Contents Global Depository Receipts Essay Example

RIL share), single shares, or multiples (such as 1 ADR = 10 RIL shares). These ADRs can be traded on US stock exchanges similar to US company stocks. GDRs operate similarly but can be traded in different countries using the country's currency. ADRs/GDRs can be categorized as unsponsored, meaning the company (RIL) has no agreement with the custodian or depository bank for issuing DRs.

The over-the-counter (OTC) market trades these, and they are issued based on market demand forces. Unsponsored SDR can be issued by multiple depository banks, with each depository serving only the DRs it has issued. Sponsored DRs, on the other hand, are those that a company sponsors itself. In this case, the foreign company designates a depository bank to issue DRs in the foreign market on its behalf. Sponsored DRs come in different types, with Level 1 Sponsored DRs being the lowest level.

OTC-traded securities are not subject to the same regulatory requirements as those listed on recognized stock exchanges. For ADRs, companies must meet minimal SEC requirements but do not have to publish reports following US GAAP standards.

Level 2 Sponsored DRs, however, are listed on established stock exchanges such as NYSE, NASDAQ, AMEX, Frankfurt Stock Exchange, Luxembourg Stock Exchange, and London Stock Exchange. These securities can be traded after they are listed. Level 2 Sponsored ADRs require companies to comply with stricter SEC regulations and also publish annual reports following either US GAAP or IFRS.

Level 3 Sponsored DRs represent the highest level of sponsored DRs and come with stringent rules and regulations. In this type of DR program, companies issue fresh ADR shares to raise capital from foreign markets instead of depositing shares

from their home market.

The necessity of ADRs and GDRs arises as they provide various advantages. Investors find them convenient to purchase and hold without dealing with government regulations or currency conversion. They can be traded and settled in the same manner as any other security in the investor's home country's stock markets. ADRs also facilitate portfolio diversification and enable better comparison between stocks of different companies. Meanwhile, GDRs, denominated in the investor's home currency, help mitigate foreign exchange risks.

• For issuers, ADRs and GDRs boost global presence, offer additional avenues to raise funds, ensure price parity with global competitors, and simplify mergers and acquisitions.

Foreign Currency Convertible Bonds (FCCB) are a type of convertible bond issued in a currency different from that of the issuer's domestic currency. In simpler terms, the funds raised by the issuer are in a foreign currency. FCCBs function as both debt and equity instruments simultaneously.

These bonds, acting like a bond, make regular coupon and principal payments and also offer the bondholder the option to convert the bond into stock. This feature makes these bonds attractive to both investors and issuers. Investors benefit from the safety of guaranteed bond payments and can also profit from potential stock price increases. This is made possible through warrants attached to the bonds, which are activated when the stock reaches a certain price. Additionally, the equity aspect of these bonds adds value, resulting in lower coupon payments for the company and reduced debt financing and costs.

Foreign Currency Convertible Bonds (FCCB's) are defined in Regulation 2(g) of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations. According to this definition, FCCB's are bonds

issued by an Indian company in a foreign currency, with the principal and interest payable in foreign currency. Corporate India commonly utilizes FCCB's to raise funds for debt restructuring, infrastructure development, and company expansion. Investors are attracted to these bonds for two reasons: they receive fixed payments in foreign currency and have the option to convert their bonds into equity when the issuer company's shares appreciate in value.

The Features of FCCB include that they can be secured or unsecured, with most Indian Companies issuing unsecured bonds. Credit rating is not mandatory for bonds issued by corporations with an excellent track record, although it does add value. The convertible option attached to FCCBs is subject to Reserve Bank of India guidelines, allowing for conversion through call and put options. FCCBs are typically listed on national and regional stock exchanges to improve liquidity. Public issuance of FCCBs must be conducted through reputable lead managers in the international capital market, while private placements are limited to banks, multilateral and bilateral financial institutions, foreign collaborators, and foreign equity holders with a minimum 5% holding in the issuing company. Private placements from unrecognized sources are prohibited. FCCB issue expenses should not exceed 4% of the issue size or 2% for private placements.Criteria and regulations for issuing FCCBs require companies to obtain approval from the Department of Economic Affairs of the Union Finance Ministry. These companies must have a consistent track record of at least three years. FCCBs can be denominated in any freely convertible foreign currency, while ordinary shares of the issuing company must be denominated in Indian rupees. When issuing FCCBs, companies should deliver ordinary shares or bonds to

a domestic custodian bank, which then instructs the overseas depositary bank to issue a global depositary receipt or certificate to non-resident investors against the shares or bonds held by the domestic custodian bank. There are two modes for raising funds through FCCBs: 1. Automatic Route, which does not require government or RBI approval, and 2. Approval Route, which does require approval. Eligibility for raising funds through FCCBs includes being a company registered under the Companies Act.

Financial intermediaries like banks and financial institutions (FIs), housing finance companies, and NBFCs are ineligible for FCCB. Individuals, Trusts, and Non-Profit making Organizations are also disqualified. Not all companies have permission to raise funds through an automatic route; only companies engaged in the real sector are allowed.

The industrial sector in India, particularly infrastructure, is eligible for the automatic route. However, other companies must follow the approval route and obtain permission from RBI before proceeding with an FCCB issue. Lenders for eligible companies can only raise funds from internationally recognized sources, including international banks, capital markets multilateral financial institutions, export credit agencies, equipment suppliers, foreign collaborators, and foreign equity holders (excluding OCBs). To qualify as a "recognized lender" under the automatic route, a foreign equity holder must have a minimum equity holding in the borrower company as specified below: For FCCBs up to USD 5 million, a minimum equity of 25 percent held directly by the lender is required. For FCCBs exceeding USD 5 million, a minimum equity of 25 percent held directly by the lender is necessary, and the debt-equity ratio should not exceed 4:1 (with the proposed ECB not exceeding four times the direct foreign equity holding).An overseas organization

and an individual can lend to a company on FCCB if they have obtained a due diligence certificate from an Overseas Bank based on the stipulated conditions in the Guidelines. The following entities are eligible to make an FCCB issue under the approval route: financial institutions exclusively dealing with infrastructure or export finance, banks and financial institutions that participated in textile or steel sector restructuring packages approved by the Government, and Non-Banking Financial Companies (NBFCs) issuing FCCBs with a minimum average maturity of 5 years from multilateral financial institutions, reputable regional financial institutions, official export credit agencies, and international banks to finance the import of infrastructure equipment for leasing to infrastructure projects. Housing Finance companies can also raise funds through FCCB, provided they fulfill the condition of having a minimum net worth of not less than Rs. [insert amount] in the previous three years.

The text highlights the requirements and guidelines for listing on the BSE or NSE with a minimum size of USD 100 million for FCCBs. Applicants must submit a purpose/plan for fund utilization. Financial institutions, including Special Purpose Vehicles, can consider FCCBs under the Approval Route. Multi-State Co-operative Societies engaged in manufacturing activity must be financially solvent and provide audited balance sheets. Eligible companies can raise funds from international banks, capital markets, multilateral financial institutions, export credit agencies, equipment suppliers, foreign collaborators, and foreign equity holders. However, if FCCBs do not convert, the reset price may lower the conversion price and cause higher dilution for equity holders.

Refinancing with a New FCCB involves issuing a new bond with a lower conversion price to repurchase the old bond. This results in higher dilution and payment

of an early redemption premium. Refinancing with plain Vanilla debt can be costly and challenging, especially during a credit crunch. Another option is to raise equity by issuing new shares to repurchase the bonds, but this also leads to significant dilution and difficulty given the current economic environment. There are rumors that legislative changes may allow companies to legally repurchase their bonds from investors before the maturity date at an agreed price. Taxation policies include deductions of tax at source on interest payments until the conversion option is exercised and on dividends from the converted portion of the bond. The conversion of FCCB into shares does not incur any capital gains tax in India. Transfers of FCCB made outside India between non-resident investors also do not impose any tax liability in India. The pricing norms for FCCBs now require a minimum price based on the average weekly high and low prices for the two weeks prior to the relevant date, rather than the previous method of using an average for six months and two weeks.The date that the board decides to issue securities will be the relevant date for determining the price, rather than 30 days before the shareholders' resolution as previously stated.

Indian companies must adhere to various regulatory requirements before issuing Foreign Currency Convertible Bonds (FCCBs) in the international markets. These requirements are crucial for facilitating the issuance of FCCBs and provide flexibility in borrowing for Indian corporates, which is essential for the overall economy's growth. However, prudent limits on total external borrowings, including FCCB issues, are maintained through these regulatory policies. The Company Law prescribes several provisions that need to be followed for

the issuance of FCCBs. These bonds, expressed in foreign currency, are issued by Indian companies or anybody corporate to non-resident investors and are classified as debentures under the purview of the definition. Therefore, the process for issuing debentures is applicable to the issuance of FCCBs. A.

Prior to the Board meeting considering the issuance of FCCBs, the issuer company listed at the Stock Exchange must inform the Stock Exchange at least 7 days in advance. The power to issue FCCBs lies with the Board of Directors, who must pass a Board resolution regarding the issuance. C. To enhance borrowing powers of the Board, convening a General Shareholders Meeting is necessary to obtain shareholders' consent. In case of issuance of secured FCCBs, obtaining authorization for creating a mortgage or approval for further issuance of capital by way of FCCB without offering it to existing shareholders requires a Special Resolution. Companies intending to make a public issue of FCCBs must establish a Trust Deed for the bonds and appoint a Trustee for the bondholders. Additionally, they must create a redemption reserve account as per the Trust Deed provisions when issuing these Bonds to foreign investors. SEBI plays a role in ensuring that pre-issue and post-issue requirements and conditions are fulfilled by the issuer company. This includes making an application for listing of the Bonds on the stock exchange where the FCCBs will be issued and traded.

The Indian Stock Exchange requires 'in-principal' approval to list shares converted from bonds when bondholders exercise the convertibility option. The Government of India considers funds raised through FCCB issuance as Foreign Direct Investment (FDI). The ECB Master Circular allows borrowing funds through FCCB

issuance under two routes: FCCBs issuance up to $750 million under the Automatic Route, and FCCBs issuance beyond US $500 million with the explicit approval of the Reserve Bank under the Approval Route. The Circular provides eligibility criteria for borrowing and lending during the FCCB issuance under the Automatic Route. Proceeds from FCCB issuance must comply with the 'End-Use' conditions as prescribed by RBI in the ECB Master Circular. Some companies have recently raised funds through issuing American Depository Receipts (ADRs) and/or Global Depository Receipts (GDRs). These shares are issued to depositories who then issue ADRs/GDRs to international investors.The entities issuing ADRs/GDRs and the depository agree that the depository will not vote on the shares they hold, unless directed by the issuer companies. Indian companies are allowed to issue Foreign Currency Convertible Bonds and Ordinary Shares using the Global Depository Mechanism. The issuer does not show FCCBs (mostly Zero Coupons) on their profit and loss statement until maturity, making it an appealing option for raising funds. From the issuer's point of view, it offers a lower rate of return in exchange for the option to convert the bond into stock.

Benefits to the issuing companies. A few years ago, Indian and emerging markets experienced high growth and provided high returns. In line with the economic and financial trends at the time, Indian companies started issuing FCCBS, which quickly became a popular tool for financing ambitious plans. This proved to be very advantageous. Despite numerous options for fundraising, including qualified institutional placements, private equity placements, public issues, and bank funding, Indian companies opted for FCCBS.

Many companies have opted for FCCB as a better financing option because it

offers several advantages. FCCB is considered a hybrid instrument, which means it has a lower coupon rate compared to pure debt instruments. This helps in reducing the cost of debt financing. Additionally, when FCCBs are converted into equity, they become book value accretive, providing further benefits. By choosing FCCB, companies can avoid the immediate dilution of equity that may occur with public shares. Unlike traditional debt instruments, FCCB does not require a rating or any covenants. It also allows companies to raise funds within a month, whereas pure debt financing usually takes longer. Another advantage is that the coupon for FCCBs is typically paid at the time of redeeming the instrument, resulting in lower withholding tax compared to other ECB instruments. Withholding tax is similar to TDS (Tax Deducted at Source) and is paid by the issuer on income remitted to a party overseas.

If the coupon is lower than the yield, the cost of withholding tax is lower for most of the Indian issues. This is because a smaller amount is paid every year in the form of a coupon, assuming conversion and not redemption takes place. Additionally, it may seem more stable and predictable than their domestic currency. The ability to access investment capital available in foreign markets is also provided to issuers, allowing companies to break into foreign markets. Furthermore, the conversion of bonds into stocks occurs at a premium price to market price, with the conversion price being fixed when the bond is issued. As a result, there is lower dilution of the company stocks. Overall, it offers investors the advantages of both equity and debt.

The investor benefits from both the

upside of equity investment and the protection of the debt element. Bond investors receive assured returns in the form of fixed coupon rate payments. Bonds are also accompanied by warrants, which allow investors to profit from stock price appreciation. At maturity, a guaranteed significant Yield to Maturity (YTM) is provided. Compared to pure debt instruments, lower coupon rates result in lower tax liability. Additionally, investors can capitalize on any substantial stock price increase. However, FCCBs present a higher exchange risk for bondholders as the bond's interest is payable in foreign currency. Therefore, FCCBs are primarily chosen by companies with low debt equity ratios and significant FOREX earnings potential. The main risk for investors is that the issuer's stock may underperform during the bond's lifespan, potentially causing bondholders to return bonds to the issuer at maturity above par, depending on the coupon structure.

FCCBs result in the creation of additional debt and require a foreign exchange outflow for interest payments. Convertible bonds typically have low interest rates (around 3 to 4%), but there is exchange risk for both interest and principal if the bonds are not converted into equity. If the stock price drops, investors may choose redemption instead of conversion. Companies then need to refinance in order to fulfill the redemption promise, which can impact earnings. The debt remains on the balance sheet until conversion occurs. In the recent past, during the 2007 and 2008 fiscal years, Indian firms took advantage of the booming equity markets by raising funds through FCCBs, a hybrid financial instrument that combines debt and equity, to support growth and expansion. Since January 2006, Indian corporate houses have raised $13.6 billion in

debt through FCCBs, with more than half of the total issuance occurring between January 2007 and January 2008 ($7 billion).

The amount of Foreign Currency Convertible Bonds (FCCBs) issued by companies in the Materials and Industrials sectors is the highest at $5 billion. However, it is interesting to note that smaller Information Technology companies raised around $1 billion during the same time period.
Currently, there are global concerns regarding European sovereign debt, and as a result, the Indian Rupee (INR) has depreciated against the USD. This depreciation has coincided with a 5-7% increase in FCCB yields since August. The excessive issuance of foreign convertibles between 2006 and 2008 has become a cause for concern as approximately 70 FCCBs are expected to mature in the next 12 months. As a result, many issuers are actively seeking board approvals for restructuring and refinancing their existing obligations.

The CDS spreads of Indian stalwarts such as ICICI, SBI, and Reliance have increased about 200 bps since August, making it difficult for lower-tier corporate India to obtain inexpensive funds. Zero-coupon convertibles are offering redemption premiums that estimate the total redemption value to be around US$12.2 billion by 2013. However, companies scheduled for conversion in the 2013 fiscal year may face challenges due to trailing stock prices, high debt levels, and low promoter shareholding. Only 13 out of 119 securities are currently trading above their conversion price, and regulatory prohibitions by RBI prevent the reduction of conversion price. Consequently, the situation looks bleak.

Refinancing or downward revision of conversion prices will result in equity dilution for shareholders of FCCBs. These options will have a negative impact on financials. Additionally, companies with outstanding FCCBs

worth around Rs15-20 billion, high debt levels, and low promoters' stake will face challenges in meeting repayment obligations. Overall, Rs31,500 crore worth of FCCBs are due for redemption in the next two years for S;P CNX 500 companies. During the bullish Indian equity market years of 2007 and 2008, many local firms raised funds through FCCBs, a hybrid instrument that combines debt and equity, for growth and expansion. The CNX Nifty is currently at 5,565 (3 May), down approximately 10% from its peak of 6,287 on 8 January 2008.

On 5 November 2010, Nifty closed at 6312. Nevertheless, many companies' share prices (representing 57% of the outstanding FCCBs due for redemption by 2012-13) continue to trail at a discount of at least 50% compared to their market price on 8 January 2008. Additionally, these companies are already facing reduced profitability due to increasing inflation and interest rates. Consequently, the maturing FCCBs will further worsen their profitability.

Considering a company’s net gearing after dilution of the promoter holding at current market price, parent company support, profitability, and cash flows, an evaluation has been made to determine the potential for redemption or price reset. If all these firms decide to redeem their FCCBs upon maturity, the repayment to bondholders will reach Rs30,100 crore, including a premium of Rs7,100 crore, which exceeds half the profits of these companies over the last four quarters. In 2008, Wockhardt Ltd failed to meet its obligations on its FCCBs, leading bondholders to take legal action against the pharmaceutical company. In February of this year, the court ruled in favor of the bondholders and initiated liquidation proceedings.

Many promoters have learned from the Wockhardt case that

defaulting can lead to messy consequences. As a result, several companies are currently engaging in discussions with bondholders to renegotiate terms and with banks to refinance their bonds. Companies that are proactively preparing for redemption, even if it is a year away, will be better equipped to manage the pressures associated with it. Companies with net gearing ratios of less than 1.5 times or a promoter's holding of at least 35%, along with strong parental support, profitability, and cash accruals, will experience less redemption pressure.

In the midst of challenging times, the recent activities in the Indian FCCB space, fueled by concerns about redemption and the depreciation of the Rupee, present us with opportunities. Although higher yields indicate the potential risks of defaults and restructuring for weaker issuers, we would like to draw attention to certain mispricing opportunities within the FCCB space. These opportunities offer high yields and lower risk due to relatively strong financial conditions. As the worries about FCCB redemption take center stage, the yields for some prominent companies' FCCBs have reached 20-25%, deviating around 10-15% from their year-to-date average. To determine the solvency of FCCB issuers, we have analyzed quantitative screens including Altman z-scores, leverage, and interest coverage ratios. By using a comprehensive convertible bond (CB) valuation methodology, we have valued the liquid securities in the FCCB space. This valuation helps identify the extent of mispricing and the implied credit risk premium for certain issuers.

Within our coverage universe, RCOM, JPA, and Suzlon are yielding more than approximately 20% despite their high leverage. However, RCOM and JPA have a reasonable ability to service their debts based on their EBITDA-to-Interest paid ratio. Additionally, we would

like to highlight Everest Kanto Cylinders, Rolta India, First source Solutions, and Videocon Industries as non-coverage companies that have high yields and a relatively stronger ability to pay their liabilities.

REFERENCES

1. www. investopedia. com
2. http://rna-cs. com/pdf/IndianFCCB. pdf
3. http://www. legalserviceindia. com/article/l282-Foreign-Currency-Convertible-Bonds.

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• Master Circular on ECB dated July 1st 2006