India Inc ‘puts’ its way around ECB norms

ET – 31/07/2007

Offers Innovative Options To Raise Money From Foreign Investors

Sugata Ghosh & Rajesh Unnikrishnan MUMBAI

BEYOND the radar of the government and regulators, several Indian companies are
offering ’put options’ to foreign investors for raising money. This is a financial
innovation resorted to by corporates to bring in foreign loans masquerading as
equity. The option is used to sell securities to international investors who, in turn, are
promised an assured return and an easy exit.
The new financial structure is aimed at overcoming the recent clampdown on
’partly and optionally’ convertible debentures and preference shares. A few months
ago, the government said money brought in by selling these instruments overseas is
not foreign direct investment (FDI). Instead, such money should be identified as
foreign loans (or external commercial borrowings) where regulations are more
stringent than FDI in terms of end-use restrictions.
The restriction, which derailed fund-raising plans of many companies, particularly
real estate firms, drove the market towards financial innovation. Indian companies
are now issuing compulsory convertible debentures (CCDs) to foreign funds and also
agreeing to buy back the securities after two to three years at a price fixed today.
This is the put option that is tagged with the CCDs. For instance, a local property
firm raising $30 million by issuing CCDs, will give an undertaking that it will buy back
the securities after two years for $33 million.
According to market estimates, more than $750 million has been raised through
this route in the past two months. What’s interesting is that such CCDs (unlike the
partly-convertible instruments) are shown as FDI, even though the underlying
structure is no different from a pure loan. More so, because issuers are also giving a
fixed interest return (just in case of loans) to foreign investors.
But, there’s nothing that violates the regulation, at least in letter.

GREEN CHANNEL

• Cos issue compulsory convertible debentures to foreign funds and agree to buy
back securities after 2-3 years at a price fixed today

• Such CCDs are shown as FDI, even though the underlying structure is no different
from a pure loan

• This allows cos to overcome restrictions on partly and optionally convertible

debentures & preference shares

Realty cos take to issuing CCDs; foreign investors also buy shares

SAYS Punit Shah, who heads the financial Services tax practice of PwC: “As per
FDI/FEMA Regulations, CCDs qualify as FDI and, therefore, are permitted to be
issued without any approvals in most cases. Because of the regulatory flexibility and
tax efficiency, these instruments have become popular of late.”
Real estate firms, which are allowed ECBs only in large projects, have been
resorting to CCD issuances as an easier funding option. Confirming the development,
chairman of the property consultant Knight Frank India Pranay Vakil said: “CCDs are
out of the external commercial borrowing norms of the government and are
becoming popular in the real estate sector.”
In fact, the funding is more advantageous than ECBs. Indian issuers not only
deduct the interest outgo to lower the taxable income, there’s also no cap on the
interest they can offer to foreign investors. One of the aggressive investors in CCDs
is German bank Hypo, which recently concluded deals worth Rs 600 crore in
Bangalore.
Significantly, the foreign investor subscribing to CCDs also invests some money in
shares of Indian companies. If it commits $30 million investment, about 10% will go
into pure shares and the balance in CCDs. The equity investment is primarily to
retain some hold in the Indian company. This is significant since the CCDs are not
backed by any collateral.
Current regulations specify that when a local firm buys back the securities from a
foreigner, the pricing has to be in line with RBI norms. But CCD issuers feel this is no
big deal since it simply involves a valuation of the company by a chartered
accountant and investment banker.
According to Ambar Maheshwari, directorinvestment advisory of the international
property consultant DTZ Debenham Tie Leung: “A CCD is a debt instrument but looks
like equity. The product has been well received in the real estate sector. Deals are
taking place by using the new instrument.”