businesses must use to develop their financial resources and transform their operational sectors while establishing new governance systems and compliance procedures. The failure to meet required milestones will result in regulatory penalties and damage market reputation because investors and issuers now consider complete compliance as a measure of organizational strength.

2. Action points for merchant bankers, issuers and boards

The merchant bankers need to establish their primary objectives through capital planning and evaluation of liquid asset reserves and examination of outsourcing agreements and assessment of their current governance systems against SEBI standards. The boards need to obtain detailed strategies which will help them achieve their requirements for net worth and liquid net worth through appropriate consolidation of business activities and enforcement of Chinese walls and conflict control measures within their organizational framework.

Issuers and deal lawyers should update their RFPs and diligence checklists to capture new regulatory parameters. Net worth and liquid buffer levels, recent SEBI inspection findings, governance arrangements and staffing profiles of proposed lead managers. For investors and independent directors overseeing capital raising, questions to ECM teams may now explicitly cover how merchant banker selection has factored in these regulatory shifts and whether underwriting and syndicate structures align with the new constraints.

Handled thoughtfully, SEBI's new merchant banker framework need not slow down India's capital markets pipeline. Instead, it offers an opportunity to strengthen the institutional backbone of the IPO and QIP ecosystem, so that when markets turn volatile or deals become contentious, the intermediaries at the centre of the process have the capital, liquid buffers and governance depth to weather the storm.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.