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SBP proposes amendments to FE rules to facilitate startups to raise convertible debts

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February 10, 2021 (MLN): The State Bank of Pakistan (SBP) has proposed amendments to the existing foreign exchange regulations regarding borrowing from abroad in an attempt to meet the specific needs of fintech and startup companies, keeping in view the issues they are facing in raising capital in the form of convertible debt from abroad under current regulations.

In a working paper titled “Raising of convertible debt from abroad by startup companies” placed on its website on Tuesday, SBP proposed changes in Chapter 19 of the Foreign Exchange Manual.

“A new type of loan may be introduced to meet the specific needs of startup companies keeping in view the issues they are facing in raising capital, in the form of convertible debt, from abroad under current regulations,” it said.

According to the SBP, during our discussions over the last one-year the representatives of Startups and Venture Capital (VC) firms have highlighted that current foreign exchange regulations governing borrowing from abroad, do not meet the requirements of Fintech and Startup companies. As per these stakeholders, foreign investors, at times, intend to invest in their companies in the form of convertible debt (i.e. loan convertible into equity) instead of directly investing as equity.

It has also been observed that foreign investors including Venture Capital/Private Equity funds and angel investors usually take interest to invest in startups; however, keeping in view the financial risks associated with startup companies, at times they prefer to provide funds initially as loan and subsequently decide about participation in the equity of the company.

Startup firms also face funding issues due to the unavailability of collateral/security, which is a prerequisite by most lenders. However, VC firms and angel investors then try to cover the risk through alternate means. Thus, sometimes foreign investors charge a premium for taking such risk, in the form of a high return on loan amount or discount at the time of issuance of shares, SBP noted.

Thus, the SBP has proposed some amendments in the foreign exchange manual to facilitate the Startup Companies.

As per proposed changes in Chapter 19 of the Foreign Exchange Manual, a company may raise funds from abroad in the form of convertible debt i.e. the lender shall have the option to convert the loan into the equity of the borrowing company, subject to the following terms and conditions.

The borrowing company is incorporated as a private limited/public unlisted company under the Companies Act, 2017 (erstwhile Companies Ordinance 1984) for not more than 7 years, provided that such entity is not formed by splitting up, or reconstruction of a business already in existence.

The borrowing company has annual revenue below PKR 2 billion since its incorporation.

The borrowing company has equity (including retained earnings) below PKR 300 million as per the latest audited financials.

The requirement of long-term credit rating shall not applicable.

In addition to the eligible lender, funds can be raised from all those investors which are eligible for issuance of shares in terms of Para 6 of Chapter 20 of the Foreign Exchange Manual.

The maturity of such loans shall range from one (1) year to five (5) years. The loans may be rolled-over subject to the condition that its total tenor will not exceed 5 years, in any case.

The Borrowing Cost Ceiling excluding relevant benchmark rate will be 250 basis points (bps) for One (01) Year to three (03) Years and 350 bps above three (03) Years up to five (05) Years.

The borrowing cost ceiling includes spread over relevant benchmark rate, loan-related insurance premium, and other loan-related fees payable in foreign currency; except the commitment fee, cost & expenses, and fees payable in local currency.

As per the intended changes, funds borrowed can be credited in a foreign currency account opened and maintained in terms of para 9(ii), Chapter 6 of the Foreign Exchange Manual.

The principal can be repaid in bullet payment on maturity and no prepayments would be allowed.

The outstanding loan amount, including accrued profit/mark-up, can be converted into equity of the borrowing company on or before the maturity of the loan. The borrowing company may issue shares in favor of the lender, in accordance with para 6 and 7 of Chapter 20 of the Foreign Exchange Manual. However, the shares cannot be issued below the latest break-up value as determined by the external auditors included in category A of the State Bank’s approved list of Auditors.

The rupee liability of the loan (including accrued profit/mark-up) shall be determined by converting the FCY loan amount, outstanding as per last month-end or quarter-end (in a case where last month-end figures are not available) financial statement, into PKR by using the prevalent mark-to-market exchange rate (mid-rate) announced by State Bank of Pakistan.

The facility of forward cover shall not be available.

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Posted on: 2021-02-10T12:24:00+05:00

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