Even as the Department of Financial Services has asked SEBI to withdraw a circular on Additional Tier 1 (AT1) perpetual bonds citing risk to the mutual fund industry, the MF industry body -- AMFI has come out in support of the same SEBI circular. It is a peculiar situation now and the Finance Minister may have to intervene, sources told BusinessLine .
AMFI is a trade body that represents the MF industry, however DFS is a government department that has powers to issue directions to SEBI.
The DFS office memo has asked SEBI to withdraw a rule treating AT1 bonds (perpetuals) as having 100-year maturity. The DFS has termed the SEBI circular on perpetual bonds as ‘disruptive’ for the Mutual Funds (MF) industry but the AMFI has taken an opposing view.
“AMFI fully supports the need and spirit of the circular in capping exposure to perpetual bonds. Most of the MF schemes are well below the cap specified in the circular. In few of the schemes, where perpetual bond exposure is higher than the SEBI prescribed cap, grandfathering is kindly permitted by SEBI to ensure that there is no unnecessary market disruption,” AMFI said in a note issued on Friday.
But the DFS has said that MFs are the largest investors in perpetual bonds and currently hold more than ₹35,000 crore worth of AT1 bond issuances of about ₹90,000 crore.
According to DFS, with the new limits that SEBI circular brings the ability of MFs to buy additional bank bonds would be constrained, which will lead to increase in coupon rates. Also, the DFS is not happy with clause on revaluation of clause of bonds in SEBI circular.
“The clause on valuation is disruptive in nature,” the DFS memo said.
SEBI had issued a circular on the AT1 bonds on March 10 and the rules were to be made effective from April 1. But according to DFS, the MFs were apprehensive with regard to the fact that a revaluation of such bonds would lead to huge losses.
As of now, the bonds are valued on the basis of a short-term instrument of similar tenor G-Sec (Government Security). But after SEBI circular these bonds will be valued at 100 year tenor for which no benchmark exists. The market-to-market loss will be very high effectively reducing them to zero.
"The abrupt drop in valuations can lead to large NAV swings as MFs sell such bonds in anticipation of redemptions causing debt market panic. 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 DFS memo said.
The DFS told SEBI that considering the capital needs of banks 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. Instructions that reduce concentration risks on such instruments in MF portfolios can be retained as MF has adequate headroom even with 10 per cent, the DFS memo to SEBI said.
Perpetual bonds or Additional Tier I Bonds are issued without any maturity date but are usually issued with call option(s) and qualify for Tier I capital. Banks have been majority issuers of Perpetual bonds.
But according to AMFI, the perpetual bond market is reasonably active with regular trades in large and higher rated issuances. Most trades in perpetual bonds happen on a yield to call basis. This is based on the established market convention, locally as well as globally, that the issuer will exercise the call option on the due date.
“SEBI had engaged with AMFI on treatment of perpetual bonds as it is a hybrid instrument and carries a differentiated risk reward ratio than a normal debt instrument. Treatment of perpetual bonds was discussed in Mutual Fund Advisory Committee (MFAC) where several members of AMFI participated. AMFI also supports 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 note issued on Friday in support of SEBI said.
AMFI further said that under guidance from SEBI, it has worked over the years to create a robust valuation process. Two Independent agencies administer the process to ensure Industry wide fair and common valuation for the debt portfolio across MFs.
“Perpetual bond market sees active participation from various players viz. Banks, Corporates, Mutual Funds and Individual Investors. Only in the event of lack of traded prices, the question arises as to whether the bond should be valued to call or to maturity. Given a reasonably active market with regular trades, the issue is narrower than it appears,” AMFI has argued in favour of SEBI’s circular that the DFS is opposing.
AMFI further said that it was in discussion with SEBI to further ease the process of implementation of its circular.
“AMFI recognises that the risk profile of such instruments is higher than regular bonds. The Regulator has always been concerned about any potential mispricing of risk in any kind of instrument. AMFI recognises that mispricing of risk is not in the best interest of its investors and is therefore committed to working with SEBI to ensure fair valuation of its investments. It’s also fully committed to SEBI’s objectives of Investor Protection and Development of Markets in India with highest level of transparency," AMFI said.
"While in the short-term prices can be influenced by many factors, in the long-term fundamentals will prevail. Past experience does suggest that Investors have benefited from ignoring short term volatility,” AMFI said.