FinMin sees red over SEBI move on AT-1 bonds tenor

A tussle appears to be brewing between the Finance Ministry’s Department of Financial Services (DFS) and market regulator SEBI on the treatment of Additional Tier-1 (AT-1) Bonds. The short-term instruments, which are also called perpetual bonds, are used by most banks to raise money to meet their capital adequacy ratio requirement.

On Wednesday, SEBI issued a circular changing the key valuation metrics of the bonds and said they should be treated as having a maturity tenor of 100 years. The new rules are to be effective from April 1. The very next day, the DFS issued an office memo asking SEBI chairman Ajay Tyagi to withdraw the circular, citing risks to both the mutual fund industry and the ability of banks to raise money.

The DFS termed the SEBI circular “disruptive” and said that it will lead to a huge swing in the net asset value (NAV) of all debt MFs. According to the DFS, MFs are currently holding over ₹35,000 crore worth of AT-1 bonds, the value of which is at risk of falling to ‘near zero’ due to the SEBI circular. It may cause an overall panic in the Indian market, the DFS cautioned SEBI and asked the regulator to reconsider its decision.

The logic is that if the nature of short-term instruments that come with no specified maturity is changed to 100 years, nobody would want to hold it in the short-run and, hence, it would trigger widespread redemptions of AT-1 bonds. Also, such a circular will shut down a short-term fund-raising avenue for banks, the DFS opined.

“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 PSBs, more equity dilution will take place, which could further depress their valuations,” the DFS memo said.

But SEBI is concerned that AT-1 bond investors get a raw deal like in the case of YES Bank and Laxmi Vilas Bank, where the RBI wrote-off the complete value of these bonds without any legislation. In YES Bank alone, investors lost over ₹8,400 crore. They moved court and the matter will come up for hearing in the Supreme Court this month.

The MF industry body, AMFI, came out in support of SEBI. In a release on Friday, AMFI said, “We fully support the need and spirit of the SEBI circular in capping exposure to perpetual bonds. Most 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 permitted by SEBI to safeguard unnecessary market disruption.”

But experts say that when the maturity tenor of the bonds goes up, the banks issuing them also have to pay higher interest. Hence, in this case, a sudden unexpected extension of their maturity tenor to 100 years will lead market forces to revalue them at once.

“The original flavour of perpetual bonds, which are quasi-equity in nature, will be lost if it is fettered by a ‘100-year tenor’. The SEBI circular can make their valuations go haywire as ‘perpetual’ gets replaced by 100 years. It will have a cascading effect on markets. AT-1 bonds often have been prone to controversy and the last time its investors faced trouble was during the YES Bank fiasco,” said Uttara Kolhatkar, Partner, J Sagar Associates.

Concern for PSBs

The CEO of a mutual fund company, however, said that the SEBI circular is definitely a concern for PSU banks as they will not be able to raise much capital through perpetual bonds and the burden will fall on the government to make good of the shortfall. “Given the current government’s financial position they do not want the SEBI order to put additional burden on banks. Hopefully, the market regulator will come out with clarification soon before the investors take any adverse step in panic,” he added.

A debt fund manager of a leading mutual fund said the perpetual bonds usually have a call option after 5 years and this used to be considered the tenure of the bond by mutual funds. “Now, suddenly if the tenure is changed to 100 years, these bonds become riskier and yields will start moving up. This will result in a notional loss on investment made by mutual funds. The notional loss will pull down the net asset value of debt schemes holding the perpetual bonds and if investors redeem their investment in panic, mutual funds have to resort to distress selling in the bond market. Mutual fund investors should stay calm till a solution is worked out,” he said.

(With inputs from Surabhi and Suresh Iyengar)