- GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
AT1 bonds: SEBI New Norms
Context: The decision of the Securities and Exchange Board of India (Sebi) to slap restrictions on mutual fund (MF) investments in additional tier-1 (AT1) bonds has raised a storm in the MF and banking sectors.
The Finance Ministry has asked the regulator to withdraw the changes as it could lead to disruption in the investments of mutual funds and the fund-raising plans of banks.
What are AT1 bonds? What’s total outstanding in these bonds?
- AT1 Bonds stand for additional tier-1 bonds.
- These are unsecured bonds which have perpetual tenure. In other words, the bonds have no maturity date.
- They have call option, which can be used by the banks to buy these bonds back from investors.
- These bonds are typically used by banks to bolster their core or tier-1 capital.
- AT1 bonds are subordinate to all other debt and only senior to common equity.
- Mutual funds (MFs) are among the largest investors in perpetual debt instruments, and hold over Rs 35,000 crore of the outstanding additional tier-I bond issuances of Rs 90,000 crore.
What action has been taken by the Sebi recently and why?
- 100-year Instrument: In a recent circular, the Sebi told mutual funds to value these perpetual bonds as a 100-year instrument. This essentially means MFs have to make the assumption that these bonds would be redeemed in 100 years.
- Limit Ownership: The regulator also asked MFs to limit the ownership of the bonds at 10 per cent of the assets of a scheme.
- Linkage with Yes Bank Crisis: According to the SEBI, these instruments could be riskier than other debt instruments. The SEBI has probably made this decision after the RBI allowed a write-off of Rs 8,400 crore on AT1 bonds issued by Yes Bank Ltd after it was rescued by SBI
What is the impact of this decision?
- Increased Risk: Typically, MFs have treated the date of the call option on AT1 bonds as maturity date. Now, if these bonds are treated as 100-year bonds, it raises the risk in these bonds as they become ultra long-term.
- Increases Volatility in Bond Prices: This could also lead to volatility in the prices of these bonds as the risk increases the yields on these bonds rises. Bond yields and bond prices move in opposite directions and therefore, higher yield will drive down the price of bond, which in turn will lead to a decrease in the net asset value of MF schemes holding these bonds.
- Push MF to engage in Panic Selling: Moreover, these bonds are not liquid and it will be difficult for MFs to sell these to meet redemption pressure. Potential redemptions on account of this new rule would lead to mutual fund houses engaging in panic selling of the bonds in the secondary market leading to widening of yields
- Impacts Fund Raising Capability of Banks: AT1 bonds have emerged as the capital instrument of choice for state banks as they strive to shore up capital ratios. If there are restrictions on investments by mutual funds in such bonds, banks will find it tough to raise capital at a time when they need funds in the wake of the soaring bad assets.
Why has the Finance Ministry asked SEBI to review the decision?
- The Finance Ministry has sought withdrawal of valuation norms for AT1 bonds prescribed by the SEBI for mutual fund houses as it might lead to mutual funds making losses and exiting from these bonds, affecting capital raising plans of PSU banks.
- The government doesn’t want a disruption in the fund mobilisation exercise of banks at a time when two PSU banks are on the privatisation block.
- Banks are yet to receive the proposed capital injection in FY21 although they will need more capital to face the asset-quality challenges in the foreseeable future.
Connecting the dots: