Foreign currency convertible bonds

While I was searching for this impact of US crisis on India and depreciation rupee I came across this term FCCB (foreign currency convertible bond).and I came to know this plays important role in Indian capital market.
Let’s see how it works
An instrument in debt market where in which convertible bond is issued in a currency which is different than issuer’s domestic currency. For e.g. reliance industries issues a convertible bond which is denominated in terms of dollars and not rupees. This is the mode of raising money by issuing company in terms of foreign currency. As the name suggests it’s a convertible bond, means bondholder has an option of converting it into stock. Therefore convertible bond is a mix between equity and debt instrument.

FCCB policy in India
MinistryFinancegovernmentofIndiadefinesFCCB.Accordingit:"Foreign Currency Convertible Bonds" means bonds issued in accordance with this scheme and subscribed by a non- resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments; "


We all know that 2-3 years back Indian and emerging markets were on high growth trajectory path and were giving high returns. At that time FCCB became the popular tool for raising funds from overseas market. Aggressive companies went for the FCCB route to fund their expansion/acquisition plans because of the shorter lead times associated with the process as well as for the fact that the company gains exposure in to a global investor base.

The reasons behing for fccb becoming so popular and companies opting for it aggressively were following:
· Being hybrid instruments, the coupon rates on fccb are particularly lower than pure debt or zero, thereby reducing the debt financing cost.
· Fccb are book value accretive on conversion.
· Saves the risk of immediate equity dilution as in the case of public shares.
Lucrative offer for investors
Investors can also book profits through fccb route:
· Assured returns to investors on bond in the form of fixed coupon rate payments.
· Ability to take advantage of price appreciation in the stock by means of warrants attached to the bonds, which are activated when price of a stock reaches a certain point.
· Significant yield to maturity (YTM) is guaranteed at maturity.
· Lower tax liability as compare to pure debt instruments due to lower coupon rates.

In May 2007, at least 10 companies converted FCCBs into equity at a price decided when the bonds were issued to respective investors. The list includes NIIT, Bharti Airtel, Sun Pharma, Glenmark Pharma, Amtek India, Jain Irrigation Systems and Maharashtra Seamless. FCCB holders have witnessed a significant rise in value of their investments in these companies on the back of a sharp rise in share prices since allotment of the bonds.

Present day situation
Indian companies that had raised money through fccb’s during Bull Run to finance their growth and acquisition plans are currently in situation of doom. With demise of Indian stock markets the conversion price of these fccb’s has gone several times higher than their current market price.
Various estimates show that India Inc has issued close to $20 billion of FCCB’s in the past few years. Now the investor will only exercise its option to convert his bond into fixed number of shares at predetermined price if conversion price is lower than the market price. Now in this scenario of dooming stock markets conversion price in most of the fccb issues is several times above the market price. Therefore in such a scenario investors won’t be interested in converting their bonds into equity.
Let’s explore now in this situation what options are left with the companies who have issued these bonds.
· Issuing companies will now have to search for resources to repay the debt along with redemption period whenever it matures. For this companies will seek to fresh borrowings, with high interest rates, which in turn would impact their profitability.
· Another option which companies have is to reset the conversion clause, to bring it closer to reality.

No doubt lender will get back his money, but this will create big pain for ordinary shareholder. With the current state of the stock markets, most of them will have to buy foreign exchange from the markets to get rid of their liability. But this will depreciation of rupee and create more volatility in forex market.
By looking at the below link you can check out data for companies which have raised money through FCCB and where they stand today.
http://www.business-standard.com/india/storypage.php?autono=336251

References:
Economic times
Business standard