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The Securities and Exchange Board of India (Sebi) is trying to find middle ground on valuing so-called perpetual bonds in a bid to assuage the concerns raised by the finance ministry and mutual fund (MF) houses, said people in the know.
The regulator is not in favour of withdrawing the proposed rules because it is of the view that tighter norms for valuing these bonds are required to protect MF investors. However, Sebi could tweak various clauses in the circular ahead of the implementation date of April 1, 2021.
Among the alternatives being discussed are reducing the maturity tenure from 100 years; narrowing the investment ceiling for certain MF schemes; applying the 100-year rule to only below A-rated paper; and extending the grandfathering clause to valuation norms as well.
Deferring the implementation of the new valuation methodology from April 1 to October 1 or even to April 2022 for smoother implementation is also being discussed, said people privy to the development. Sebi is considering the alternatives with credit-rating agencies, fund houses, and ministry officials, they added.
“The ministry’s request cannot be acceded to because reversing the rule would be an anti-investor move. However, we are evaluating that specific clause in the circular and will see if we can do some fine-tuning to it,” said a regulatory official privy to the discussion.
On March 10, Sebi issued a circular capping MF exposure to bonds such as additional tier-I (AT1) and tier II bonds, which are mainly issued by banks. Sebi further said the maturity of all perpetual bonds should be 100 years from the date the bond was issued.
Sebi’s move followed the write-down of AT1 instruments issued by YES Bank. It impacted MF investors. Soon after Sebi’s circular, the ministry shot off a letter saying that the valuation norms were disruptive and could lead to higher borrowing cost at a time when economic recovery is nascent.
The proposed 100-year valuation norm will lead to higher borrowing costs for issuers. Typically, the longer the maturity, the higher is the yield for the debt instrument. Currently, MFs value perpetual bonds based on the immediate call date — the date when an issuer offers to buy back the bonds.
Industry sources said just as Sebi had provided grandfathering benefits on capping exposure, the same can be extended for valuation norms. By doing so, the 100-year rule will apply only to incremental investments, while existing exposure valuation can continue according to existing practice.
A source said Sebi had objected to the high exposure of debt MF schemes in categories such as short-duration, medium-duration and banking and public sector debt funds.
“These schemes’ investment in perpetual bonds goes against their philosophy of investing in shorter-tenure bonds,” said the chief executive officer of a fund house. Another official said one proposal was to continue with the existing valuation methodology for papers above the ‘A’ rating and enacting a stricter methodology for below ‘A’ rated papers.
According to an estimate by Nomura, the system level AT-1 and Tier II bonds by banks in general is Rs 3.5 trillion. The bulk of this, at nearly Rs 2.4 trillion, is by state-owned banks. “These are risky instruments and hence the regulator has introduced caps on such investments. Another key issue is the valuation, because with the recent move there could be sell-offs and lower appetite for such papers,” said Karthik Srinivasan, vice president and sector head (financial sector ratings), ICRA.
