FCEBs – Understanding a new debt instrument

The finance minister, in his 2007-2008 Budget speech, promised a mechanism for Indian companies to unlock a part of their holding in group companies to meet financing needs by issuing exchangeable bonds. This led to the formulation of the Issue of Foreign Currency Exchangeable Bonds Scheme, 2008, in February. The scheme was operationalized pursuant to a Reserve Bank of India (RBI) circular dated 23 September, to facilitate the issuance of foreign currency exchangeable bonds (FCEBs).

Previously, Indian companies had the option of raising foreign currency debt by either raising external commercial borrowings (ECBs), or issuing foreign currency convertible bonds (FCCBs) convertible into shares. The scheme has now opened the doors for Indian companies to explore a third option through the issuance of FCEBs.

FCEBs have been defined as a “bond expressed in foreign currency, the principal and interest in respect of which is payable in foreign currency, issued by an Issuing Company and subscribed to by a person who is a resident outside India in foreign currency and exchangeable into equity share of another company, to be called the Offered Company, in any manner, either wholly, or partly or on the basis of any equity related warrants attached to debt instruments”.

FCEBs can be issued only by Indian companies. Pursuant to the scheme, the issuing company, which is part of the promoter group of the offered company, would issue FCEBs denominated in a foreign currency, and exchangeable into shares of the offered company, only to individuals residing outside India.

Both the issuing and offered company are defined to mean Indian companies under the Companies Act, 1956, and are required to be part of the same promoter group.

Entities prohibited by the Securities and Exchange Board of India (SEBI) from buying, selling or dealing in securities are not eligible to subscribe to FCEBs. The proceeds of the FCEBs may be invested by the issuing company by way of direct investments, including in joint ventures or wholly owned subsidiaries, in accordance with the existing guidelines on such investments, and in promoter group companies, which, in turn, may invest such amounts in accordance with the ECB guidelines then in force.

These amounts are restricted to investments in the import of capital goods, new or existing product units, the industrial sector, including small and medium enterprises, the infrastructure sector which is defined as power, telecommunications, railways, roads including bridges, sea ports and airports, industrial parks and urban infrastructure (water supply, sanitation and sewage projects).

We note that the use of FCEB proceeds is more limited that the use of ECB proceeds since the issuing company may only use such proceeds for direct investments abroad or in promoter group companies. It is the promoter group companies that may, in turn, use such proceeds in the manner set forth in the ECB guidelines

While the scheme specifically requires the offered company to be a listed company, it is ambiguous as to whether the issuing company must also be listed. In our view, since the scheme requires the offered company to be listed, an additional requirement for the issuing company to be listed should not be necessary.

There are fundamental differences between FCCBs and FCEBs. In the case of FCCBs, the bonds convert into shares of the company that issued the bonds, while in the case of FCEBs, the bonds are exchangeable for the shares of another company, i.e. the offered company.

Further, in the case of FCCBs, when the holder exercises the option to convert, the issuer company issues fresh shares to the holder upon conversion of the FCCB.

However, in the case of FCEBs, when the exchange option is exercised, there is no issuance of fresh shares by the offered company. Instead, it is a requirement that the shares of the offered company, into which the FCEBs are exchanged, be held by the issuing company at the time of issuance of the FCEBs and until redemption or exchange.

Thus, upon exchange, there is merely a transfer of the shares held by the issuing company to the holder of the FCEB. As such, the issuance of FCEBs will have only a limited effect on the price of shares of the offered company since there is no threat of future dilution, unlike in FCCBs.

The scheme provides Indian promoter companies the option of raising money overseas by unlocking the value embedded in the shares held by them in other promoter group companies, without causing equity dilution.

This avenue may prove to be useful in the case of promoter shares that are subject to a three-year lock-in pursuant to the disclosure investment protection guidelines. As such, the marketability of the FCEB will depend entirely on prevailing market conditions and the future value of the offered company’s shares.

While the scheme is undoubtedly a step in the right direction, its benefits are inherently limited on account of the restrictions on the use of proceeds, minimum maturity, the all-in-cost ceilings and the requirement of prior RBI approval in all cases.

Shardul Shroff is the managing partner, Dharini Mathur is a prinipal associate and Rahul Singh is an associate at Amarchand & Mangaldas & Suresh A Shroff & Co.