LIABILITY RISK MANAGEMENT BY INDIAN CORPORATES

1. LIABILITY RISK MANAGEMENT BY INDIAN CORPORATES BY Nirav Jain

2. Forms of ECBs/FCLs • Long Term Loan In Foreign Currencies • Foreign Currency Convertible Bonds (FCCB) • Foreign Currency Exchangeable Bonds (FCEB) • Buyer’s Credit • Supplier’s Credit

3. REVISED ECB FRAMEWORK TRACK- 1 Short term TRACK- 1 LongTerm INR denominated ECB TERM : ECB up to50 m USDmaturing on an average of 3yrs ECB above 50m USDmaturing up to 5yrs Celing Cost : ECB maturing on an average of 3yrs is 300 bps abovebenchmark and averagematurity above 5 yrs is 450bps over 6m libor P.A TERM : ECB maturing on an average of 10 yrs Celing Cost : Maximum celing cost is 500bps over the benchmark P.A remaining conditions are same as in TracK 1 TERM : Same as under Track 1 Celing Cost : All coats will be line with market conditions

4. Limits for Raising ECB * The above mentioned limits are via automatic use only

5. END USE PERMISSIONS • Import of Capital Goods or Sourcing locally • Executing new projects • Modernization / Expansion of existing units • Acquiring share of PSU at any stage of disinvestment process • Refinancing any trade credit for imported capital goods • Refinancing of existing maturity provided residual maturity is not reduced • Payment of capital goods already imported but not yet paid • For general corporate purpose (including for WC) provided ECB is raised from direct/indirect equity holder or of group companies with an average maturity of 5 yrs • Shipping & Airlines companies for import of vessel and aircrafts • Proceeds from ECB can be parked overseas with branch of Indian banks overseas

6. END USE RESTRICTIONS • Real estate activities • Investing in capital markets • Using the proceed for equity investment domestically • Lending to other entity without any objective • Purchase of land • Repayment of existing Rupee Loan

7. Conversion of ECB into Equities • Minimum maturity of FCEB should be 5 yrs • Issuance of FCEB requires prior approval of the RBI under the Approval Route for raising ECB. • Redemption is possible before maturity but it is not cash settled • An Indian company, which is not eligible to raise funds from the Indian securities are not be eligible to issue FCEB • Government (FIPB) approval for foreign equity participation has been obtained by the company

8. Commandments For Prudent Structuring of ECBs • Fair and Realistic Cash Flow Projection • Keep in Mind Benchmark Ratios • Negotiate for a better ‘SPREAD’ • Ensure No Hidden Cost • Understanding of Variable Elements of Borrowing Cost

9. Types of Risks • Fx risk on Principal. • Interest rate risk. • Fx risk on Interest. • Drawdown Risk.

10. Hedging Instrument • FRA – Libor risk is fixed • Interest Rate Swap – Libor risk is fixed • Coupon Only Swap (I Only) - FX Risk on interest + Libor risk is fixed. • Principal Only Swap (P Only) - FX Risk on Principal. • Cross Currency Swap (P+I) - FX Risk on Principal and interest + Libor risk is fixed. • Plain Vanilla Options • Structured Options

11. Forward Rate Agreement • A contractual agreement to exchange interest rate payment on a notional principal for a specified future date • A typical FRA quote looks like: 6 X 9 months 7.20% - 7.30% • Settlement takes place at the start date of FRA • At the start date the contract rate is compared with the benchmark • Buy FRA - pay fixed & receive benchmark rate • Sell FRA – pay benchmark rate & receive Fixed rate

12. Interest Rate Swaps (IRS) • An interest rate swap is a contractual agreement between two parties to exchange interest payments on a notional principal. • A simple example of XYZ limited who have borrowed 10M USD at variable interest rate(6M Libor + 300 bps) and interested to converted floating rate loan to fixed rate loan with IRS • XYZ Pays to lender 6M Libor + 3 % Receive from bank 6M Libor Pays to Bank 1.5 % All in rate for XYZ 4.5%

13. Principal Only Swaps • POS is exchange of principal in two different at a predetermined future date • POS in economic terms is similar to forward contract instrument • POS typically involve a periodic payment of swaps cost opposed to forward contract where payment and receipt of premium is done only at the settlement date • An exporter who have periodic USD receivable will prefer to opt for POS to protect his principal liability • In POS a corporate will switch USD principal liability to a Fixed INR liability

14. Options An call option gives the holder a right to buy an underlying of a specific strike price by paying premium • Plain Vanilla option • A standalone call option can be ATMF, ITM, OTM • Structured option • Call Spread(2 legs) Buy ATMF or ITM Call option (Premium paid) Sell OTM Call option (Premium received) • Seagull Buy ATMF or ITM Call option (Premium paid) Sell OTM Call option (Premium received) Sell OTM Put option (Premium received)

15. Cross Currency Swaps • CCS is a contract between two parties to exchange a set of interest and principal cash flows in two different currencies reduced cost • The objective of these arrangement is to convert foreign currency denominated loan in INR loan • It hedges both interest rate & exchange risk • For e.g. Company ABC has availed ECB of $ 100 million with interest cost of three months LIBOR +300. The prevailing spot rate of the dollar is Rs 65/-. Bank gives a consolidated interest rate of 9.85% for this arrangement. • In such arrangement ABC will pay interest on the notional amount of outstanding principal at a fixed interest of 9.85% • ABC will repay the identical amount of principal received by it in Indian rupee while taking the disbursement

16. Case-1 • Indian PSU raised a 12B JPY loan for a period of 15 year (draw down date was 10 Mar 2011) at an fixed Interest rate of 2.85% in JPY . This PSU want to convert its yen liability to USD. The entire yen liability both principal and interest is converted to USD on the draw down date. The arrangement was structured in such a way PSU will pay 6M libor + 2.33% to the bank & bank in turn will pay JPY interest to the lender. At the time of maturity after 15 years i.e. 15 march 2026 PSU will pay its USD component to the bank in lieu bank to pay the JPY component in japanes yen . Net Liability (principal amount) of this PSU stands for about USD 145.9 M.…

17. Case- -2 • Refinancing of USD 400M loan drawn on 22 Nov 2013 . Initial maturity of the loan was 5 years bullet repayment . Interest rate is paid semi- annually @ 6M libor + 1.47 % & p.a. The existing ECB loan was refinanced to avail advantage of lower interest rate. Residual maturity was 3 years i.e. till 3rd December 2018. The loan is refinanced at 6M libor + 0.60 % p.a. Outstanding principal liability stands the same of USD 400M .

18. Case – 3 • ROKI MINDA Loan Details are as follow USD : 4 ,000,000 M Start Date :18-Sep-12 End Date 31-Jul-18 Interest : 2.27% Other Details : Ammortised loan with repayment beginning from 30 April 15 • Entered in a cross currency swap • Full Hedge (P+I) Drawdown Hedge Rate 7.42% Current Market Hedge Rate 9.30%

19. Case - 4 Company Name: Kemwell Biopharma Industry: Pharma, Contract manufacturing Loans : ECB of 85 cr. INR Payable quarterly in next 3 years. FCNR B: 70 cr INR, payable half yearly. • Managing exposure: • They have taken ECB and FCNRB loan at the drawdown rate of 49.16 and 53.96 respectively. • Repayment is scheduled quarterly for ECB loan and amt is USD 6 lac and half yearly for FCNRB loan and amt. varies from USD 1.2 M to 1.5 M. • Repayment has started in July’15 and it will run until Oct ’18. • They take forward contract to cover at least half of the repayment and rest half either they buy from market or utilize their EEFC balance. • Originally, it was a Rupee loan converted into FCNR B to reduce Interest cost. Taken for working capital requirement and can roll over up to 5 years

20. Case-5 Client : Parksons Packaging Loan Amt : 2000000 Loan Structure : Repaid in 14 equal installments 21 months after the drawdown date Start Date 21-Mar-16 End Date 21-Mar-21 Hedging Alternatives Evaluated & Pricing :

21. Case - 6 Client -Bharti Airtel Assignment –Valuation Loan Description – Bhatri have issued a fixed rate bond , their treasury is expecting that libor is not going to rise and want to swap their fixed liability into floating liability Swap Arrangement – IRS swap in which Bharti will receive fixed interest and pay floating interest rate

22. Case - 7 • The Client has a habit of availing Buyer’s Credit on different rates for their import requirements. • The Client has a board approved policy which says that out of the total liability of all the loans, • They have to hedge at least 30% of the outstanding payments. • We manage it in such a way, we regularly do the mark to market of the buyer’s credit Details as per the attached file and work out the total cost of the loan. • If the total cost comes close to 6% on a MTM basis or threatens to move above 8% on the upper side decision is taken to hedge the payables. • This way, the client is prevented from speculating on the Exchange Rates and is made to take a decision when the cost reduction is achieved.