Finance Ministry has written to the capital market regulator Sebi to withdraw the rule to treat all Perpetual Bonds as 100 year tenor. The letter was sent on Thursday. In a circular dated March 10, Sebi has asked that these bonds to be valued as 100-year bonds.
"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the capital markets, it is requested that the revised valuation norms to treat all perpetual bonds as 100 year tenor be withdrawn.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 Finance Ministry's letter to the Sebi said.
As per Sebi's circular, the new rules will become effective from April 1, 2021. Currently, the AT1 bonds are valued on the basis of short term instrument of similar tenor G-Sec. "Now they will be valued at 100 years maturity, for which no benchmark exists.," said the letter. Mark-to-market losses will be high, effectively reducing them to near zero, FinMin added.
FinMin's letter stated that the change will lead to large NAV swings as the mutual funds will look to sell these bonds anticipating redemptions by investors. This in turn could create a panic in the debt market.
The whole ecosystem will get disturbed. "Capital raising for the PSU banks will from the market will be adversely impacted due to limited appetite from other investors. This would lead to increased reliance on government for capital raising by the PSU Banks at AT1 and Tier 2 would need to be replaced by core equity," said the letter.
Mutual funds are one of the largest investors in perpetual debt investments and currently hold Rs 35,000 crore of the outstanding Additional Tier (AT1) issuances of about Rs 90,000 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 said.
Perpetual bonds are quasi debt instruments without any fixed maturity. The risk lies in the event if the issuer sinks. Like in case of YES Bank, it becomes nearly impossible to find buyers for such bonds. Redemption becomes unlikely. Debt mutual fund managers believe SEBI's new rules will make debt mutual funds more transparent and safer.
"Debt funds do become safer as there is lower concentration risk with issuer level cap in place. Also, the closed ended funds not being able to invest in perpetual bonds is a step in the right direction," says Raj Mehta, fund manager, PPFAS Mutual Fund. "The maturity of the bonds has to match the maturity of the fund," he adds.
AMFI, the association of all the asset management companies of SEBI registered mutual funds in India, fully supports Sebi's new rules pertaining to capping exposure to Perpetual bonds. Most of the mutual fund 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, grand fathering is kindly permitted by SEBI to ensure that there is no unnecessary market disruption," said a release by AMFI.
AMFI recognises that the risk profile of such instruments is higher than regular bonds. It agrees that while in the short-term prices can be influenced by many factors, in the long-term fundamentals will prevail.
"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," says a release by AMFI.
Also read: SEBI's new debt investment rules to make mutual funds safer