Foreign Currency Convertible Bond (FCCB) is one of the lucrative fund raising avenues for corporates. Being hybrid (features of both debt and equity) in nature the interest cost on such instruments is lower when compared to raising money via plain vanilla debt. Further, if the stock price is above the conversion price on the redemption date the instrument gets converted into equity. If not, the issuer has to repay the money back to the bondholders along with the redemption premium. And that's where the problem arises especially if the issuer is facing liquidity crunch.
In the recent past, many companies have been unable to redeem their FCCB debt due to the liquidity issues being faced by them. Rupee depreciation has made the matter even worse. In that case, the only recourse the bond holders have is to either restructure the debt and take a haircut or undertake arbitration proceedings against the company.
The problem with the second option is the timeline involved in court proceedings. Since, it could take ages to resolve the matter investors are a bit hesitant to opt for it. Also, since the FCCB debt is not backed by any collateral convincing the court becomes all the more difficult task.
However, in the recent past there have been cases where the FCCB debt holders have resorted to arbitration for non-payment. And they have been, surprisingly, successful in getting their payments when due. The current outcome is the benchmark that will shape the future demand of these convertibles. That's because if the FCCB debt holders do not get their payment on time they would be unwilling to lend. And this would mean that India Inc might lose a cheap source of liquidity in the future.
Right now, the market for these convertibles is not buoyant considering the current state of equity markets. But once the market condition improves (the probability of conversion into equity increases) issuers might flood the markets with new issues. This makes them an irresistible option in trending markets.
However, the future of these FCCBs depends upon how the companies are able to deal with the current crisis situation. Inability to service the debt now might shut the doors of cheap funding in future.