What Are Foreign Currency Convertible Bonds (FCCB)?

What Exactly Are FCCBs?

FCCBs are bonds issued by an Indian company in a foreign currency, typically US dollars, euros, or any other internationally accepted currency. They include the option for the bondholder to convert their bonds into equity shares of the company at a pre-determined price after a certain period. In other words, they are a hybrid between a traditional bond and a stock option.

But why foreign currency? The answer is simple. A company issuing FCCBs in an international currency can easily capitalize on and expand into global markets. This allows them to access larger pools of capital and competitive interest rates against local borrowing alternatives.

Why Do Companies Use FCCBs?

Many companies today are opting for FCCBs, and they prefer it for a few reasons:

Affordable Way of Raising Funds

Due to the precious equity conversion option, interest rates on FCCBs are typically low compared to pure debt instruments.

Global Market Access

FCCBs provide firms with global market access to finance their operations. This becomes important in emergent markets where funding sources may be very expensive or limited.

Equity Conversion Option

When investors convert their bonds into shares, the company doesn't have to return the principal amount.

Why Are Investors Interested?

FCCBs are an attractive proposition for investors. They offer the predictability of fixed interest from a bond and the potential for even greater returns based on a company's equity performance. For example, if the stock price starts to rise and appreciate considerably, investors can convert their bonds to shares and receive their profits.

In addition, since FCCBs are issued in a stable foreign currency, investors are hedged against any fluctuation in the exchange rate in the company's local market that could impact the value of their returns.

RBI Requirements for FCCB

The Reserve Bank of India (RBI) sets guidelines for the issuance and investment in FCCBs to ensure regulatory compliance and safety of the investors:

• Issuers must comply with the Foreign Exchange Management Act (FEMA).
• FCCBs must be issued in accordance with the guidelines for external commercial borrowings (ECB).
• FCCBs can be issued only by Indian companies with an established track record.
• The maturity period must typically range between 5 to 7 years.
• RBI approval is required for any deviation from prescribed guidelines.

Tax on Foreign Currency Convertible Bonds

The issuance of FCCBs is regulated by specific taxes in India to the FCCB issuers as well as to the holders of the bonds:

• FCCBs interest income is also exigible to tax under the head ‘Income from Other Sources.’
• Bondholders are jointly and severally liable for tax on capital gains when switching from bonds to equity or selling FCCBs.
• Earnings from the sale of assets are further distinguished by whether an investor has held an asset for a short-term or long-term period.
• The LTCG tax is 10% (without indexation), and for STCG, the tax amount is 15%.

Wrapping Up

FCCBs are intelligent, flexible financial tools for companies looking to expand their fundraising globally. To investors, they offer a rare blend of safety and potential growth. Of course, they come with risks, but when managed well, FCCBs can be a win-win for everyone involved.