Faced with acute redemption pressures on foreign currency convertible bonds (FCCBs) issued between 2005 and 2008, a clutch of Indian corporates is allegedly resorting to ways less than honest to escape defaults. Some hedge funds have complained to the banking and markets regulators about issuers hammering bond prices, and then cornering them in the secondary market through various nominees, sources said.
Once they get control over the majority of these FCCBs, issuing companies can then restructure the terms of these bonds, such as the conversion price and redemption premium, in a manner that suits their plans. But the practice would indeed undermine minority bondholders? interests, these hedge fund managers told the regulators. Worse, since India?s bankruptcy system is far from perfect, bondholders could virtually be left with no recourse if the companies choose to shortchange the bondholders.
A company can pass a resolution for changes in FCCB terms with the approval of a majority of bondholders, which can be 67% or 75%, depending on the terms of bond issues.
Two hedge fund managers, one based in Singapore and another in Hong Kong, told FE that corporate India could still be staring at the ?mother of all defaults?on their FCCB issuance, and matters could get worse if bondholders and issuers get dragged into long-drawn legal battles. Some companies, by the way, are working with bondholders to renegotiate the bond terms.
Indian companies raised over R70,000 crore via FCCBs during the bull run between 2005-06 and 2007-08. As much as R43,000 crore worth of FCCBs will mature by March 2013.
The Reserve Bank of India and the finance ministry have highlighted the redemption risks relating to these bonds, especially since stock prices of most issuers have tumbled much below their conversion prices.
Rating agency Crisil said in a May report that FCCBs worth Rs 22,000-24000 crore may not get converted into equity shares.
Only last week, a Singapore-based hedge fund 3 Degrees Asset Management Pte complained to Sebi alleging a foul play by FCCB issuer Tamil Nadu-based Karur KCP Packagings, which restructured terms of its $10 million FCCBs after securing majority bondholders? approval. The fund owns 11% of the packaging company?s bonds. Karur KCP has maintained that the restructuring was done after securing all approvals required under the law, and keeping the enterprise interests in mind.
?We are having a case with a packaging company Karur KCP Packagings, where we are minority bondholders. We at 3 Degrees Asset Management have reasons to believe that the company covertly bought back its bonds back from the secondary market through various nominees. These nominees then voted against other minority bondholders to change the terms of the FCCBs unfavorably,?said Tanuj Khosla, Research Analyst at 3 Degrees Asset Management.
The foreign fund earlier wrote to the Reserve Bank of India to recover its investments, and has now moved the Securities and Exchange Board of India. ?We have filed an official complaint with the RBI (some months ago). They (RBI) have told us to go to Sebi, and we have sent our complaint to the market regulator last week,? said Khosla.
A leading supplier of cement bags, Karur KCP raised funds through FCCBs in April 2006 bearing 2% interest coupon at a conversion price of Rs 75 a share. Closer to the maturity, the company extended the tenure of FCCBs by another 5 years while coupon was cut to zero. The new conversion price was reset at Rs 300.
These changes were approved by majority bondholders as well as the RBI but 3 Degrees Asset Management alleged irregularities in this scheme.
V Venkatesan, company secretary & compliance officer, Karur KCP, said: ?Twice we held our AGM to restructure terms of FCCBs. Everything was done in a proper manner, and we went ahead only after the majority bondholders? approval and RBI?s permission.?
He said the decision to increase the tenure of bonds was taken to support expansion plans of the company and keeping the financial position in mind. The company is committed to return its dues as soon as it generates good profits, he added.
However, Khosla argued that Karur?s action subverted the spirit of law, and has the potential to adversely affect the FCCB market as investors lose confidence in companies.
?If a company is defaulting on debt, then one can understand. Corporate defaults are not a new phenomenon. But what Karur did subverts the spirit of law. And to top it all, the company was considering a dividend payout to shareholders at a recent board meeting,? he said.
A Delhi-based lawyer specialising in securities laws, who did not wished to be named, said some companies are driving down their FCCB prices, and then gaining a direct or indirect majority control by buying back the bonds. He also pointed out the poor protection that Indian laws offer to the investors.
Ajay Shah, senior economist at the National Institute of Public Finance and Policy, said Indian bankruptcy laws provide poor protection to all bondholders, and that the bondholders are mostly at the mercy of the issuer. But Shah noted that RBI and Sebi may not be able to do ?anything much? in case the defaults rise.
Industry analysts note that redemption problems could get compounded if the world economy goes into a recession. That would be double blow as issuers? stock prices would fall further while the cash flow position will weaken, severely affecting the debt-to-equity ratios of the companies concerned.
The RBI recently allowed companies to buyback FCCBs up to March 31, 2012 at increased discount rates, while the government liberalised the external commercial borrowings window to help companies refinance FCCBs. Industry-watchers, however, argue that buybacks would only postpone the problem, not resolve it.