The bull run witnessed by the Indian stock markets over the last few years saw several companies tapping finance by issuing foreign currency convertible bonds (FCCBs). News reports estimate such issuances at almost US$20 billion. Among the many victims of the current credit crisis are Indian companies that have such FCCBs outstanding on their balance sheets.
With the recent bloodbath on the stock markets, the stocks of many issuers of FCCBs are trading at values significantly below the contracted conversion price. The exercise of conversion options seems unlikely in this environment and the redemption of these FCCBs, therefore, seems imminent.
For several companies, the redemption amounts payable from these trades will result in a further strain on already stretched cash flows and profitability. For companies that do not have the necessary funds to meet their redemption liability, raising finances could be a challenge given the present liquidity situation of many financial institutions.
For some issuers, however, the concerns are immediate. Certain companies are already in default under one or more financial or other covenants under bond issuances. Where issuers have sought voluntary premature redemption of these bonds on account of such covenant defaults (to avoid enforcement action), the Reserve Bank of India (RBI) has not been forthcoming in granting its approval for such prepayment.
While restructuring could be considered, through the revision of conversion prices to a more realistic level given today’s market conditions, flexibility is limited to the overall restriction on floor price calculated at the time of the issuance. Where issuers are seeking to retire such liabilities on a negotiated basis even on account of events of default, the RBI is not forthcoming in granting approvals. Until the recent relaxations by the RBI, these issues were a grave concern for many issuers.
As part of the further measures for liquidity management and credit flow communicated on 15 November, the RBI provided specific relaxations for such FCCB issuances. Recognizing that FCCBs issued by Indian corporates are currently trading at a discount, the RBI stated that it would consider proposals from Indian companies to prematurely buy back their FCCBs at the prevailing discounted rates. The buyback must be financed by the company’s foreign currency resources held in India or abroad and/or out of fresh external commercial borrowings (ECBs) raised in conformity with the current norms for ECBs.
The press release further clarified that such proposals would be considered under the approval route. However, this position was further relaxed pursuant to the RBI’s “Growth Stimulus Package” released on 6 December. The buyback of the bonds has now been categorized into two distinct categories – the automatic route and the approval route.
The RBI has granted Category-I authorized dealers the power to dispense with applications under the automatic route. This route applies to the re-purchase of bonds funded through foreign currency sources (held in India or abroad) or out of the proceeds of a fresh ECB raised in accordance with existing ECB guidelines. All-in-cost ceilings are capped to 6 month Libor plus 200 basis points where the fresh ECB is co-terminus with the outstanding maturity of the original bond issuance and less than three years.
In all other cases, the applicable all-in-cost ceilings under the ECB guidelines apply. The buyback value of the FCCB must be at a minimum discount of 15% of the book value of the bonds.
Companies are also permitted to use rupee funds to repurchase the bonds, by obtaining prior RBI approval. The buyback must be at a minimum discount of 25% on the book value, and the aggregate buyback should not exceed 50% of the redemption value, per company.
Furthermore, rupee funds used must be from internal accruals, thereby preventing companies from borrowing locally to fund such buybacks. The US$50 million ceiling further limits companies’ ability to repurchase all outstanding bonds, closing off this avenue to companies with large issuances on their books.
The RBI clarifies that these routes are not prejudiced to existing provisions relating to prepayment and refinancing, which would continue as before.The relaxations are welcome and should hopefully provide FCCB issuers some room to extricate themselves. However, given the current scarcity of dollars in the financial markets, the industry is sceptical on the ready availability of ECBs as an avenue to fund such buybacks.
This leaves issuers with options to fund the repurchase through their existing foreign currency or rupee resources. The RBI should consider providing greater flexibility in retiring or rescheduling the FCCB obligations, at least under the approval route, given the potential pressure FCCB redemption can have on the balance sheets of numerous mid and large-cap entities.
Karan Singh is a partner and Ameya Khandge is a counsel at Trilegal in Mumbai. Trilegal is a full-service law firm that advises on corporate and commercial law in India and provides commercially oriented legal advice in relation to all sectors of the economy. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and has over 100 lawyers, some with experience at law firms in the US, the UK and Japan.
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