Overseas investment in Joint ventures (JV) and Wholly Owned Subsidiaries (WOS) have been recognized as important avenues for promoting global business by Indians entrepreneurs in terms of Foreign Exchange earnings like dividend, royalty, technical know-how fee and other entitlements on such investments. They are also a major source of increased exports of plant & machinery and goods from India. JVs have also been perceived as a medium of economic co-operation between India and other countries. Transfer of technology and skill, sharing of results of R&D, access to wider global market, promotion of brand image, generation of employment and utilization of raw materials available in India and in the host country are other significant benefits arising out of such overseas investments.
Traditionally, overseas acquisitions were being funded through a variety of sources such as drawl of Foreign Exchange in India, capitalization of exports, balances held in Exchange Earner’s Foreign Currency accounts (EEFC), Share swaps, through ADR/GDR, External Commercial Borrowings/Foreign Currency Convertible Bonds. A substantial portion of investments takes place through special purpose vehicles (SPVs) set up for the purpose abroad. Existing WOS / JV or the SPVs are being used to fund acquisitions through Leveraged buy-out (LBO) route. In fact the Tata – Corus deal was made possible by the scheme of leveraged buy-out.
However the recent introduction of the Foreign Currency Exchangeable Bonds (FCEB) has given the investors a new opportunity for funding overseas acquisitions. FCEBs help the promoters to meet the financing requirements within the group by issuing foreign currency bonds against the value of their investments in shares of listed group companies.
Meaning of FCEB
The FCEB scheme of 20081 has given the Indian corporates an additional avenue for raising funds from overseas by unlocking the value embedded in the shares they hold in other promoter group companies, without causing equity dilution. The scheme seeks to help Indian promoters raise money abroad by issuing foreign currency bonds against the value of their investments in shares of listed group companies. The bonds are described as ‘exchangeable’ bonds as investors abroad could exchange them into equity shares or warrants of the listed group company before their redemption. So far, holding companies were allowed to raise funds through foreign currency convertible bonds (FCCBs), under which they issue their own shares to subscribers at a predetermined price. However, now a holding company can raise foreign funds by offering its equity holdings in other group companies in the international markets through FCEB.
FCEBs means “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.”
The Eligible Issuer under the scheme is the Issuing Company which shall be part of the promoter group of the Offered Company and shall hold the equity share/s being offered at the time of issuance of FCEB and the Offered Company is the listed company, which is engaged in a sector eligible to receive Foreign Direct Investment and eligible to issue or avail of Foreign Currency Convertible Bond (FCCB) or External Commercial Borrowings (ECB).
Eligibility conditions for FCEBs
- The Issuing Company shall be part of the promoter group of the Offered Company and shall hold the equity share/s being offered at the time of issuance of FCEB.
- The Offered Company shall be a listed company which is engaged in a sector eligible to receive Foreign Direct Investment and eligible to issue or avail of Foreign Currency Convertible Bond or External Commercial Borrowings.
- An Indian Company, which is not eligible to raise funds from the Indian securities market, including a company which has been restrained from accessing the securities market by the Securities and Exchange Board of India shall not be eligible to issue Foreign Currency Exchangeable Bond.
- The subscriber to the Foreign Currency Exchangeable Bond shall comply with the Foreign Direct Investment policy and adhere to the sectoral caps at the time of issuance of Foreign Currency Exchangeable Bond. Prior approval of Foreign Investment Promotion Board, wherever required under the Foreign Direct Investment policy, should be obtained. Entities prohibited to buy, sell or deal in securities by Securities and Exchange Board of India will not be eligible to subscribe to Foreign Currency Exchangeable Bond.
End- Use requirements of FCEBs proceeds
- Issuing Company:
(i) The proceeds of FCEB may be invested by the issuing company in the promoter group companies.
(ii) The proceeds of FCEB may be invested by the issuing company overseas by way of direct investment including in Joint Ventures or Wholly Owned Subsidiaries abroad, subject to the existing guidelines on overseas investment in Joint Ventures / Wholly Owned Subsidiaries.
- Promoter Group Companies:
Promoter Group Companies receiving investments out of the FCEB proceeds may utilize the amount in accordance with end-uses prescribed under the ECB policy.
- End-uses not permitted : The promoter group company receiving such investments will not be permitted to utilise the proceeds for investments in the capital market or in real estate in India.
Procedure for issuing FCEBs
- Prior approval of the Reserve Bank of India is required for issuance of FCEBs under the Approval Route for raising ECB. The Reporting arrangement for FCEB shall be as per extant ECB policy. The Bonds can be denominated in any freely convertible foreign currency.
- The Issuing Company shall comply with the provisions of the Companies Act, 1956 (1 of 1956) and obtain necessary approvals of its Board of Directors and shareholders if applicable. The Offered Company shall also obtain the approval of its Board of Directors in favor of the Foreign Currency Exchangeable Bond proposal of the issuing company.
- The Issuing Company intending to offer shares of the offered company under Foreign Currency Exchangeable Bond shall comply with all the applicable provisions of the Securities and Exchange Board of India Act, Rules, Regulations or Guidelines with respect to disclosures of their shareholding in the Offered Company.
- Restrictions: The Issuing Company shall not transfer, mortgage or offer as collateral or trade in the offered shares under Foreign Currency Exchangeable Bond from the date of issuance of the Foreign Currency Exchangeable Bond till the date of exchange or redemption. Further, the Issuing Company shall keep the offered shares under Foreign Currency Exchangeable Bond free from all encumbrances from the date of issuance of the Foreign Currency Exchangeable Bond till the date of exchange or redemption.
Pricing and Maturity
· The rate of interest payable on FCEBS and the issue expenses incurred in foreign currency shall be within the all in cost ceiling as specified by Reserve Bank of India under the External Commercial Borrowings policy.
· At the time of issuance of Foreign Currency Exchangeable Bond the exchange price of the offered listed equity shares shall not be less than the higher of the following two:
i. The average of the weekly high and low of the closing prices of the shares of the offered company quoted on the stock exchange during the six months preceding the relevant date; and
ii. The average of the weekly high and low of the closing prices of the shares of the offered company quoted on a stock exchange during the two week preceding the relevant date.
- The minimum maturity of the Foreign Currency Exchangeable Bond shall be five years for purposes of redemption. The exchange option can be exercised at any time before redemption. While exercising the exchange option, the holder of the Foreign Currency Exchangeable Bond shall take delivery of the offered shares. Cash (Net) settlement of Foreign Currency Exchangeable Bonds shall not be permissible.
Difference between FCCBs and FCEBs
1. The essential difference between an FCCB and FCEB lies in their convertibility. Unlike an FCCB, which is convertible into new shares of the issuing company, an FCEB is convertible into existing shares of the offered company held by the issuing company.
2. The company that issues FCCB and the company that issues shares on conversion are one and the same whereas the company that issues FCEB and the company whose shares are issued on exchange are different but should belong to the same promoter group.
3. The shares issued on conversion of FCCB would be issued afresh by the issuing company on conversion, whereas when the investor in FCEB wants shares in exchange, he has to approach the issuing company which already holds these shares.
4. FCCBs are issued by a company to non-residents giving them the option to convert them into shares of the same company at a predetermined price. On the other hand, FCEBs are issued by the investment or holding company of a group to non-residents which are exchangeable for the shares of the specified group company at a predetermined price.
5. Finally, FCCB involves just one company whereas FCEB involves at least two companies- the bonds are usually of the parent company while the shares are of the operating company which must be a listed company.
Advantages of FCEBS over FCCBs
- FCEBS 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.
- 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.
- From a bondholder’s perspective, FCEBs entitle the bondholders to listed offered shares which an be easily disposed off on a stock exchange as against unlisted shares which may not be as marketable.
- FCEBs have been seen to outperform the offered shares in adverse market situations due to the assured returns (coupon payment) and perform just as good or even better than the underlying offered shares in an appreciating market.
- Disadvantages of FCEBs: 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. 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 this route will be utilised in any meaningful way by Indian companies.
· Pursuant to the FCEB scheme, RBI issued a circular operationalizing the FCEB scheme. The behind this initiative is to provide greater funding options for Indian promoters, whereby a bond expressed in a foreign currency can be issued and subscribed to by a non-resident. Subsequently the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 have also been amended to incorporate the FCEB scheme. Foreign Exchange Management (Transfer or Issue of any Foreign Security) (Second Amendment) Regulations, 2009 have added the definition of FCEBs, issuing company, offered company and promoted group to Section 2 of the Regulations of 2004. Further Regulation 21, providing for “prohibition on issue of foreign security by a person resident in India” has also been amended, permitting a person resident in India to “issue Foreign Currency Exchangeable Bonds to a person resident outside India in accordance with and subject to the conditions specified in Schedule IV with the specific approval of the Reserve Bank.”
Conclusion:
The unique and flexible nature of FCEBs have generated a lot of interest among large Indian corporate houses looking to raise funds overseas, for acquisitions or greenfield projects. The introduction of FCEBs is a very laudable initiative and provides an additional avenue for Indian promoters to raise funds from foreign investors to fund new projects or acquisitions.
