Finance ministry asks Sebi to revoke 100-year maturity rule on AT1 bonds

On Wednesday, the market regulator issued curbs on mutual fund (MF) investment in debt instruments with special features such as additional tier I (AT1) bonds
The finance ministry has written to the Securities and Exchange Board of India (Sebi), requesting it to withdraw a rule that fixes the tenor or maturity of all perpetual bonds at 100 years.

The letter states the clause on valuation is disruptive in nature and could lead to higher borrowing cost for companies at a time when economic recovery is nascent.

“Considering the capital needs of banks … and the need to source the same from the capital markets, it is requested that the revised valuation norms to treat all perpetual bonds as 100 year tenor be withdrawn,” said the letter.

On Wednesday, the market regulator issued curbs on mutual fund (MF) investment in debt instruments with special features such as additional tier I (AT1) bonds.

In a circular, Sebi had said that no MF would own more than 10 per cent of AT1 bonds issued by a single issuer.

Further, at the scheme level, the exposure to such instruments will be less than 10 per cent of the assets and less than 5 per cent towards a single issuer.

However, the contentious part of the circular was that the maturity of perpetual bonds will be treated as 100 years from the date of issuance of the bond for valuation. Currently, mutual funds value perpetual bonds as if they mature on their call date, which is the date when issuers might call back bonds and repay their investors. Participants in the MF industry believe that changes in valuation will lead to higher yields, causing losses to investors and outflows from debt schemes.

“AT1 bonds were valued hitherto on the basis of a short-term instrument of a similar tenor G-Sec. They will now be valued as 100-year bonds, for which no benchmark exists. Mark-to-market (MTM) losses will be very high, effectively reducing them (the bond value) to near zero,” said the finance ministry’s letter.

MFs are one of the largest investors in perpetual debt instruments and hold more than Rs 35,000 crore of outstanding AT1 issuances of about Rs 90,000 crore.

Perpetual bonds are a fixed-income security with no maturity date. These bonds are redeemable when the issuer wants. A regular coupon, which is typically higher than other debt instruments like corporate bonds or debentures, is paid on these bonds by issuers, which are mostly banks.

One of the major concerns of the finance ministry is that the market regulator’s new norms would increase public sector banks’ (PSBs’) dependence on the government for capital infusion at a time when lenders are being pushed to raise equity from the market.

“This financial year, the government has set aside Rs 20,000 crore for infusion into PSBs, and the same amount has been allocated for the next financial year, when the expectation of government infusing capital into banks was higher, anticipating Covid-related stress. This was in line with the government’s objective to push public sector lenders to raise capital from the market for supporting credit growth, and meeting regulatory requirements,” said an official from the finance ministry.

The ministry’s letter states that the instruction to reduce the concentration risk of such bonds in MF portfolios could be retained. Senior officials in the MF industry say while the finance ministry and regulators communicate regularly, this is one of the very few instances in many years where an issue between the two has come out into the open.

The Association of Mutual Funds in India (Amfi), which had made a representation to review valuation norms on Thursday, is supporting Sebi’s objective of fair valuation.

“Market-determined price is the best price to arrive at a valuation, which is fair to investors who are subscribing, redeeming or staying invested in a mutual fund scheme. AMFI under guidance from Sebi has worked over the years to create a robust valuation process,” said Amfi’s press release on Friday.

The mutual fund trade body is talking to Sebi to further smoothen the implementation of this circular.

However, several senior industry officials say the norms regarding valuation were not discussed in any of the previous meetings between Sebi and the MF industry.

“It’s not right to openly criticise the regulator and we hope some solution will be announced soon. Earlier also it had come out with solutions when the MF industry was facing crises,” said a top fund official.

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