INSIGHT

Investing via convertible debt instruments in Vietnam

By Linh Bui, Ngoc Anh Tran, Ngoc Nguyen
Funds Private Equity Project Finance Vietnam

In brief 10 min read

COVID-19 and its impact on the global economy present significant challenges to investors in making new investments.

In addition to having to be more rigorous in their investment assessment and decisions, investors must now look beyond traditional equity investment for structures that could provide them with more flexibility in a volatile market, such as convertible debt instruments. A hybrid debt with a conversion option may provide investors with a higher chance to recover their investment in a downside situation, while giving them an option to convert into equity once the economy is back on track.

Convertible loan (CL) and convertible bond (CB) have been the two convertible instruments most commonly used by foreign investors in Vietnam.

In this Insight, we look at the pros and cons of convertible debt instruments1 compared to traditional equity investment, the availability of these instruments to foreign investors and a comparison between CL and CB.

Why convertible debt instruments?

Compared to traditional equity investment, convertible debt instruments have the following key advantages:

  • Higher chance of investment recovery: in a volatile market, convertible debt instruments provide a better chance to recover the investment, since debt generally ranks higher than equity in the case of liquidation or bankruptcy. From the legal perspective, debt repayment can be made directly to investors (as lenders/bondholders) when repayment events are triggered, as opposed to a lengthy redemption process for equity return which is subject to various statutory conditions (such as limits on the amount of redeemed shares and the redemption price, and the requirement for solvency after redemption).
  • Dealing with foreign investment restrictions: some forms of convertible debt instruments provide an interim solution to deal with (i) foreign ownership limits applicable to foreign equity investment in certain sectors; and (ii) conditions applicable to a 'foreign invested company', such as trading license in the retail sector (by keeping the target company's status as a Vietnamese company). However, in the long run, unless it is expected with a level of certainty that the relevant restrictions will be lifted, convertible debt instruments may not be a suitable option as the investors may not be able to convert the debt into equity due to these restrictions.
  • Foreign exchange risk mitigation: while all equity investments must be made in VND, some forms of convertible debt instruments (eg foreign convertible loans) can be denominated in a foreign currency. Given the depreciation of the VND and the lack of adequate forex hedging methods in the Vietnamese market, these convertible debt instruments provide an option to mitigate foreign exchange risks for the investors.

On the other hand, the choice of convertible debt instruments needs to factor in the following issues:

  • Lack of statutory shareholders' rights: prior to the conversion of debt into equity, investors do not have any direct statutory shareholder rights in the target company (eg voting, dividend and information rights). Therefore, investors will have to rely on contractual agreements with the target company and its shareholders to exercise their quasi-shareholder rights under these instruments.
  • Complicated conversion process: Vietnamese law only provides a statutory conversion process for CBs, but not for any other types of convertible instruments. In practice, at the time of conversion of any convertible debt instruments (including CBs), foreign investors still need to go through some or all steps of the standard share issuance process in order to convert into equity. These steps may include corporate approval of the target company, regulatory approval from the licensing authority, or, in case of CLs, registration with the State Bank of Vietnam (SBV) for repayment of CL by way of shares issuance. Therefore, a certain level of cooperation from the target company will be required to effect the conversion.
  • Limits on interest / return: convertible debt instrument structure may not be suitable for investments with high returns which may exceed the statutory cap on interest rate of 20% per annum prescribed by law.
    Furthermore, this structure may also create complications for investments with frequent dividend payments because dividend-linked interest/coupon rate is not recognised by law. Therefore, in practice, interest/coupon rate of convertible debt instruments is often fixed at signing and has to be adjusted each time a dividend is declared and paid. This will create an extra administrative burden for the parties, particularly where the instrument is structured as medium- or long-term foreign loan which requires re-registration of interest rate with the SBV.

What convertible debt instruments are available in Vietnam?

While convertible debt instruments in the international markets can be diversified, CB and CL are most commonly used in the Vietnamese market. Exchangeable loans/bonds (which can be exchanged into equity of a company other than the borrower/bond issuer) can be found in some deals, but are not as common.

  • Convertible Bond: at present, only CB is clearly regulated by law and, therefore, has a direct statutory conversion process. A CB can be denominated in either VND or a foreign currency. However, in practice, foreign currency-denominated CB is not often used, except for large institutions or commercial banks, as it is required to be issued offshore in a foreign market (and not domestically in Vietnam) and, therefore, involves various complicated conditions and regulatory approvals from both the Vietnamese and foreign authorities.
  • Convertible Loan: unlike CB, there is no specific legal framework for CLs in Vietnam. In practice, CLs are normally structured as a foreign loan subject to the general regulations on foreign loans into Vietnam, with additional contractual agreements on convertibility and management rights. Therefore, the conversion process of CL can be complicated, as discussed above.
  • Exchangeable Bond/Loan: similar to CL, there is no specific legal framework regulating exchangeable bonds/loans. The use and enforcement of exchangeable bond/loan mainly rely on the parties' contractual agreements. In addition, the exchange process could be more complicated than the conversion of CLs as this process will involve the holder/issuer of the exchange shares, and a tripartite set-off mechanism may need to be implemented.

Convertible Bond vs Convertible Loan

Depending on the specific circumstance of the transaction and the key objectives of the investor, one type of convertible instrument may be more suitable than the other. The table below compares the key features of CB and CL so that investors can evaluate the most suitable structure.

Denomination
Convertible Bond

CB can be denominated in either VND or a foreign currency.

In practice, issuance of foreign-currency-denominated CB is complicated and not common.
Convertible Loan

CL can only be denominated in a foreign currency, except for limited cases in which it can be denominated in VND.

In practice VND-denominated CL is not common.
Eligible issuers
Convertible Bond

Only joint stock companies which have been operating for at least one year can issue CBs.

Convertible Loan

Any type of company can issue CLs and there is no minimum operation duration requirement.

Eligible subscribers
Convertible Bond

From 1 January 20212, only the following eligible investors can subscribe for a CB:

  • Professional Securities Investors, defined by law as investors who have financial capacity or expertise in securities, including banks, finance/securities companies, investment funds, international financial institutions, listed companies or companies having charter capital of more than VND100 billion (c. US$4.3 million) etc; and
  • Strategic Investors, defined by law as investors selected by the General Meeting of Shareholders of the issuer based on the investors' financial and technical capacity and who commit to cooperate with the issuer for at least 3 years.
Convertible Loan

Lenders must be an offshore foreign organization. It is not necessary for the foreign lender to be a licensed credit institution in its home country.

Permissible use purpose
Convertible Bond

Bond proceeds can be used for broader purposes, including:

  • restructuring both domestic and foreign loans;
  • implementing investment projects of the issuer; and
  • increasing the operational capital scale of the issuer.
Convertible Loan

Loan proceeds can only be used for limited purposes, including:

  • restructuring foreign loans only, and not domestic loans;
  • implementing business and production plans or investment projects (except for residential housing projects) of the borrower or its direct investee companies.

In addition, a short-term foreign loan (ie having term of 12 months or less) can only be used for working capital purposes but not for long-term purposes (eg for a construction project).

Borrowing limit
Convertible Bond
  • The total amount of all outstanding bonds of a company must not exceed five times its equity capital (note that this cap does not apply to credit institutions).
  • For foreign-currency-denominated CBs, the issuance limit for each issue must be approved by the SBV.
Convertible Loan
  • The total outstanding loans borrowed for an investment project must not exceed the borrowing limit set out in the investment registration certificate of such project or, if there is no investment registration certificate, the approved loan capital for such project; and
There is an overall limit on total foreign loans in Vietnam issued by the Prime Minister each year, which is currently set at c. US$5.5 billion per annum.
Key conditions for issuance
Convertible Bond

The key conditions for CB issuance by both public and private companies include:

  • the issuer must have an audited financial statement for the preceding year and must satisfy any applicable prudential ratios;
  • the issuer must have made full payment of any bond principal and interest falling due in the three years preceding the date of issuance;
  • each issuance tranche must be completed within 90 days from the date the issuance is announced;
  • bonds issued in the same issuance tranche must have the same terms and conditions; and
  • there must be a cooling-off period of at least six months between two issuance tranches of CBs.
Convertible Loan

No special conditions apply to CLs.

CLs must comply with the general requirements on foreign loans (eg loan currency, borrowing limit, registration requirement as discussed in this table).

Key regulatory approvals
Convertible Bond
  • No pre-approval required for issuance of CB by a private company.
  • Approval from the State Securities Commission is required for issuance of CB by a public/listed company.
  • Pre-notification (eg information on the issuer, CB terms and issuance plan) and post-issuance notification (eg information on issuance results and periodic report on the status of the issuer and CB repayment) are required to be submitted to the Hanoi Stock Exchange and such information will be made public by the Hanoi Stock Exchange.
Convertible Loan
  • No pre-approval required for short term CLs of 12 months or less.
  • Registration with the SBV prior to disbursement is required for long-term CLs having a term of more than 12 months.
  • No information on CLs will be made public by the SBV.
Transferability
Convertible Bond

CB can be transferred to both foreign and Vietnamese investors.

However, the transfer is subject to a statutory lock-up period of one year from the date of CB issuance, except in certain specified cases (eg a transfer to or between Professional Securities Investors).

In addition, from 1 January 20213,

  • CB issued by a public company to a Strategic Investor can only be transferred after the lock-up period of at least three years from the date of issuance4.
  • CB issued by a private company can only be transferred to a Strategic Investor or a Professional Security Investor.
Convertible Loan

CLs can only be transferred to another foreign investor (as foreign lender) and not a Vietnamese investor.

There is no lock-up period and no specific requirement in respect of the transferee.

The transfer must be registered with the SBV.

Conclusion

As the Vietnamese market continues to develop, foreign investors will look to adopt more complex and sophisticated investment structures to achieve their investment objectives and to secure protection in a downside situation, particularly amidst the COVID-19 pandemic.

However, the Vietnamese legal framework has not been keeping up with such a fast pace of market development and, in certain instances, does not provide for specific regulations on such investment structures, including convertible debt instruments. As the result, foreign investors will need to take into account various legal issues when considering the most appropriate structure for their investment in Vietnam and may have to accept a certain level of uncertainty in enforcement of their rights given the lack of statutory process and regulations. it is critical, then, to ensure the transaction documents provide for sufficient protection of the investors' rights and workable enforcement mechanics.

Footnotes

  1. This Insight focuses on privately issued convertible debt instruments and does not cover public issuance of these instruments.

  2. The effective date of the new Law on Securities and new Law on Enterprises 2019.

  3. The effective date of the new Law on Securities and new Law on Enterprises 2019.

  4. It is unclear whether after the lock-up period, CBs of a public company can be transferred to any investor or only Strategic Investors and Professional Security Investors like CBs of a private company. This is pending clarification in the implementing regulations to be issued.