The Securities Exchange Board of India (SEBI) has done small investors a good turn by restricting their access to so-called innovative debt instruments such as perpetual non-cumulative preference shares and perpetual bonds (also known as AT-1 bonds). It has said that offers of such instruments should henceforth take the electronic book provider route, with participation restricted to Qualified Institutional Buyers (QIBs). The minimum ticket size for initial offers and secondary market trading in these bonds has been raised to ₹1 crore. Explicit disclosures will now be required on the perpetual character of these bonds, and the Point-of-Non-Viability (PONV) clause that allows the RBI to direct a troubled bank to completely write-off the principal value. These new requirements are a welcome attempt by SEBI to ward off YES Bank-like situations, where the write-off of AT-1 bonds as a part of the bank’s restructuring plan came as a rude shock to the hundreds of retail investors. This case brought into focus the widespread mis-selling of AT-1 bonds to retirees and low-risk investors by banks and intermediaries — who plugged them as high-yield fixed deposit substitutes without disclosing clauses that allow the issuer to forfeit both interest and principal.
While SEBI’s new rules will keep retail investors off these instruments, there are loose ends that need tying up. With a key category of investors — high net worth individuals — now blocked out, banks may have to contend with fewer buyers for their future AT-1 offerings at a time when sentiment towards these bonds has already been soured by the YES Bank write-off. After all, it was to broad-base demand and give public sector bank (PSB) bond offers a leg-up that the RBI opened AT-1 bonds to retail investors a couple of years ago. The increase in the minimum trading lot can impact secondary market liquidity, rendering these bonds less appealing to institutions. A shallow market for AT-1 bonds can hurt when Tier 1 capital requirements for PSBs are expected to shoot up on the back of Covid-related provisioning. Fitch estimates banks’ capital requirement at $15-58 billion in the coming year.
In this context, SEBI and the RBI can evaluate if AT-1 bond participation can be opened up to informed non-QIB investors such as corporate treasuries and family offices with appropriate caveats. The regulators also need to work out an exit window, perhaps through buybacks, for retail investors stuck in older AT-1 bonds with a current outstanding value of over ₹84,000 crore. Barring investors from an asset class also isn’t the ideal solution to the pervasive problem of mis-selling that plagues many financial products. While SEBI needs to initiate specific penal actions against intermediaries guilty of mis-selling, the RBI needs to tighten its lax oversight of banks acting as intermediaries for third-party products. SEBI’s actions should serve as a wake-up call for the RBI to pay more serious attention to investor protection.