Investing via convertible debt instruments in Vietnam

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.

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.

Contact for further information

Linh Bui, Partner

Ho Chi Minh City

• +84 28 3822 1717
• Linh.bui@allens.com.au

Ngoc Anh Tran, Managing Associate

Ho Chi Minh City

• +84 28 3822 1717
• NgocAnh.Tran@allens.com.a