WHAT IS A CONVERTIBLE BOND?
A convertible bond is a bond which can be mandatorily/optionally converted fully/partially to common stocks. The bond comes with a call or a put option. A call option gives the issuer option to call back the bond and pay the bondholders in the form of shares. A put option gives the bondholder the right to redeem the bond and claim shares of the company as payment.
WHAT IS A FOREIGN CURRENCY CONVERTIBLE BOND (FCCB)?
An FCCB is a convertible bond issued in a currency other than the local currency of the country the company is listed to the non-residents. For example, an Indian company issues a USD denominated convertible bonds in the USA. The interest and the principal repayment for such a bond will in USD.
WHAT IS IN IT FOR THE INVESTORS AND THE ISSUERS?
1. For the Investors
For an investor, the FCCBs offer two kinds of benefits –
1. Benefits associated with investing in a foreign currency bond and
2. Benefits associated with investing in a convertible bond.
The primary benefit associated with a foreign currency bond is an opportunity to earn higher interest than the domestic market. Generally, FCCBs are issued in low-interest rate countries by companies located in high-interest-rate countries.
A convertible bond offers a potential benefit of conversion to equity.
2. For the issuers
FCCBs are generally issued by multinational companies who deal with multiple currencies. For such companies, FCCBs offers a way to mitigate the currency risk by raising money in the country of operation. Also, an importer can manage the currency risk by raising money from which they are importing.
As mentioned before, FCCBs are often issued in low-interest rate countries by companies located in high-interest-rate countries. The companies can offer lower interest rates than their domestic countries which still can be attractive in the country in which the bonds are being issued. For example, an India company issuing FCCBs in the USA may offer lower interest rates than the Indian market which will still be attractive to the investors in the USA.
RISK ASSOCIATED WITH FCCBs
1. For Investors
In case of an FCCB which is mandatorily convertible, the bondholders do not have any say on the conversion event. It is possible that the conversion of the bond to shares happen when the market price of the shares are considerably lower than the price at which the bonds were issued. This may result in a considerable loss for the investors.
2. For issuers.
In the case of optionally convertible FCCBs, a drastic decrease in the share price may create a situation where the bondholders do not have any incentive for the conversion. This leaves the company with a loan in foreign currency which may strain the finances. This is especially problematic when the currency of the domestic currency depreciates in comparison to the foreign currency as the FCCBs are issued in as FCCBs are exposed to the currency risk.
REGULATION IN INDIA
FCCBs are regulated by notifications under the RBI Foreign Exchange Management Act (FEMA). As per notification no. FEMA 55 /2002-RB dated 2nd March 2002, Indian companies can issue FCCBs up to USD 50 million without seeking any permission from the regulators. For issues, more than US 50 million but less than US 100 million needs the permission of RBI. For issues, more than US 100 million needs the permission of the Ministry of Finance.
The minimum maturity should be 5 years and any call or put option associated with the FCCB cannot be exercised before 5 years.