Thursday, July 10, 2008

Foreign currency convertible bonds (FCCBs)

Foreign currency convertible bonds (FCCBs) have been hugely popular with Indian corporates as a source of capital mobilisation. And they have been lapped up by foreign investors wanting to test the waters first before committing themselves to the uncertain, yet hugely rewarding, world of equity.

Cheap funds

An FCCB has all the trappings of a convertible debenture; only it is denominated in a foreign currency. Till conversion, which is entirely optional, companies get to enjoy some cheap funds given the fact that the interest rates in the US and European markets have always been low vis-À-vis the Indian rates of interest.

What beckons the foreign investors is the promise of acquiring shares at a discount vis-À-vis the ruling market price. But unfortunately for many Indian companies, the inexorable decline in their fortunes in the Indian bourses has spelt non-exercise of the conversion option by the foreign investors resulting in a huge redemption liability staring at them in the near future for which they were not obviously prepared punch drunk as they were with confidence that such an eventuality would never arise.

Markets however have the ability to humble anyone, including the high and mighty as well as those who are blasé.

In a bind

These companies are now at their wits’ end. First, how to pay back the foreign investors when the redemption time arrives? Second, Section 117C of the Companies Act mandates them to create reserve out of profits so as to be able to redeem the debentures out of such accumulated profits. And, third, user charges for these funds have not been provided for in the accounts, thus giving a bloated and exaggerated figure of profits.

The first predicament of these companies is not the subject of this article. The second and the third are. The reason trotted out as to why these companies did not provide for user charges and did not create a redemption reserve is simple — never in their wildest dreams did they foresee the possibility of investors not exercising their conversion option.

The Ministry of Company Affairs (MCA) stand is that reserve under Section 117C is to be created only on the non-convertible portion of the bonds or debentures. In fact, this has come handy for companies which say that they did not know how much is redeemable so as to be in a position to create a reserve, anticipating as they did 100 per cent exercise of conversion option.

And the same we-lived-in-fools-paradise theory has been extended for not providing for user charges that has had the effect all these years of considerably overstating their profits.

Foreign investors have often complained of lax regulatory framework as an inhibiting factor. The FCCB accounting fiasco is a telling example of this. Unfortunately, AS-31 is some distant away, taking as it does mandatory effect only from the year 2011.

Notify standard

But it does throw some valuable light on the issue to the benighted corporates: “The company’s contractual liability to make future payments remain outstanding until it is extinguished through conversion ….”

2 comments:

Ntiya said...

sir, article was good. it would have been more helpful to me had it been a little more elaborative and a little more self explanatory

nitya

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