1. BACKGROUND - EMBRACING THE "NEW NORMALS"
As recent as six months ago, only robbers entered banks in hazmat suits. Today, we all do. COVID-19 has created "new normals" in every aspect of life, including in economies, markets, businesses, and the funds that power them. Riding an 11 year bull run, global markets have nosedived. Portfolios have been panic- sold at huge discounts. Deals have been shelved - some, abandoned. Asian markets have followed suit; the IMF has predicted that economic growth in Asia will, for the first time in 60 years, come to a grinding halt.
On the flip-side, with stocks trading at over 52-week lows, valuations may seem attractive. Large private equity funds have seldom been richer, many coming off follow-on investment rounds with much "dry powder" to expend. Businesses will inevitably seek new capital to balance negative cashflows and, in the process, embrace the "new-normals" of fund-raising. The recent Singapore Airlines ("SIA") deal is a case in point. On a day when its stock stopped trading for the first time in 22 years, SIA announced a composite US$ 11 billion rights offering of shares and 10-year convertible bonds - paper that is slated not just to tide over COVID-19, but also support future growth. With traditional routes and markets on lockdown, companies in India and overseas should look towards similar disruptions of their own.
2. NEW-NORMALS FOR LISTED COMPANIES IN INDIA
The principal routes to access domestic equity capital by listed companies in India are well recognised and understood. A listed company may:
- undertake a follow-on public offering ("FPO");
- undertake a negotiated private placement ("Preferential Issue");
- make a rights offering to its existing shareholders ("Rights Issue"); or
- sell securities to qualified institutional buyers ("QIBs") through a qualified institutions placement ("QIP").
The first two have their own share of challenges. FPOs and Preferential Issues are largely market-driven. More often than not, FPOs involve lengthy review by the Securities and Exchange Board of India ("SEBI"). Pricing in Preferential Issues is based on prior 26-week trading averages. Since this floor may not accurately reflect current value, SEBI has recently mooted rationalising the 26-week lookback (albeit currently only for a limited category of "stressed" companies). Given these considerations, QIPs and Rights Issues have the potential to emerge as products of choice. Reflecting the existing normal, companies have most often used these methods to issue equity shares, even though regulations permit convertibles and combinations. In this article, we explore alternative fundraising structures that Indian listed companies may consider: issuance of convertible instruments through Rights Issues, QIPs and foreign currency convertible bonds ("FCCBs").
3. RIGHTS ISSUES OF CONVERTIBLES
The laws governing Rights Issues have been much discussed and refurbished over the last year to make the product more efficient. In December 2019, SEBI amended the extant regulations to reduce the time taken to complete a Rights Issue, thereby, attempting to reduce the impact of market fluctuations on participating investors. While the reduced timeline itself is a welcome change, in COVID-19 times, non-traditional Rights Issue structures have the potential to further incentivise investors.
3.1. Alternate Structures. Apart from the typical equity model, a Rights Issue may also be structured as an offering of:
- Compulsorily convertible instruments ("CCIs"), i.e., preference shares ("CCPS") or debentures ("CCDs"), with or without warrants; or
- Optionally convertible instruments ("OCIs"), i.e., preference shares ("OCPS") or debentures ("OCDs"), with or without warrants; or
- Equity shares along with warrants.
A Rights Issue of CCIs or OCIs continues to retain the advantages of equity rights offerings, such as flexibility in pricing and the ability to conduct a fast track offering with truncated disclosures (provided the issuer is eligible), but also provides the investor with additional incentive of coupon on the instruments until it is converted into equity shares or redeemed. Further, an issue of OCIs also provides the investor with an option to either redeem the instrument upon maturity, in the event the market price of the underlying equity shares has fallen or, alternatively, convert into equity shares to benefit from the upside in the price of the equity shares. Also relevant to note is that in the recent past, there have been only Rights Issues of CCDs and CCPS.
A Rights Issue of equity shares (or CCIs/OCIs) can also be undertaken by providing the shareholders a combined offer of equity shares with warrants, which can be converted after the specified time period. In such deals, the issuer may price the offering at a slight premium. Specified securities (equity shares, CCIs or OCIs) issued pursuant to a Rights Issue require to be listed. Given that the specified securities (equity shares, CCIs or OCIs) and warrants can be listed and traded separately on the exchanges, and the investor is not forced to exercise the warrants, these offerings have the potential to prove to be win-wins for issuers and investors alike.
3.2. Structuring considerations. Some key considerations for a Rights Issue with these alternate structures are discussed below.
- Conversion timelines: The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 ("ICDR Regulations") do not prescribe any timelines for conversion of convertible instruments, except for warrants which can have a maximum tenure of 18 months. However, under the Companies Act, 2013 ("CA 2013"), OCDs/CCDs which are convertible into shares, should be converted within 10 years, failing which they become "deposits", while for OCPS/CCPS, guidance is typically drawn from CA 2013's requirement for redeemable preference shares, i.e., 20 years. However, shorter timelines for conversion of these instruments are dictated by commercial considerations, as is evident from precedent deals where conversion timelines have typically ranged between 12 and 18 months.
- Partly-paid instruments: The ICDR
Regulations allow part-payment for instruments issued under a
Rights Issue - at least 25% has to be paid upfront and the balance,
within 12 months. In case a monitoring agency is appointed, a
company is free to defer payment of the balance amount beyond even
this 12-month period. Even though the ICDR Regulations allow
issuers to ask only for part- payment for all types of instruments
issued on a rights basis, there is some ambiguity since the
regulation in relation to making calls for the balance amount
speaks only of "equity shares".
Further, partly-paid securities come with their own set of implications, especially on certain corporate actions that a company with outstanding partly-paid securities can undertake. Activities such as buybacks, de-listings, takeover offers, declaration of dividend and further fundraises get impacted in case a company has outstanding partly-paid securities, with most of these requiring a company to either make the securities fully paid up or forfeit such securities prior to undertaking them. While there are numerous instances of partly-paid equity shares issued in a Rights Issue, no prior issues have involved issuance of partly-paid CCIs/OCIs. Also, it is pertinent to note here that the exchange control regulations allow only partly-paid "shares" to be issued to non-residents. Therefore, while part- payment of equity shares and preference shares can be allowed, it remains to be examined whether part-payment would work for convertible debt instruments (issued through a Rights Issue). In addition, for warrants which are issued along with any of the instruments, only 25% of the consideration is required to be paid upfront.
- Fast track and truncated disclosures: In case an issuer complies with certain specified eligibility conditions, it can undertake a Rights Issue on a "fast-track" basis. A fast-track Rights Issue's timelines are much shorter, similar to that of a QIP. Notably, SEBI has, in a recent slew of COVID-19 driven measures, provided temporary relaxations from crucial eligibility requirements that will allow a larger pool of issuers to fast-track their Rights Issues. For instance, the minimum subscription threshold for a Rights Issue (that opens before March 31, 2021) has been reduced from 90% to 75%1. Further, issuers can also take the benefit of a reduced disclosure regime (Part B) in case they satisfy certain other eligibility conditions, as opposed to detailed IPO-style disclosures under Part A. The Part B regime allows issuers to further reduce the time to prepare documentation for the offering. Coupled with the fast-track route, this would imply a much shorter timeline from kick-off to listing. In the absence of a 'fast-track' route combined with a 'Part B' disclosure regime, the disclosures would be similar to an IPO document with timelines needing to factor between six and eight weeks of SEBI review.
- Employee reservation: The ICDR Regulations allow an issuer to make reservation of a portion of its Rights Issue for employees. Such reservation helps an issuer reward its employees, considering the flexibility that the issuer has when it comes to pricing. The value of allotment to any employee should not exceed Rs. 200,000. However, in the event of under-subscription in the reservation, the unsubscribed portion can be allotted on a proportionate basis, for a value in excess of Rs. 200,000, subject to the total allotment to an employee not exceeding Rs. 500,000. A point to keep mind from a timeline perspective is that if an employee reservation is included in a Rights Issue, shareholders' approval will be required.
- Additional exchange control considerations:
- Renunciation in favour of non-residents: Non-resident shareholders can subscribe to their entitlements (and apply for additional securities) at the Rights Issue price. In this regard, Rule 7A has been recently introduced in the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules"), setting forth conditions for renunciation from a resident to a non- resident. The introduction of Rule 7A appears to be the result of various discussions on renunciation in rights issues between the Reserve Bank of India ("RBI") and intermediaries in the past and accordingly, it will be prudent to analyze the impact of Rule 7A on Rights Issues by listed companies with the authorised dealer on the transaction.
- Press Note 3. The Indian government has, through its famed Press Note 3 ("PN 3"), decreed that foreign direct investment ("FDI") inflow from countries that share land borders with India shall only be through the approval route. While PN 3, and its corresponding amendment to the NDI Rules, does not explicitly provide any exemptions, it is understood that participation by foreign portfolio investor ("FPI") shareholders in a Rights Issue will be considered under the portfolio investment (and not FDI) route, and only in case the investment breaches the threshold of 10%, the FPI (if covered by PN3) will be required to receive prior government approval.
- Participation by non-residents through OCIs. While the ICDR Regulations allow Rights Issues of OCIs, the RBI has, in its regulations governing forex borrowings and lending, clarified that optionally convertible and other hybrid instruments issued to non-residents are currently governed by its external commercial borrowings ("ECB") regulations, where only eligible lenders would be allowed to subscribe. Further, OCIs issued to eligible lenders will be subject to stringent ECB regulations on all-in-cost ceiling (GSec + 450 bps), minimum average maturity (between one and 10 years) and end-use restrictions (such as in real estate activities and equity investments). In addition, an issuer of OCIs should also be eligible to raise FDI. These conditionalities can lead to significant structuring conundrums, including marketing lower-cost OCIs to investors (domestic or otherwise), delaying redemption beyond minimum residual maturity and monitoring the end-uses of proceeds received from non-residents.
1. It should be noted that these relaxations are not available in case warrants are issued in a Rights Issue.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.