The article below seeks to provide an oversight of the FCCB market and food for thought for Indian companies embarking on newer and more innovative ways of raising capital

A convertible bond is a hybrid of a debt and an equity instrument. It has the features of an unsecured bond, with regular interest payments, and at maturity, the principal to be repaid. A convertible bond also has the attractive characteristic that, at or before maturity, the bondholder has the option to convert the bonds into equitable equity shares in the company. The conversion price at which the bond will be converted into shares is decided beforehand. If the shares of the company fail to reach the predetermined conversion price, and the bond reaches its maturity, then the principal is repaid to the bondholder along with a redemption premium if any

Depth and Dynamism in capital markets is key to any developing economy and the capital markets must promote efficiency and innovation. Issuances such as FCCB’s require the backing of a robust financial framework built by regulators and market participants, both

From the regulatory end, the story so far has been nothing short of being exemplary. The FCCB guidelines were first issued in 1993, by the Finance Ministry under the “Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993”, which has been revised and relaxed several times. By 2003, the right to approve FCCB borrowings was delegated to the central bank, the RBI under FEMA regulations, and the RBI has been issuing ECB guidelines from time-to time, which is applicable to FCCBs and also subject to compliance of the above scheme, issued by the Finance Ministry. The Issue Of Foreign Currency Convertible Bonds and Ordinary Shares (through the depository receipt mechanism) Scheme, 1993, has undergone several piecemeal amendments to meet the emerging needs of India Inc. The Reserve Bank of India (RBI) has been extremely supportive of the corporate sector by amending the FCCB guidelines from time to time to meet industry demand thus exhibiting a sustained programme of liberalization by India to integrate more seamlessly with the international capital markets.

And with this inspiration and confidence, India Inc. embraced this highly innovative hybrid instrument to access capital from the international investors between the period of 2005 and 2012. In practicality, FCCB is essentially a mix of a bond and an equity option that allows the issuer to raise money rather inexpensively, compared to domestic markets, whilst giving an upside to the investor on the option to convert into shares at a pre-determined price (usually at a premium to the current stock price) at a pre-determined date. If the investor exercises the option to convert into shares, the bond gets lapsed and no repayment of principal is required

As of 2014, FCCB market in Asia – Pacific is estimated to be about USD 50 bn. In 2008, the market was at a high of USD 80 bn with issuers mainly from Korea, Taiwan & India. Indian FCCB market peaked at USD 16 bn of the total outstanding FCCBs pre-2008 with India taking up 20% of the market share of Asian FCCBs. However, after 2008 there have been almost no new issuances and the outstanding FCCBs estimated at USD 2 bn – USD 3 bn are a result of re-structuring mostly
On the backdrop of a rising economy and well performing equity markets, Issuers of all sizes, types and shapes from India (close to 300) accessed this market between 2005 – 2012 raising in access of USD 30 billion in FCCBs. In 2005, Indian companies such as Tata Chemicals, Jaiprakash Associates, Glenmark, Tata Power, Bharat Forge, Amteck Auto, Ballarpur Industries, Reliance Energy, Indian Hotels, Bharti Telecom and Ashok Leyland issued FCCBs to the tune of USD 1.4 bn. Out of the 30 Issuances in that year, 15 were from India, 6 were from Taiwan and the rest from other parts of Asia

The beauty of an FCCB instrument is that it can tune itself to look more debt like or more equity like giving a very high degree of flexibility in the hands of the issuers and investors. Some of the examples of the innovation in FCCB world were Reliance Communications Zero bond FCCB with a face value of USD 1 billion with a conversion price set at 30% premium to the prevailing stock price and Essar Oil’s ability to raise USD 262 million for a period of 18 years making FCCB a great tool for corporate finance

FCCBs issued from India

Year

Issues

USD / Mn

2002

1

126.6

2003

4

212.0

2004

23

2,362.9

2005

59

3,919.6

2006

72

5,410.3

2007

71

7,685.5

2008

9

532.0

2009

19

3,816.5

2010

11

1,270.0

Total

269

25,335.4

 

 

  • FCCBs are tradeable and generally listed in Singapore Stock Exchange and in some cases in Luxembourg Stock Exchange. Secondary trading happens in both part and full, that is to say, a holder can sell the debt part of FCCB while holding the option or vice versa making it a part sell which happens mainly OTC. Trading of full FCCBs are through the exchanges
  • Market players are limited to FIIs, Banks, Hedge Funds and HNIs/Family offices. FIIs like Citicorp, Goldman Sachs & JP Morgan, Hedge funds like TPG Capital, QVT Financial, Citadel Investment Group, 3 Degrees Asset Management & ELM Park and HNIs through private banks like Credit Suisse, Deutsche Bank formed the corpus of investors in the bonds
  • Issuers are largely listed Indian companies with a track record of stock trading in the main bourse for investors to understand the share price movement and volatility 
  • Banks who played a major role in the issuance of FCCBs for Indian Corporates included JP Morgan, Deutsche Bank, ICICI Bank, Standard Chartered and Credit Suisse

At the end of 2010, there were estimated to be USD 7.8 billion of outstanding FCCBs, many of which facing funding difficulties. This was followed by a tough period of winding up companies, litigations, re-structuring, fire sale of assets and finally a deeply discounted FCCB market
So what went wrong here?
In fact several factors contributed to the ultimate demise of the FCCB market in 2012. There was overcrowding by both the issuers and investors. Several of the issuers approached the FCCB market for wrong reasons and several investors helped fuel these issuances by placing bets that later proved to be wrong but by then the fire was wide spread
As with any complex financial instrument, performance of FCCB is highly dependent on the performance of currency (INR/USD) and the equity markets. 2008 – 2012 witnessed an era of depreciating INR as well as extreme volatility in equity markets. Whilst for the investors, the markets didn’t perform well enough to trigger the conversion this only led to the inevitable redemption burden on the issuer. Issuer’s burden got exasperated by the weakening rupee and several of the issuers who had raised foreign currency bonds to finance their overseas expenses found themselves in a tough spot without any foreign currency earnings to hedge the currency exchange risks

Fitch estimated that out of the estimated USD 7.8 billion, USD 1.2 billion had defaulted and many others restructured. Amongst those who defaulted included names like Sterling Biotech, Piramyd Saimara, KSL and Industries, 3i Infotech and Zenith Infotech. Those that restructured included GTL Infrastructure, Subex, XL Industries and Gayatri Projects

FCCB issuances in 2013 had virtually dried up and putting an end to a seemingly golden instrument that allowed issuers to access to funding from the international investors and the international investors access into the Indian markets

With a new government in 2014 and renewed confidence in the country, once again investors and markets went upbeat thereby bringing the international investors attention into India, a more familiar terrain given the experience in FCCBs between 2005 and 2012. Yet, the convertible bonds desks at various investment banks remain either shut or thinly manned and transaction volumes negligible

Shouldn’t the market forces be able to revive the FCCB market?
The answer to this question lies in the experience that International investors took away during the wave of FCCB issuances between 2005 and 2012. International investors have cited very tricky to navigate Indian laws when it comes to implementation and many of them terming the processes as messy when an event of default occurs followed by default notices, winding up petitions and/or re-structuring of bonds

So is it the end or the beginning of a new era of FCCB market?
One thing is very clear, the definition of risk has changed after world went through the global financial crisis in 2008. Acknowledging the very unsecure nature of the instrument, the investors are likely to put more caution ahead of their decisions to invest in FCCBs. Notwithstanding the complex legal system, the risk attached to FCCBs in case of a default is huge. Issuers too will use more prudence in understanding the nature of the corporate earnings thereby the ability to payback its investors. RBI continues with its liberalization streak and allow for more relaxations with respect to buy backs etc. Market participants including intermediaries see a new and more dynamic landscape and will play an ever more important role in defining the market going forward. Increasing role of rating agencies is envisaged as bond holders inculcate better risk methodologies

Market sentiment alone should not drive the 2nd round of FCCBs for India Inc.

 

Akashdeep Grover

 

Mr. Akash Grover, is Executive Director with IL&FS Global Financial Services Ltd. ( Hong Kong ) – IGFSL
IGFSL,HK  is a 100% subsidiary of IL&FS Financial Services Ltd.

Website link : http://www.ilfsifin.com/hongkong/index.html


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