Over a week after the finance ministry asked the market regulator to withdraw its recent circular on valuation norms for additional tier-I (AT-1) bonds, Securities and Exchange Board of India (SEBI) has amended and eased the regulations.
In a circular, the regulator said the deemed residual maturity of Basel III AT-1 or the perpetual bonds will be 10 years until 31 March 2022. Eventually, it will be increased to 20 and 30 years over the subsequent six-month period.
Staring April 2023, the residual maturity of AT-1 bonds will become 100 years from the date of issuance of the bond, it said.
Earlier, SEBI had directed mutual funds (MFs) to value perpetual bonds (AT-1) based on a 100-year maturity—a change from the current methodology where the call option date of the bond was considered for calculation.
Soon, the department of financial services (DFS) under the ministry of finance issued a ‘written request’ to the market regulator for withdrawing its revised guidelines for treating all perpetual bonds to be considered as having 100-year maturity. In the letter, the DFS says the revised norms issued by SEBI on 10th March will lead to huge 'mark-to-market losses' for investors.
"Considering the capital needs of banks going forward and the need to source the same from the capital markets, it is requested that the revised valuation norms to treat all perpetual bonds as 100-year tenor be withdrawn. The clause on valuation is disruptive in nature," the letter says.
The finance ministry’s letter adds "Now the bonds will be valued at 100 years maturity, for which no benchmark exists. Mark-to-market losses will be high, effectively reducing them to near zero. The abrupt drop in valuation is likely to lead to large swings in net asset value (NAV) and potential disruption in debt markets as the mutual funds will seek to sell these bonds anticipating investor redemptions causing panic in the debt markets.”
Mutual funds are among of the largest investors in perpetual debt investments and currently hold Rs35,000 crore of the outstanding AT-1 issuances of about Rs90,000 crore. "With new limits, the incremental ability of the mutual funds to buy bank bonds would be constrained. This will result in increase in coupon rates," the letter hypothesised.
On 10th March, SEBI had issued a circular on the additional tier-1 (AT-1) and the rule was to take effect from 1 April 2021.
The circular had caused a lot of apprehension in the mutual fund industry about losses resulting from the revised valuation norms. The Association of Mutual Funds in India (AMFI) that represents 44 asset management companies (AMCs) even submitted a representation to SEBI expressing reservation on the revised guidelines.
SEBI says the decision to amend the rules has been taken, based on the representation of the mutual fund industry to consider a glide path for implementation of the policy and request of other stakeholders.
"Further, if the issuer does not exercise call option for any ISIN, then the valuation and calculation of Macaulay Duration shall be done considering maturity of 100 years from the date of issuance for AT-1 bonds and contractual maturity for Tier 2 bonds, for all ISINs of the issuer," it said.
In addition, if the non-exercise of call option is due to the financial stress of the issuer or if there is any adverse news, it will be reflected in the valuation, the market regulator says.