FCCB Basics

What is Foreign Currency Convertible Bond (FCCB)?

A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuer's domestic currency. 

In other words, the money being raised by the issuing company is in the form of a foreign currency. It gives two options:

a   One is, to get the regular interest and principal and

b)  The other is to convert the bond in to equities. It is a hybrid between bond and stock.

How FCCB is different to Company while raising though Equity and Debt?

Equity

Immediate Equity dilution, and

Dividend distribution

Debt

High Interest rate in borrowing

High Coupon rate in Bond

ECB is limited to capital goods, capacity augmentation, and overseas acquisitions

FCCB

Very low coupon/interest as compared to debt

No immediate dilution of equity

No cash payment in good market conditions

All transactions in foreign currency

ADVANTAGES TO ISSUER	ADVANTAGES TO INVESTORS
·         It may appear to be more stable and predictable than their domestic currency.	·         Safety of guaranteed payments on the bond.
·         It gives issuers the ability to access investment capital available in foreign markets.	·         Can take advantage of any large price appreciation in the company's stock
·         Companies can use the process to break into foreign markets.	·         Redeemable at maturity if not converted
·         The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock.	·         Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation.
·         It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component.	·         To bring down their exposure in one country by diversifying their portfolio.
·         Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks.	·         Investors buy FCCBs not as an instrument of debt but for the lure of equity.

Are there any disadvantages to the Investors And Company?

Yes, like any financial instrument, FCCBs also have disadvantages. Some of these are:

ü  The exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs.

ü  FCCBs mean creation of more debt and a forex outgo in terms of interest which is in foreign exchange.

ü  In case of convertible bond the interest rate is low (around 3 to 4 per cent) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity.

ü  If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earnings.

ü  It will remain as debt in the balance sheet until conversion.

RBI recent Guidelines:

In December 2008, RBI relaxed guidelines of FCCBs to companies by allowing premature buy-back of FCCBs through rupee resources

On March 13, 2009, RBI further liberalized the norms by extending the deadline for companies to complete the buyback by nine months from March 31, 2009 to December 31, 2009

In April 2009, under approval route, RBI relaxed amount of buy back from $50 Mn of the redemption value per company to $100 Mn

The FCCBs bought back/repurchased from the holders must be cancelled and should not be re-issued or re-sold.

In detailed analysis on the same ………….

RBI's recent policy changes: FCCB buyback route

In order to cushion the effects of the global financial slowdown on the Indian economy, the RBI announced that it will consider proposals for FCCB buyback under the approval route if funding for such buyback is financed either out of:

• Existing foreign currency resources of the company held in India or abroad; or

• Fresh external commercial borrowing (ECB).

The RBI's quick fix move has been viewed in some quarters as inadequate because:

• FCCB issuers did not have adequate overseas foreign currency resources;

• It would be difficult to raise more ECB especially for discharging existing debt; and

• The buyback, permissible under the approval route, would still require the RBI's approval which may be time consuming and discretionary.

In a circular of 8 December 2008 (Circular)2, the RBI further liberalized the buyback process by permitting FCCB buyback under the automatic route and also permitting use of Indian Rupee proceeds for buyback (subject to certain conditions).

The Circular permits FCCB issuers to buy back FCCBs under the automatic route and approval route subject to the following conditions:

	Specific conditions for Automatic route		Specific Conditions for Approval Route
Internal accruals	Buyback of FCCBs out of internal accruals is not permitted.		Buyback of FCCBs out of internal accruals is permitted subject to prior approval of the RBI and fulfillment of conditions listed below.
Discount on book value	The buyback of the FCCB is done at a discount of at least 15 per cent on the book value.		The buyback value of the FCCB is done at a minimum discount of 25 per cent on the book value.
Funding for buyback	Funds used for buyback are either out of: • existing foreign currency funds held either in India (including funds held in an "Exchange Earners" Foreign Currency Account with an AD3 in India) or abroad; and/or • Fresh ECB is raised in conformity with the current ECB norms. If the fresh ECB is coterminous with the residual maturity of the original FCCB and is for less than three years, the all-in-cost ceiling should not exceed six month LIBOR plus 200 bps; and in other cases as per the existing guidelines of the RBI.		The funds used for the buyback are: • Out of internal accruals, to be evidenced by the statutory auditor of the issuer and a bank's4 certificate; and • The total amount of buyback does not exceed US$50m of the redemption value per company.
General conditions for FCCB Buyback applicable under both routes:
Compliance		The FCCBs that are proposed to be bought back should have been issued in compliance with the extant guidelines and registered with the RBI. Further, the issuer should not have any pending proceedings for contravention of the Foreign Exchange Management Act 1999 (FEMA).
Cancellation of FCCBs		The FCCBs bought back must be cancelled and cannot be re-issued or resold.
FCCB holder's consent		The right of buyback is vested with the FCCB issuer but the FCCB holder's consent will be required for actual buyback. This would mean that the FCCB buyback will not have any effect on the FCCB holders not opting for the buyback.
Escrow account		FCCB issuers are required to open an escrow account with the branch or subsidiary of an Indian bank overseas or an international bank to ensure that the funds proposed to be used for the buyback are earmarked and not used for any other purpose.
Filing requirements		After completion of the buyback procedure the FCCB issuer is required to make the following filings with the AD: • ECB2 form prescribed under the guidelines issued from time to time by the RBI under the FEMA on ECBs (ECB Guidelines); and • Report stating details of the buyback including outstanding amount of the FCCBs, book value of the FCCBs, rate at which the FCCBs were bought back, amount paid and the source of funds.

Points to ponder:

·         Increase (from $50M to $100M) in limit of premature buy-back of FCCBs using Indian currency - Very less impact because of unavailability of sellers and a scarcity of funds with Indian companies.

·         Another option is to buy back those bonds using foreign currency reserves or through fresh borrowing in foreign currency (No limit) - But raising funds in foreign markets at this moment is a big challenge (Global credit crunch).

·         So it benefits only those companies who have enough cash in their internal accruals - But there are not many companies.

Parting thought …

"Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.”  

~ Ogden Nash