Many businesses in today’s globalised world go to overseas markets for funding in order to finance their business objectives, increase investor diversity, and get lower loan rates. Foreign currency convertible bonds (FCCBs) are an instrument that helps them achieve these objectives. FCCBs are a particular kind of bond that is receivable and denominated in foreign currencies and that may be exchanged into shares of the issuing company at a fixed price or exchange rate.
This article will deep dive into the meaning, characteristics, benefits, and ways that FCCBs may help investors as well as issuers.
What are FCCBs?
As the phrase indicates, these bonds are a type of bond that has been issued in a currency other than the local currency of the investor. In addition, the term implies that the bonds are convertible, meaning that in addition to principal and coupon payments, investors have the ability to convert their bonds into shares.
FCCBs are often issued by businesses looking to raise money on the foreign exchange markets. Investors who seek the chance to earn via interest payments, as well as the possibility of capital growth through currency conversion, may find them to be a worthwhile option.
The following chart shows India’s FCCBs from October 2004 to August 2023:
The price at which a bond may be converted into stocks is known as the conversion price, and the total number of stocks that can be obtained for each converted bond is known as the conversion ratio. When it comes to FCCBs, the market value of the shares that are being converted at the time of exchange determines whether the conversion price is fixed or floating.FCCBs are vulnerable to both market and currency fluctuations. This is because the bond’s value and its ability to be converted into stocks are based on the current value of the underlying stocks and the value of the exchange rate.
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A look into FCEB
Since we are discussing FCCBs, it is important to consider the comparatively newer FCEBs or Foreign Currency Exchangeable Bonds as well. When an Indian company issues a bond written in a foreign currency, the capital and interest are also paid in that currency.
Bonds like these are issued by an “issuing company” and subscribed by someone from a country other than India. FCEBs can be changed into equity shares of another company, typically referred to as an “offered company.”
In contrast to FCCB bonds, which can be converted into stocks of the issuing company, FCEB bonds can be exchanged for shares of another company.
How does FCCB work?
Large, globally functioning, publicly listed businesses often issue foreign currency bonds as a means of raising foreign currency funding. These bonds have all the characteristics of convertible bonds. In other words, principal and interest payments are required to be paid in a similar currency since the business issuing this bond is a foreign one.
Businesses that raise money abroad have access to new markets for growth. Companies often choose to issue FCCBs in a country with an economy that is more stable than their own or has a lower interest rate. Likewise, FCCBs have lower interest rates than regular bonds due to their convertible nature into equity.
When the company makes its maturity payment, any negative shift in exchange rates might make the local currency less valuable. After repayment, it increases cash flows. As a result, the issuing company may suffer losses. Foreign currency convertible bond issuing corporations are also exposed to various socioeconomic and legal issues associated with the country.
If the value of the business’s shares falls beneath the conversion price, investors holding FCCBs will not be able to convert their bonds into stocks. The business will have to pay when it matures. On the other hand, investors may convert their bonds into stocks when the business’s stock price rises.
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Features of foreign currency convertible bonds
The following are the distinct characteristics of FCCB:
- FCCBs and convertible securities are comparable. Up until a specific date, they consistently make principal and coupon payments in a foreign currency. The issuer is then permitted to convert it into equity.
- Compared to regular bonds, these convertible bond offerings have lower interest rates.
- No collateral or security is required to issue FCCBs.
- FCCBs are exchanged on an overseas stock market.
- These bonds are equity-linked debt securities, which means that after a certain amount of time, the holder can change them into equity or a depository receipt.
- Call or put options may be used by companies to issue bonds. Through the use of put options, the investor may convert the bonds into stock.
Foreign currency convertible bonds: Pros and cons
FCCB advantages
For the business issuing convertible bonds denominated in another currency:
- Debt financing is less expensive with FCCBs as their coupon rates are often lower than those of commercial banks.
- FCCBs allow the corporation to lower its debt if they are converted, providing much-needed extra equity capital.
- The corporation could profit from a drop in the cost of debt if the exchange rate shifts in its favour.
Regarding the investors:
- Minimal set rate of return that is guaranteed.
- After conversion, investors are eligible to profit from any price increases in the issuer’s shares.
- Being able to choose between having a steady income stream from bond payments or entering the capital market. With foreign exchange convertible bonds, investors have a special dual benefit of debt and equity.
FCCB disadvantages
For the business issuing convertible bonds denominated in another currency:
- There is less demand for foreign currency convertible bonds when the share market is noticing a drop.
- For any issuer who chooses to convert their bonds into stocks, ownership will be diluted, and profits per share will decline.
- Bondholders will incur higher principal and coupon payments if the currency of the issuing firm underperforms relative to their home currency.
- It is possible for bondholders to decide against converting at all. This implies that the loan and interest must be fully paid by the issuing entity.
Regarding the investors:
- Bonds denominated in foreign currencies are exposed to credit and exchange rate risk.
- It may become impossible to repay face value at maturity if the issuing corporation files for bankruptcy.
- The set prices and conversion rates are not subject to the control of bondholders.
Also read: Government bonds in India – Meaning, types and features
Conclusion
Special RBI approval is required for any plan concerning the restructuring of FCCBs that does not include changes to the conversion price. On a regular basis, the policy is evaluated in light of the macroeconomic backdrop and other conditions. Foreign currency convertible bonds, however, have the potential to significantly damage both parties’ finances in some unique circumstances.
