Following the sustained liberalisation programme undertaken by the Indian Government to integrate with the global economy, the foreign currency convertible bond (FCCB) market took a quantum leap during the bull run of 2005– 2008. Reports state that 201 Indian companies raised approximately US$16bn through FCCBs during that period.1
Companies issued FCCBs to reduce their borrowing costs. They issued the bonds at very low coupon rates; some were even zero coupon. However, they fixed the conversion prices between 25 per cent and 150 per cent higher than the prevailing market prices in expectation of an increase in share prices. This theory fell flat with the subsequent crash in global equity markets. It is estimated that two thirds of the FCCBs due to mature before March 2013 will not be converted into equity shares.
Most of the FCCBs that will mature in 2012 were issued in the years 2007–2008, when the foreign exchange rate was approximately 42 Indian rupees (INR) to a US dollar. The INR has since lost more than 30 per cent against the US dollar. This has added approximately US$2bn to the value of FCCB maturities in 2012.2
In cases where the current price is trading at a significant discount to the conversion price, it appears that the companies will need to adopt other alternatives to pay back their investors. Although a number of companies have managed to convert their FCCBs to equity, low investor appetite and the expensive debt market are making it difficult for further conversions to take place. In the present market, companies have the following options.
A company may raise equity to finance redemption/repayment of the FCCBs. However, it may be difficult to find new investors considering the present liquidity crunch and the FCCB repayment liability in the books of the issuer company. Further, the present shareholders may not agree to dilute their equity by inducting new shareholders. The present shareholders will probably be required to bring in the capital. This may not be feasible in the current market.
Raising domestic debt
Interest rates in India are generally far higher than interest rates overseas. Considering the present credit crunch and high interest rates, raising new domestic debt to service cheaper FCCB debt may prove expensive and unfeasible.
Redemption of FCCBs by refinancing
The FCCB Guidelines were issued in 1993 by the Ministry of Finance under the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 (the 'Scheme'). The right to approve FCCB borrowings was delegated to the central bank, the Reserve Bank of India (RBI) pursuant to the Foreign Exchange Management Act, 2000 (FEMA). The RBI issues guidelines for External Commercial Borrowings (ECBs) from time to time, which are also applicable to FCCBs.
Envisaging the difficulties that Indian companies may face in arranging funds for redemption of the FCCBs, on 4 July 2011 the RBI permitted companies to raise fresh ECBs/FCCBs under the automatic route (ie, without the requirement to obtain prior written permission from the RBI) to facilitate the refinancing of existing FCCBs on the following conditions:
- the amount of the new ECB/FCCB cannot exceed the outstanding redemption value at the maturity of the FCCBs;
- the new ECB must be raised within a period of six months prior to the FCCB maturity date;
- a new ECB/FCCB in excess of US$500m will require prior RBI approval;
- where the new ECB is co-terminus with the outstanding maturity of the original FCCB, it can have a term of less than three years (which is generally the minimum term for an ECB); and
- the FCCB Guidelines prohibit a change in the conversion price. However, an FCCB may be restructured by changing the maturity period and interest rates.
Refinancing entails settlement of debt by the issuer and mandates funds at the disposal of the issuer company to redeem the bonds. Several large Indian companies have been able to refinance their FCCBs, but this route is not viable for companies that do not have a strong credit profile. Reports estimate that Indian companies may have to pay additional interest of US$700m per annum to refinance the US$5bn of FCCB debt maturing in 2012.3
Buy-back of FCCBs
The RBI has, from time to time, permitted Indian companies to buy back their FCCBs, including for a period ending March 2012, on the following terms:
- category 1 authorised dealers were allowed, pursuant to delegated authority from the RBI, to approve the buy-back under the automatic route, where the funds used were from existing foreign currency funds or from a new ECB;
- where the buy-back was under the automatic route, prepayment was permitted at a minimum discount of eight per cent to the book value;
- if a new ECB was raised, co-terminus with the FCCB to be prepaid, the borrowing cost was not to exceed the London Interbank Offered Rate (LIBOR) + 200 basis points;
- where RBI approval was obtained for a buy-back funded from the internal accruals of the issuer company, the minimum discount mandated ranged from ten per cent to 20 per cent depending on the amount prepaid; and
- all other terms of the ECB policy were to be complied with.
Some companies availed of this opportunity. In a buy-back of FCCBs, the company has an opportunity to reduce its debt. From the perspective of the Indian Government, this option potentially reduces the higher foreign exchange outflow.
Restructuring the FCCBs
Indian companies may restructure the terms of their FCCBs with the agreement of the bond-holders. Obviously, this presupposes the acceptance of the bond-holders. Proposals for restructuring FCCBs that do not involve a change in the conversion price will be considered by the RBI under the approval route, on a case-by-case basis. Prior approval of the RBI is required to change the conversion price. Reports estimate that approximately half of the FCCBs due to mature in the second half of 2012 will need to be restructured, as it will prove difficult for companies to refinance the FCCBs in the current debt market.4
In February 2009, the Ministry of Finance permitted companies to change the conversion price of FCCBs issued prior to 27 November 2008, based on the market price prevailing on the date of the Board meeting of the company approving the price revision. Several companies availed of the opportunity to reset the conversion prices of their FCCBs falling due in 2011–2012.
Enforcement of bond-holders' rights
In the event of a dispute between an Indian company and its bond-holders in respect of redemption of FCCBs, the bond-holder may seek recourse to the contractual dispute resolution mechanism prescribed in the FCCB transaction documents – typically arbitration.
The (Indian) Companies Act, 1956 provides a statutory remedy for failure to pay an admitted debt (such as the FCCB): the creditor may file a petition seeking that the debtor company be wound up so that its assets may be liquidated and the creditor repaid.
Generally, FCCBs are unsecured and therefore rank lower in terms of repayment of debt; FCCB-holders receive their payment only after the secured creditors and statutory dues of the liquidated company are paid.
However, filing a winding-up petition currently appears to be the preferred route for bond-holders. The bond-holders of Wockhardt Ltd have had some success in Indian courts. They filed a petition seeking to wind up the affairs of the company so that they could be repaid. The court directed the company to repay its bond-holders first, prior to the secured creditors of the company.5
Given the current liquidity and equity market conditions, companies have little choice but to borrow monies at high interest rates and redeem the FCCBs on the due dates. The credit squeeze in global and local markets has made it difficult for Indian companies to find willing lenders.
The Indian regulator is attempting to provide a cordial and practical approach. The RBI tried to prevent further defaults by extending the deadline for the buy-back of FCCBs from June 2011 to March 2012. Further, it imposed a minimum discount as a condition for the buy-back of FCCBs.
The global economic crisis has slowed the revenue and profit growth of Indian companies, dragged down their stock prices and left them less able to service debt. However, the regulator and the courts continue to work towards creating a climate that facilitates redemption of FCCBs in India.
This article first appeared in the September 2012 issue of the Newsletter of the Asia Pacific Regional Forum of the Legal Practice Division of the International Bar Association (Vol 19, No 2), and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.
1 Prime Database report.
2 Standard & Poor's report of 21 June 2012.
5 Wockhardt Ltd v BNY Corporate Trustee Services Ltd: unreported judgment of the Bombay High Court dated 11 October 2011 in Appeal No 503 of 2011 in Company Petition No 971 of 2009.
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