3. Session Readings (Euro Issues)

7/29/2019 3. Session Readings (Euro Issues)

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E-NEWSLINE NNNN FEBRUARY 2007

Disclaimer This newsletter is for information purposes and should not be construed as legal advice.

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CONTENTS

Raising Foreign Capital through FCCB and ADR/GDR

Introduction......................................................................................................21. Meaning and Salient Features of FCCB and ADR/GDR .......................22. Regulatory Framework Governing FCCB & GDR ..................................22.1 Regulatory Provisions under the Ministry of Finance Guidelines..........32.2 RBI Guidelines .................................................................................................42.2.1FCCB..................................................................................................................42.2.2GDR/ADR.......................................................................................................53. Reasons for increase in raising Overseas Capital.......................................64. FCCB/GDR versus QIP................................................................................65. FCCB in a bearish run.....................................................................................6

Conclusion.........................................................................................................7


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Raising Foreign Capital throughFCCB and ADR/GDR

LLLL INTRODUCTION

In recent times, there has been acontinuous surge in the issue of ForeignCurrency Convertible Bond (FCCB) andGlobal Depository Receipt (GDR) withcompanies such as Reliance Communications,

Mahindra & Mahindra, Ranbaxy resorting tothe FCCB route to meet their financing needs.This newsletter seeks to analyze the meaningand salient features of these instruments. Itfurther discusses the regulatory mechanismgoverning them and the reasons for theirpopularity. Finally, it touches the very vitalissue as to whether FCCB is the answer tosatiate corporate Indias thirst for capital in allsituations.

1. Meaning and Salient Features of FCCB

and ADR/GDR

Issue of FCCB is governed by ForeignExchange Management (Transfer or Issue ofany Foreign Security) Regulations, 2004 (theRegulations). The Regulations defineFCCB as a bond issued by an Indian companyexpressed in foreign currency, and theprincipal and interest in respect of which ispayable in foreign currency.1 A convertiblebond is a quasi-debt instrument, which can beconverted into equity shares at the choice of

investor either immediately after issue, orupon maturity, or during a set period, at a pre-determined strike rate. It acts like a bond bymaking regular interest and principalpayments, but these bonds also give thebondholder the option to convert the bondinto stock. The investor benefits if theconversion price is higher than the traded

1 Clause 2(g) of the Regulations.

price and suffers a loss if the traded price ishigher than the conversion price. However,the investor has the discretion to hold thebond till maturity, receive regular interestpayments and principal on maturity, without

exercising the option of converting the debtinstruments into equity.

GDR means a security issued by abank or a depository outside India againstunderlying rupee shares of a companyincorporated in India.2 Security issued by abank or depository in USA against underlyingrupee shares of a company incorporated inIndia is known as American DepositoryReceipt (ADR).3 Therefore, the differencebetween ADR and GDR is only with respect

to the location of depository or bank issuingthe shares. FCCB is denominated in dollars orany other currency other than rupee. Thisbrings about an element of exchange risk inthe issue of FCCB due to currencyfluctuations. In contrast, GDR is denominatedin dollars with the equity shares comprised ineach GDR denominated in rupees, hence,there is no exchange risk for the issuer.

2. Regulatory Framework Governing FCCB& GDR

In India, FCCB and ADR/GDR areissued in accordance with guidelines andregulations framed under Foreign ExchangeManagement Act, 1999 (FEMA) the

2 Clause 2(i) of the Regulations.3 Clause 2(c) of Regulations.


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Reserve Bank of India (RBI)4 and schemesnotified by the Ministry of Finance,Government of India as well as theRegulations for FCCB. The latestcomprehensive guidelines on the issue of

FCCB have been consolidated in the MasterCircular on External Commercial Borrowingsand Trade Credits dated July 1, 2006 (theCircular) issued by the RBI. The Circular isapplicable for FCCB issuance as well.5 Issue of

ADR/GDR is governed by the RBI guidelineson foreign investments in India that have beenconsolidated into Master Circular on ForeignInvestments in India dated July 1, 2006 (theFI Circular).6 Finally, issue of FCCB andGDR/ADR should also comply with theIssue of Foreign Currency Convertible Bonds

and Ordinary Shares (through DepositoryReceipt Mechanism) Scheme, 1993 (theScheme) notified by the Ministry ofFinance. Therefore, issue ofFCCB/ADR/GDR is governed by four keyregulations as aforesaid.

Further, issue of FCCBs will have toconform to the Foreign Direct Investment(FDI) policy (including sectoral caps andsectors where FDI is permissible) of theGovernment of India and the RBIs

regulations/directions issued from time totime.7 Similarly, regulation 8.1 of the FICircular states that Indian companies issuing

ADR/GDR should not be ineligible in termsof the FI Circular to issue shares to personsresident outside India. This implies that issueof ADR/GDR will have to adhere to all such

4 Section 6 (3) confers upon RBI the power to regulate, restrictor prohibit by way of regulations the capital account transactionsmentioned under section 6 (3)(a) to 6(3)(j).5 The Master Circular no. 7/2006-2007 consolidates all existing

notifications and circulars on the subject of ExternalCommercial Borrowings and Trade Credits. The introductoryprovisions of the Circular expressly state that policy for ECB isalso applicable to FCCB. The Circular has a sunset clause of 1year which means that it shall stand withdrawn on July 1, 2007and will be replaced by an updated Master Circular on thesubject.6 The Master Circular no. 2/2006-2007 on Foreign Investmentsin India. Even FI Circular has a sunset clause of 1 year whichmeans that it shall stand withdrawn on July 1, 2007 and will bereplaced by an updated Master Circular on the subject.7 Clause (i) of the Schedule to the Regulations.

RBI guidelines on FDI as consolidated in theFI Circular. Accordingly, an Indian companyengaged in retail trading cannot issue

ADR/GDR/FCCB for raising capital as retailtrading (except single brand product retailing)

is a prohibited sector for FDI.

2.1 Regulatory Provisions under the Ministryof Finance Guidelines

In terms of the Scheme, priorpermission of Ministry of Finance is notrequired for the issue of ADR/GDR if it isissued through an exchange that is registered

with or recognized by the appropriateregulatory authority in the country of issue.Private placement of ADRs/GDRs is also

eligible for automatic approval, provided theissue is lead managed by an investmentbanker.8

In order to bring the Scheme inalignment with Securities and Exchange Boardof India (SEBI) guidelines on domesticcapital issues, the Ministry of Financeamended the same in August 20059 to includethe following provisions:

1. An Indian company which is not eligibleor is restrained10 from raising funds fromthe Indian capital market will not beeligible to issue FCCB or ordinary sharesthrough GDR.

2. Erstwhile Overseas Corporate Bodies(OCB) not eligible to invest in Indiathrough the portfolio route and entitiesprohibited to buy, sell or deal in securities

8 The Scheme was amended to include the automatic route of

approval in January 2000 vide Press release F.No. 15/7/99-NRIdated January 19, 2000 issued by the Ministry of Finance. For thepurpose of this Scheme, an investment banker is defined as aninvestment banker registered with Securities and ExchangeCommission in the USA, or under Financial Services Act in UKor the appropriate regulatory authority in Europe, Singapore orin Japan.9 Vide Press release F. No. 15/4/2004-NRI dated August 31,2005. Revisions/modifications to the operative guidelines of theScheme are made from time to time by the Ministry of Finance.10 Companies restrained by SEBI order under section 11(4) (b) ofSEBI Act, 1992 to access the securities market.


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by SEBI will not be eligible to issue FCCBor ordinary shares through GDR.11

3. Unlisted companies issuing GDR/FCCBshall be required to simultaneously list inthe domestic market.12

4. The ADR/GDR/FCCB issues should bemade at a price higher of the following:(i) The average of the weekly high and

low of the closing prices of the relatedshares quoted on the stock exchangeduring the six month preceding therelevant date;

(ii)The average of the weekly high andlow of the closing prices of the relatedshares quoted on the stock exchangeduring the two weeks preceding the

relevant date.13

The aforesaid pricing guidelinesinitiated a debate and were perceived to beunreasonable and indifferent to marketrealities. Such a pricing guideline restrictsaccess to overseas capital.14 The Ministry ofFinance has offered some respite for theinvestors planning a simultaneous domesticand overseas issue.15 Companies going publicsimultaneously in the domestic and foreignmarkets, or within 30 days of the domestic

issue, are not obliged to conform toabovementioned pricing guidelines withrespect to issue of FCCB and GDR/ADR,provided they secure approval from themarket regulator. Also, the issue prices, bothdomestic and foreign, must be at par. Thus,SEBI is empowered to exempt companies

11 OCBs have been prohibited from investing in any security inIndia vide Foreign Exchange Management (Withdrawal ofGeneral Permission to Overseas Corporate Bodies) Regulations,2003.12 Unlisted companies, which had already issued

ADRs/GDRs/FCCBs in the international market, were requiredto list in the domestic market on making profit beginningfinancial year 2005-06 or within three years of such issue ofADRs/GDRs/FCCBs, whichever is earlier.13 The relevant date means the date thirty days prior to thedate on which the meeting of the general body of shareholders isheld, in terms of section 81 (IA) of the Companies Act, 1956, toconsider the proposed issue.14 The reasons for this are explained in section 5 of thisnewsletter.15 Vide Press Release dated November 17, 2005 issued by theMinistry of Finance.

from adhering to the pricing guidelinesstipulated under the Scheme.16

2.2 RBI Guidelines

Though both the Scheme as well asthe Circular stipulate eligibility criteria forborrowers and lenders, the Circularconcentrates on volume of permissible totalborrowing and its maturity structure as well asthe permitted end use of the funds raised. Onthe other hand, the Scheme deals with theoperational parameters of the issue includingbut not limited to pricing guidelines, listingrequirements and issue structure.

2.2.1 FCCB

In terms of the Circular, FCCB can beaccessed through two modes -automatic routeand approval route. Under the automaticroute, no approval is required from RBI.Indian companies (except financialintermediaries)17 are eligible to raise anaggregate principal amount of upto US$ 500million under the automatic route. Minimumaverage maturity for FCCBs upto US$ 20million should be three years and for FCCBsbetween US$ 20 million and US$ 500 million,

five years.18

The proceeds from the issue of FCCBsare permitted to be utilized only for thefollowing end uses:

For investment (e.g. import of capital goods),implementation of new projects, andmodernization/expansion of existingproduction units in real sector, industrialsector including small and medium enterprisesand infrastructure sector.

16 Section 11 of SEBI Act, 1992 empowers SEBI to performfunctions mentioned therein. Section 11(2)(m) is the residuaryclause that empowers SEBI to perform any other function thatmay be prescribed.17 Financial institutions dealing exclusively with infrastructurefinance or export finance, textile or steel sector restructuringpackage can issue FCCB under the approval route.18 There is no limit on number of bonds that can be issued orsize or value of each bond.


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For overseas direct investment in JointVentures (JV)/Wholly-Owned Subsidiaries(WOS) subject to the existing guidelines onIndian direct investment in JV/WOS abroad.

For the first stage acquisition of shares in thedisinvestment process and also in themandatory second stage offer to the publicunder the Governments disinvestmentprogramme of PSU shares.

For lending to self-help groups or for micro-credit or for bonafide microfinance activityincluding capacity building by NGOs engagedin micro finance activities.

Refinancing of an existing ECB/FCCB,provided that the fresh FCCB is raised at alower all-in-cost19 and the outstandingmaturity of the original FCCB is maintained.

This means that proceeds of FCCB may beused to refinance an existing FCCB issueprovided that total amount payable onaccount of rate of interest, other fees andexpenses is lower in the fresh FCCB issuedthan in the existing FCCB.

Indian companies are prohibited to useFCCB proceeds under the automatic as well asapproval route for the following purposes:

On-lending or investment in capitalmarket or acquiring a company (or a partthereof) in India;

Real estate; Working capital, general corporate

purpose and repayment of existing rupeeloans.

In terms of the Circular no guarantee,letter of comfort or letter of undertaking canbe issued by banks, financial institutions orNon-Banking Financial Companies relating toFCCB. Further, the issue of security to be

provided to the lender is left at the discretionof issuer company.20 Prepayment of FCCB is

19 All-in-cost includes rate of interest, other fees and expensesexcept commitment fees, pre-payment fee, and fees payable inIndian rupees, (para (iv) of part I(A) of the Circular).20 Creation of charge over immovable assets and financialsecurities, such as shares, in favour of the overseas lender issubject to Regulation 8 of Notification No. FEMA 21/RB-2000dated May 3, 2000 and Regulation 3 of Notification No. FEMA20/RB-2000 dated May 3, 2000.

permitted upto US$ 200 million subject tocompliance of minimum average maturityperiod. For higher prepayment amount, RBIapproval is needed.21 The Circular providesthat funds received through FCCB should be

parked abroad till the actual requirement arisesin India.22

2.2.2 GDR/ADR

The FI Circular contains provisionsrelating to issue of shares by Indian companiesunder GDR/ADR.23 The proceeds must bekept abroad till actually required in India.

There are no end use restrictions except for aban on deployment/investment of such fundsin real estate or the stock market.24 A limited

two-way fungibility scheme has been put inplace by the Government of India for

ADRs/GDRs.25 This means that thedepository receipts can be converted intounderlying shares and vice versa. Under thisscheme, a SEBI registered stock broker inIndia can purchase the shares from the marketfor conversion into ADRs/GDRs. Re-issuance of ADRs/GDRs would be permittedto the extent of ADRs/GDRs which havebeen redeemed into underlying shares andsold in the Indian market. Earlier, no re-

issuance of depository receipts was permitted.Investors could only cancel the depositoryreceipts and avail of the underlying shares ortake back the proceeds by selling theunderlying shares. Hence, over a period oftime, the outstanding balance of depositoryreceipts would get reduced thereby reducingthe liquid float of depository receipts to theinternational investors. Two-way fungibilityscheme overcomes this problem.

An Indian company can also sponsor

an issue of ADR/GDR. Under thismechanism, the company offers its residentshareholders a choice to submit their shares

21 Para (ix) of part I (B) of the Circular.22 Para (ix) of part I (A) and para (viii) of part I (B) of theCircular.23 Regulation 8 of FI Circular.24 Regulation 8.1 of FI Circular.25 Vide A.P. (Dir Series) Circular No. 21 dated February 13,2002.


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back to the company so that on the basis ofsuch shares, ADRs/GDRs can be issuedabroad. The proceeds of the ADR/GDR issueis remitted back to India and distributedamong the resident investors who had offered

their rupee denominated shares forconversion. These proceeds can be kept inresident foreign currency (domestic) accountsin India by the shareholders who havetendered such shares for conversion into

ADR/GDR.26

3. Reasons for increase in raising OverseasCapital through FCCB/GDR

The rush for FCCB issues is drivenclearly in the light of cheaper funds abroad.

The interest payable in case of FCCB isgenerally lower than on other loans or bonds.

The Yield-to-Maturity (YTM)27 in case ofFCCB generally ranges from three to sevenpercent, much cheaper than the prevailinginterest rates in the domestic market.28Further, there is a renewed confidence inIndian companies and they realize the need tohave an offshore presence. Most of theGDRs/FCCBs are raised from stockexchanges like London, Singapore andLuxembourg exchanges where the disclosure

norms are not very stringent. Further, FCCBsare attractive to both investors and issuers.

The investors receive assured payments on thebond and also have the opportunity to takeadvantage of any price appreciation in thecompanys stock by means of warrantsattached to the bonds that represent a right toacquire shares in the entity issuing the bond.Due to the equity side of the bond, theinterest payments on the bond are lower,thereby reducing the costs for the issuer.

26 Regulation 8.5 of FI Circular.27 Yield-to-Maturity is a premium to be paid at redemption if thebonds are not converted into equity.28 3i Infotech's FCCB had a YTM of 5.8 per cent, RelianceCommunication's $500-million FCCB issue had a YTM of 4.65per cent, M&M five-year FCCB issue of $200 million had a YTMof 5 per cent, while Ranbaxy's $400-million February 2006 FCCBissue had a YTM of 4.8 per cent.

4. FCCB/GDR versus QIP

SEBI introduced the option for listedcompanies to raise funds through QualifiedInstitutional Placement (QIP) as it was

concerned over the growing number of Indianlisted companies tapping funds through theGDR/FCCB route. In comparison withFCCB/GDR, QIP is a cheaper option to raisefunds as the issue costs are lower. Further, it isa less time consuming option due to lowerregulatory approvals which need to beprocured. For example, there is norequirement of prior approval of thepreliminary placement document before theissue of specified securities. Also, no pre-issuefiling with SEBI is to be done. Therefore, QIP

may prove to be a more viable option formedium sized companies to raise capital asthey do not have global presence. However,there is a cap on the funds that can be raisedthrough QIP in a financial year.29 There is nosuch restriction on the amount that can beraised through FCCB/GDR. Hence,FCCB/GDR remains a viable option forraising funds on a large scale.

5. FCCB in a bearish run

In terms of the Scheme, issue ofFCCB and GDR/ADR have to be priced atthe average six monthly prices of the relatedshares or the average price thereof in the lastfortnight before the relevant date30,

whichever is higher. Such a provision makes iteasy to raise capital in a situation when stockprices are generally on the rise. However, in abearish market run, the stock prices fall and itbecomes difficult to garner capital. Such aprovision adds to the hardship of the investorby requiring the issues to be priced at theaverage six monthly prices or the averageprices of the last fortnight before the duedate.31 In such a scenario, there remains verylittle scope for the companies to fetch capital

29 The issue size in one financial year shall not exceed five timesof the net worth of the issuing company at the end of itsprevious financial year.30 Supra, n. 12.31 Supra, n. 5.


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and make profits. Thus, it is pertinent to notethat FCCB/GDR cannot be considered as a

viable option to raise capital in all situations asthe instruments are sensitive towards themarket trend.

LLLL CONCLUSION

FCCB and GDR are being increasinglyused by Indian companies as a major financeraising tool for meeting its capitalrequirements at competitive rates. The presentregulatory environment has fully supportedthe industrys efforts to meet its financingneeds by allowing issuers to raise considerableamounts under the automatic route. At thesame time, steps have been taken to secure theinterest of lenders as well as borrowers byexcluding any tainted players. However,

raising funds through FCCB/GDR is notfeasible in a bearish market run. Further, theissue costs as well as the time taken to issueFCCBs or GDR/ADR, as the case may be, isconsiderable. This makes instruments like QIP

a better option to raise funds for mediumsized companies. Nonetheless, FCCBs/GDRsmake available large scale cheap funds tosatisfy the capital requirements of companiesand it is likely that big sized companies wouldcontinue to resort to these instruments fortheir financial needs.

(Nikita Ved)


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Contact Lawyers Contact Details

Priti Suri [email protected] Legal CounsellorsMobile +(91) 98100-92842 E-601, Gauri Sadan

5, Hailey RoadNikita Ved New Delhi 110 [email protected] IndiaMobile +(91) 98688-81982

Tel: +(91 11) 43500-500Fax: + (91 11) 43500-502

Documents

3. Session Readings (Euro Issues)