Finance Ministry asks Sebi to withdraw circular on AT1 bonds: Report

Panic redemption by mutual funds would impact the overall corporate bond market as MFs may resort to selling other bonds to raise liquidity in debt schemes, says the memorandum

The Department of Financial Services (DFS) has issued a memorandum to Sebi Chairman Ajay Tyagi asking him to withdraw a rule treating AT1 bonds (perpetuals) as having 100-year maturity, said multiple news reports on Friday. The memorandum was sent on Thursday, said the reports.

"Considering the capital needs of banks going forward and the need to source the same from the capital markets, it is requested that the revised capital norms to treat all perpetual bonds as 100-year tenor be withdrawn. The clause on valuation is disruptive in nature. Instructions that reduce concentration risks on such instruments in MF portfolio can be retailed as MF have adequate headroom even with 10% ceiling," the Finance Ministry note told the market regulator, reported Hindu Business Line.

Considering the capital needs of banks going forward and the need to source the same from the capital markets, the department requested Sebi to withdraw the revised valuation norms to treat all perpetual bonds as 100-year tenor.

"This can also affect capital raising by PSU banks, forcing them to rely more on the government for capital. Over the long run, for all banks, not just PSUs, more equity dilution will take place (due to Sebi circular). This will lead to further depressed valuations," the FinMin letter further said. 

The Sebi circular had generated significant apprehension in the mutual fund industry that losses would result from a consequential revaluation of such bonds.

"Panic redemption by mutual funds would impact the overall corporate bond market as MFs may resort to selling other bonds to raise liquidity in debt schemes. This could lead to higher borrowing cost for corporates at a time when the economic recovery is still nascent," the letter said.

AT-1 bonds were valued hitherto on the basis of a short-term instrument of similar G-Sec. They will now be valued as 100-year bonds for which no benchmark exists, it said.

"Mark to Market (MTM) loss will be very high, effectively reducing them to near zero," said the memorandum dated March 11.

Putting in place restrictions on the exposure of mutual funds to debt instruments with special features, regulator Sebi on Wednesday said that a mutual fund under all its schemes will not be permitted to own more than 10 per cent of such instruments issued by a single issuer.

Sebi said that the maturity of all perpetual bonds should be treated as 100 years from the date of issuance of the bond for the purpose of valuation.

In addition, Sebi said that close ended debt schemes would not invest in perpetual bonds.

This new framework is slated to come into effect from April 1.

Last year, several MFs were caught on the wrong foot over their investments in Yes Bank’s AT1 bonds, which were written down before equity following the RBI’s rescue plan for the lender.

According to data, at the end of January 2021 nearly Rs 37,000 crore was invested by MFs in perpetual bonds.

Perpetual bonds are a fixed income security with no maturity date. These bonds are not redeemable by the issuer. A regular coupon, which is typically higher than other debt instruments, is paid on these bonds by the issuer, who are mostly banks.