When it came to borrowings in foreign currency, Indian companies hitherto had two options, namely (i) external commercial borrowings (ECBs) where they borrow monies in foreign currency, or (ii) foreign currency convertible bonds (FCCBs) where they issue bonds denominated in foreign currency that are convertible into shares of the issuer company.
About a week ago, the Ministry of Finance granted Indian industry a third option (but only in fulfillment of a Budget promise made last year), which is foreign currency exchangeable bonds (FCEBs). The Ministry issued a notification on February 15, 2008. I have been meaning to study this over the last few days, but finally got down to doing so only today.
I located a summary of the notification on LawFuel which is less technical than the notification itself. Although it appears that this type of instrument is fairly common internationally, it is unique to the Indian markets, and presents some interesting elements that we shall see.
Under this option, an issuer company may issue FCEBs in foreign currency, and these FCEBs are convertible into shares of another company (offered company) that forms part of the same promoter group as the issuer company. In other words, if company A issues FCEBs, then the FCEBs will be convertible into shares of company B that are held by company A and where companies A and B form part of the same promoter group. There is a fundamental difference between an FCCB and an FCEB whereby in the case of an FCCB offering, the bonds convert into shares of the company that issued the bonds, while in the case of an FCEB offering, the bonds are convertible into shares not of the issuer company, but that of another company forming part of its group.
There are a couple of other mechanical matters that are of interest. In an FCCB, when the holder exercises the option to covert, the issuer company will issue fresh shares to the holder in exchange for the bonds. However, in case of FCEBs, when the option is exercised, there is no issuance of fresh shares. What occurs is a transfer by the issuer company of the shares it holds in the listed (offered) company to the holder in exchange for the bonds. Further, although the FCEBs are issued on the strength of the underlying shares held by the issuer company, it does not automatically means that the shares are pledged in favour of the FCEB holder. In the event of bankruptcy of the issuer company prior to conversion, the position of the FCEB holder would be only that of an unsecured creditor, and to that extent, this structure is not bankruptcy proof so far as the issuer company is concerned.
Pros and Cons
In doing a pros and cons analysis, one finds several advantages in this scheme. First, it provides an additional avenue for Indian companies raising funds from overseas. Second, it helps companies unlock the value of their holdings in other companies. Simply stated, it allows companies (such as holding companies or investment companies) that hold shares in other group companies (which are listed on the stock exchange) to leverage on the value of their investments by borrowing on their strength. Third, it helps companies raise financing without further dilution. For instance, instead of a listed company issuing further shares to raise capital, one of its promoter entities may issue FCEBs on the strength of its holding in the listed company and fund the listed company with the proceeds of the FCEB offering. This way, the promoter entity’s shareholding in the listed company would not be diluted at all, unlike in the case of direct capital raising by the listed company. Fourth, there seem to be no perceived disadvantages from a taxation standpoint (although some doubts have been raised on some technical issues regarding taxation: see The Hindu Business Line).
The principal disadvantage of FCEB route lies in its scope. It is permissible only in certain areas and to the extent that ECBs and FCCBs are permitted. Changes effected to the ECB/FCCB policy last year (that are perceptibly linked to capital controls and the need to stem the rising Rupee) have restricted such borrowings only to very limited types of activities. This has resulted virtually in a demise of these routes, unless and until they are resuscitated by further policy change. Further, proceeds of FCEBs cannot be used for investment in the real estate sector or in capital markets.
Therefore, unless and until foreign currency borrowings are permissible for Indian companies in a wider array of activities and with lesser restrictions, it is unlikely that the route will be utilised in any meaningful way by Indian companies. Until then, it will remain on the rule book without implementation, and to that extent this single disadvantage pretty much overshadows all its benefits that are largely on paper. At the same time, any positive changes to the policy on foreign currency borrowing will spring this route into action.