Enforcement Action on Merchant Bankers for Market Maker’s Non-Participation in SME Segment - MMJC

1. Introduction

The National Stock Exchange of India (‘NSE’) has issued a circular dated September 25, 2024, introducing a new enforcement mechanism aimed at ensuring compliance by Merchant Bankers with their obligations in the Small and Medium Enterprise (SME) segment.

This circular addresses non-participation by Market Makers and outlines graded disciplinary actions against Merchant Bankers found in violation of these obligations. The circular draws its authority from Regulation 261 of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘SEBI ICDR’) which establishes the role and responsibilities of Merchant Bankers regarding market-making in the SME segment.

2. Role of Merchant Bankers in SME Market Making

Before going forward with the role of merchant bankers in SME market making let us understand who is a market maker?

A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the bid–ask spread, or turn. The benefit to the firm is that it makes money from doing so; the benefit to the market is that this helps limit price variation (volatility) by setting a limited trading price range for the assets being traded.[1]

Market making is a crucial aspect of the SME segment as it provides liquidity, price stability, and investor confidence in securities that are typically less liquid compared to larger firms on the main board. Under Regulation 261 of SEBI ICDR which provides for the role and responsibilities of Merchant Banker/Lead Manager  , the Lead Manager (Merchant Banker) must ensure compulsory market making for at least three years from the date of listing or migration from the main board in terms of  regulation 276.

This regulation is fundamental to the sustainability and growth of SMEs in the public markets. Non-compliance with these obligations risks liquidity issues, price manipulation, and potential loss of investor interest, ultimately threatening the SME’s success post-listing.

3. Graded Enforcement Actions Against Merchant Bankers

The circular provides a structured approach to handling violations by Merchant Bankers, emphasizing corrective action before proceeding to more severe penalties.

• First Violation: If the first instance of non-compliance is reported  regarding a Market Maker for a specific scrip, the Merchant Banker will receive an advisory letter from the NSE for lapse by the market maker. This letter advises the Merchant Banker to appoint a new Market Maker for the non-complied scrip.
• Second Violation: If the same Market Maker and scrip face another instance of non-compliance, more stringent actions are applied. All ongoing applications handled by the Merchant Banker (excluding open IPOs) will be put on hold for one month. During this period, the Merchant Banker is required to appoint a new Market Maker for the concerned scrip.
• Third Violation: A third violation triggers the most severe penalty. The Merchant Banker will be debarred from accepting new assignments for six months. This also includes keeping all ongoing applications (except open IPOs) on hold. The NSE will report this to SEBI for further regulatory action.

These graded actions reflect a balance between encouraging compliance and imposing disciplinary measures, ensuring Merchant Bankers fulfil their essential role in sustaining the liquidity of SME stocks.

4. Actions Against Market Makers

Along with penalizing Merchant Bankers, this circular also touches on disciplinary actions for Market Makers directly. Any non-compliance observed in market-making activities will result in disciplinary measures as outlined in NSE Circular NSE/INSP/64144 dated September 25, 2024.

The circular has come into force from October 1, 2024.

5. Conclusion

This enforcement mechanism introduced by NSE is a critical step towards safeguarding the liquidity and proper functioning of the SME segment. By holding Merchant Bankers accountable for the actions (or inactions) of the Market Makers they appoint, the NSE seeks to maintain market integrity and investor confidence. The structured, progressive penalties ensure that Merchant Bankers are given opportunities to rectify the situation but face escalating consequences for repeated offenses. This approach aligns with SEBI’s broader regulatory framework designed to foster growth in the SME segment while protecting investor interests.

[1] https://en.wikipedia.org/wiki/Market_maker

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