With yet another foreign convertible bond default hitting our desk, we cannot help but wonder what the future has in store for Asian convertible bonds and debt capital markets restructurings. This is particularly relevant when you consider that Indian companies and banks issued foreign currency bonds aggregating up to approximately $6.3 billion in the first quarter of 2013. This momentum continued throughout 2013 with Indian companies expected to raise another $10 billion by the beginning of 2014 by issuing foreign currency bonds in the international capital markets.
The Story so far
The convertible bond has always been a favourite of corporate India. Turning back the clock, one would recall that, particularly between 2005 and 2008, several companies across multiple industries used a variety of structures to access the international debt capital markets by issuing foreign currency convertible bonds (FCCBs) to investors. Such issuers included National Thermal Power Corporation, Indian Oil Corporation, Bharat Petroleum Corporation, Power Finance Corporation, Tata Steel, Tata Communications, Vedanta, Bharti Airtel, Amtek Auto and Rural Electrification Corporation (just a few names amongst an endless list of issuers back in the day).
Fast forward to 2014 and FCCB defaults have dominated recent headlines (think major companies like Sterling Biotech, KSL and Industries and Suzlon Energy).
The double whammy!
To cut to the chase this is what happened. Firstly, Stock prices of most FCCB issuers fell sharply post-2008, due to the global financial crisis as well as Indian macro issues. FCCBs worth more than $7 billion were due for redemption. Many companies faced a severe funding crunch, since most FCCBs did not get converted as a result of the conversion price being higher than the market price (with the conversion option out, of course, no lender wanted equity!), and consequently required refinancing at higher prevailing interest rates. Secondly, the depreciation in the value of the rupee coupled with the fact that most of the foreign currency exposures were unhedged, exacerbated the issue and ballooned the principal repayment due in rupee terms, consequently complicating the refinancing challenges.
From a legal perspective, the process is often a messy one: in addition to the usual steps which a Trustee would take of confirming the occurrence of an event of default, providing default notices to the issuer and the noteholders, receiving pre-funding from the issuer, obtaining an indemnity and instructions from noteholders, a “Section 434 Notice” is often delivered too. A Section 434 Notice is a statutory demand (or “winding-up notice” – not to be confused with a “winding-up petition”) requiring the issuer to make payment of the full outstanding amount due under the bonds within 21 days. Assuming such amount is not paid a winding-up petition may then be lodged – whilst unlikely that the issuer will actually be wound up it is a useful tactic to apply pressure on the issuer often leading to a restructuring of the bonds or a buy-back by the issuer. The key in this situation is to find an experienced Indian law firm to assist with this process. In addition to the winding-up process in India, an aggressive noteholder may also consider bringing proceedings in England in addition to a winding-up in India. Although the volume of FCCB defaults decreased in 2013 compared to the previous year, there are a few big ones due for redemption in the second half of this year – so better to be prepared!
Then we have restructurings. You will sometimes see a “Scheme of Arrangement” being used to implement a restructuring. A Scheme of Arrangement is a court-approved, binding arrangement between creditors. It is often used where there are multiple types of creditors (not just bondholders). But it can be useful where there are only bondholder creditors to circumvent the requirement to obtain 100% noteholder consent generally required for amendments under a New York law governed indenture (a Scheme would typically require approval by a majority of – but not all – bondholders). In our experience, these can be tricky to navigate from the Trustee’s point of view (particularly in view of Trustee’s fees and indemnity arrangements) – consider for example the role of the Trustee in the voting process (ideally the Court should direct the Trustee not to vote). Is the Trustee protected in other jurisdictions other than that of the jurisdiction of the Scheme – for example, if the Scheme is under Singapore law and the Notes are governed by New York law and there are US noteholders, could the Trustee have potential liability in the US? In such a situation there are often ways for the Trustee to protect itself. The Trustee will also need to ensure that all Noteholders have the opportunity to vote in the Scheme and that none are disenfranchised. These and other issues are critical to be aware of – the next Scheme may be right around the corner.
Winds of change
FCCBs and depository receipts rules are administered by the government of India (the Government of India). The Issue Of Foreign Currency Convertible Bonds and Ordinary Shares (through the depository receipt mechanism) Scheme, 1993, has undergone several piecemeal amendments to meet the emerging needs of the economy. Particularly, in view of the new Companies Act in India (the Companies Act), the Government of India is now looking into a comprehensive review of the FCCB rules. Therefore, along with the ongoing restructuring of numerous historic transactions, market participants are also keeping a close watch on the regulatory developments and the impact that such regulations will have on legal documentation, transaction structures and issuers.
Whilst there are positive signs for greater international investor confidence in the Indian capital markets, as witnessed from the recent increase in international transactions, there may be further opportunities for investors and borrowers (particularly in view of the Reserve Bank of India’s (RBI’s) permissions to refinance FCCBs (subject to certain criteria) through external commercial borrowings (ECBs) and debt capital market transactions). International investors may have a greater role to play in 2014 with a flurry of transactions expected to hit the international debt capital markets this year.