Foreign Currency Convertible Bond (FCCB)
What is FCCB?
A foreign currency convertible bond (FCCB) is a type of corporate bond issued by an Indian listed company in an overseas market and hence, in a currency different from that of the issuer. The highlight of the FCCB, however, is the option of converting the bonds into equity at a price determined at the time the bond is issued.
It also has the benefits of a debt instrument as it includes guaranteed returns or yields which are payable in foreign currency.
FCCBs have a maturity period of about five years during which no call or put option can be exercised. They are generally viewed as a means of foreign investment into a company and have to comply with the limits imposed depending on the sector. Currently Indian companies can raise up to $50 million in a FY through issue of such bonds via automatic route.
Why were they popular in the past?
For companies, FCCBs gave them access to funds at cheaper rates, given the fact that many of these were zero coupon bonds with a yield-to-maturity structure , meaning the company would have to make large-scale payments only when the bonds were redeemed.
Also, the interest rates were much lower than that of normal debt.
In fact, given the boom in the markets and rising share prices, the assumption was that a larger number of bondholders would choose to convert their bonds into shares eventually.
The company could also then benefit from the lack of outflows from their reserves.
What were the recent complications?
With the slowdown and stocks trading at prices below conversion price, the chances of bondholders exercising conversion option became minimal.
In fact, a large number of Indian companies found themselves in a position where they had not made provisions for the redemption of bonds maturing from 2009 and would reach a height in 2010-11. The weakening rupee became an added complication.
Thus, at the end of 2008, the RBI said Indian corporates could buy back FCCBs using forex either in India or overseas, provided the companies could ensure that the buyback value was at least at a discount to the book value of FCCB. There was also the option of generating resources using the ECB route.
While companies could initially buy back FCCBs worth $50 million, the limit was further raised to $100 million. The norms were further eased this year to allow companies to buyback from internal accruals.
(Updated - 08 April 2012)
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Why is it in the news now?
Earlier this week, the RBI announced plans to withdraw the facility of allowing companies to buy back FCCBs from January. This is line with the improving economy as well as buoying stock prices.
In fact, a few companies, including L&T , Tata Power and Rai Agro, have started the process of issuing FCCBs for capital inflow in the last two months, while Unitech is in the process of getting approvals.