The mis-selling menace

Sebi order on AT-1 bonds is in the right direction

The Securities and Exchange Board of India (Sebi) in an order has imposed a fine of Rs 25 crore on YES Bank for mis-selling additional tier-1 (AT-1) bonds to individual investors, which has the potential to set a new, healthier trend. In addition to a severe indictment of the bank, Sebi has penalised three senior bank executives who are being held responsible for misleading retail investors. The bank had raised Rs 8,800 crore from this issue of high-risk instruments. The entire amount was written off by the Reserve Bank of India (RBI) when YES Bank was forced to restructure. The bank has said it would appeal the judgment in a regulatory filing. The fine itself is a slap on the wrist, and it cannot compensate the 1,300-odd retail investors who suffered huge capital losses. However, the Sebi order is strongly worded and it could be a template for further regulatory action designed to curb mis-selling.

The regulator has characterised the marketing of these bonds as a “devious scheme to dump the AT-1 bonds on their hapless customers”. YES Bank’s marketing team misrepresented the bonds as a “super fixed deposit” and sold them as being “as safe as an FD”. The order states the bank’s senior executives deliberately targeted individuals and the marketing team did not conduct the risk profiling of individual clients, especially of senior citizens above 70. The lot size of the AT-1 bonds was also substantially reduced to ensure these could be sold to retail. The term sheet wasn’t shared with all customers and no explicit confirmation was taken on their understanding of the products’ features and associated risks. Of the 1,346 individual investors who invested in these bonds, 1,311 were existing customers of YES Bank. Some of these customers even prematurely encashed FDs in order to buy the bonds.

As subsequent events have proved, AT-1 bonds are difficult to understand even for sophisticated institutional investors. Mutual funds have lost money on AT-1 bonds, and they have not been able to value such bonds realistically. These bonds offer higher yields but they are unsecured and have a perpetual tenure, which means the issuer is not obliged to pay interest or ever redeem the principal. They can even be written off with 100 per cent capital loss as has been seen. In addition, the issuer has a call option, which means that it gets periodic chances to redeem. This further complicates valuation. The mutual funds were assuming tenures of five and 10 years and, hence, overstating the net present value of such bonds. Sebi has now released a phased scheme for valuing these instruments realistically, assuming the tenure is 100 years.

India’s financial sector has been characterised by perennial mis-selling, which usually targets less savvy retail investors. In the equity and bond markets, there have been public issues made by promoters with shady financials. In the insurance sphere, there have been multiple issues with opaque structures and a complex fine print of unit-linked insurance plans and other insurance products. The risks are always understated when it comes to selling complex instruments to individual customers, who are incapable of deciphering the fine print. Financial regulators like Sebi, the RBI, and the Insurance Regulatory and Development Authority of India have all struggled to curb this often blatant practice of mis-selling. It may be hoped that the Sebi action in this instance, including the punishment of responsible individuals, will help set a new trend of greater transparency, and better disclosure of risks.