Regulatory authorities have expanded their investigation into the management of retail subscriptions for public debt issues by merchant banks. The move comes amid concerns of potential irregularities in the subscription process, according to two sources familiar with the matter who spoke to Reuters.

The Securities and Exchange Board of India (SEBI) recently imposed restrictions on JM Financial from securing new mandates, citing findings that funds from associated entities were utilised to artificially inflate subscriptions, offering investors an assured exit. In response, JM Financial affirmed its commitment to full cooperation with SEBI's inquiries, as stated in a stock exchange filing on Thursday.

Meanwhile, the Reserve Bank of India (RBI) directed JM Financial's non-banking unit to cease all forms of financing against shares and debentures, including loans extended to customers for subscribing to initial public offerings (IPOs).

The ongoing investigation extends to multiple cases examining whether merchant banks facilitated exits for investors through connected non-banking finance firms, the sources disclosed. Investigators are also scrutinising the provision of disproportionate loans to subscribers and potential lapses in customer identification protocols.

Despite requests for comments, SEBI and RBI have yet to respond, maintaining a cautious stance on the matter.

While regulations currently permit investors to leverage credit for subscribing to debt securities in public issues, assuring investors of a profitable exit violates merchant banks' code of conduct, prohibiting the creation of artificial markets.

The ramifications of the regulatory scrutiny are reverberating across the market. Companies have raised over Rs 20,000 crore through public bond issues this financial year, marking a major uptick compared to previous years, as per data from Prime Database. However, the heightened scrutiny is expected to temper retail subscriptions and potentially elevate the cost of funds.

According to insights from industry experts, the regulatory scrutiny may particularly impact non-bank lenders seeking diversified funding sources following increased capital requirements imposed by the central bank. Vinay Pai, head of fixed income at Equirus, suggests that SEBI's investigation might steer non-bank lenders towards private debt placements amid a slowdown in bank lending to NBFCs in recent months.

(With Reuters inputs)