What is Foreign Currency Convertible Bonds?
Foreign Currency Convertible Bonds is a special type of debt instrument issued in a currency other than a home currency. An FCCB is a bond with a dual character of debt and equity instrument. It acts like a bond making regular coupon and principal payments and provides investors with an option to convert them into equity. Therefore, upon maturity, the holders can convert the equivalent value of equity at a set conversion rate. Usually, the Indian company issues these convertible bonds abroad to raise money in foreign currency.
The hedge fund arbitrators or foreign nationals are usually the investors for FCCB. Also, the company issues these bonds with a call option (redemption rights lies with the bond issuer) and put option (redemption rights lies with bondholder).
The company have to issue FCCBs under the guidelines of SEBI and RBI. They have to follow the ECB and FDI norms and the various scheme regulations concerning the Issue of Securities. Thus, the issuance of FCCB requires careful analysis of business needs, corporate finance structure and financial market sentiments. It helps the companies for pursuing their strategic growth initiatives.
How Foreign Currency Convertible Bonds Works?
Generally, large listed multinational companies that have a presence worldwide issue foreign currency convertible bonds to raise capital in foreign currency. These bonds inherit all the features of a convertible bond. In other words, the company issues this bond in foreign currency, which means that principal and interest payments are also payable in foreign currency.
When companies raise money outside their home country, it gives them access to the new markets for expansion. Generally, companies choose to issue FCCB in a country with a lower interest rate or the economy of a country that is more stable than the home country. Also, these bonds have lower interest rates than regular bonds because FCCBs are convertible into equity.
When the company has to repay on maturity, any adverse change in the exchange rates can weaken the local currency, thereby increasing the cash flows on repayment. As a result, the issuing company can incur losses. Moreover, foreign currency convertible bonds expose the issuing company to the various political, economic and legal risks of the foreign country.
When the company’s stock price falls below the conversion price, the FCCB investors will not convert their bonds into equity. As a result, the company has to make repayments on maturity. On the other hand, when the stock price appreciates, investors can participate by converting the bonds into equity. They can take advantage of this appreciation through warrants (that is active) when a stock price reaches a certain point.
Features of Foreign Currency Convertible Bonds
The following are the features of foreign currency convertible bonds
- FCCBs are similar to convertible debentures. It makes regular coupon and principal payments in a foreign currency till a specific date. After which, the issuer can convert into equity.
- These bonds have lower interest rates than regular bonds because of the inherent option available to investors for conversion into equities.
- The issuance of FCCBs does not require it to be backed by any collateral or security.
- They are listed and traded on a foreign stock exchange, similar to a debenture.
- Since FCCBs are equity-linked debt securities that gives the holder the right to convert the bond into equity or depository receipt (DR) after some time.
- Companies can issue bonds with a call or put option. The investor has the right or authority to convert the bonds into stocks in a put option. Whereas call option, the issuing company has the right to redemption.
- The funds that the company collects through the FCCB issue shall be usable as per External Commercial Borrowing (ECB) guidelines.
RBI Requirement for FCCB
As per the RBI circular, FCCBs are governed by ‘Issue of Foreign Currency Convertible Bonds and Ordinary Shares Scheme, 1993. The issuance of FCCB happens under External Commercial Borrowings (ECB) guidelines which have the following requirements –
- The maturity of FCCB should not be less than five years
- If there is a call or put option, it cannot be exercisable before five years
- Companies should not issue FCCBs without any warrants attached.
- The issue related expenses should not exceed 4% of the issue size
Redemption of FCCBs
The following are the guidelines by RBI for the companies facing difficulty in meeting the redemption obligations. To help the issuing company refinance the outstanding FCCBs, they have to meet the following terms and conditions –
- Issuers can raise fresh FCCBs with stipulated maturity and follow the ECB norms.
- The fresh FCCB value shall not exceed the outstanding maturity value.
- Also, issures should not raise new FCCb six months before the maturity date of outstanding FCCBs
- The purpose of FCCB shall be clear as ‘Redemption of Outstanding FCCBs’ in Form 83 at the time of registration with RBI.
- A designated AD – Category I bank should monitor the usage of funds
- All aspects with respect to ECB policy, including the borrower, lender, repayment, etc., shall remain the same.
- If the FCCB issue is up to USD $750 million for refinancing existing outstanding FCCB, it will be available under the automatic approval route.
- FCCB issue is beyond USD $500 for the purpose of redemption of existing FCCB, they require special approval from RBI.
Furthermore, the proposal for restructuring FCCB without involving any change in conversion price requires special approval from RBI. This policy will be reviewed periodically and appropriately depending on the macroeconomic conditions and other relevant factors.
Tax on Foreign Currency Convertible Bonds
- Until the conversion option is exercised, the interest payment on these bonds are subject to deduction to TDS at a rate of 10%.
- TDS will be deducted at a rate of 10% on dividend on the converted portion of the bond
- If the investor converts the FCCBs in to shares then such a conversion will not be considered as capital gain
- Transfers of Foreign Currency Convertible Bonds made outside India by a non-resident investor to another non-resident investor will not be considered as capital gain