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Explained: Will Sebi’s easing of valuation standards for AT1 bonds relieve MFs and banks?

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Written by George Mathew, Khushboo Narayan, edited by Explained Desk | Mumbai |

March 23, 2021 12:18:26 pm

Days after the Ministry of Finance asked the Securities and Exchange Board of India (Sebi) to review restrictions on mutual fund (MF) investments in additional Tier 1 (AT1) bonds, the regulator announced some relaxation of appraisal standards, granting temporary relief. to mutual funds and banks.

While there may not be any panic buyouts now, the main issues remain: AT1 bonds will continue to be treated as 100-year bonds, and mutual fund positions will be closed within a time frame. specific.

What are AT1 bonds? What is the total amount of these obligations?

AT1 bonds represent additional level 1 bonds. These are unsecured bonds that have a perpetual tenor. In other words, bonds do not have a maturity date. They have a call option, which can be used by banks to buy back those bonds from investors. These bonds are generally used by banks to strengthen their base or level 1 capital. AT1 bonds are subordinated to all other debts and only have priority over ordinary shares. Mutual funds (MF) are among the largest investors in perpetual debt securities and hold over Rs 35,000 crore on the additional Level I bond issues outstanding of Rs 90,000 crore.

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What’s the latest Sebi relaxation?

On March 22, the regulator declared that the assumed residual maturity of the additional Basel III level 1 (AT-1) bonds would be 10 years until March 31, 2022. It will be increased to 20 years from April 1, 2022 to September 2022 and 30 years from the following six-month period. From April 2023, the residual maturity of AT-1 bonds will become 100 years from the date of issue of the bond. In addition, the deemed residual maturity of Basel III Level 2 bonds will be considered 10 years or the contractual maturity, whichever occurs first until March 2022. After that, it will be in accordance with the contractual maturity. In addition, he asked the Association of Mutual Funds of India (AMFI) to publish detailed guidelines for the valuation of bonds issued under Basel III, which are expected to be implemented by April 1, 2021. .

What will be the impact of relaxation?

The regulator has given a specific deadline to unwind the AT1 bond investment positions of mutual funds. This is a temporary relief as they don’t have to rush for redemptions and avoid losses. However, the Sebi’s initial position that perpetual bonds like AT1 bonds will be treated as 100-year bonds remains. There is no change in the 10 percent limit on bond ownership in a particular mutual fund plan. In short, Sebi has held firm on its basic principle of perpetuity and limit investments while still allowing mutual funds to exit at specific intervals. There will be no panic buybacks, but banks are unlikely to be fully satisfied with the partial relief.

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What was the original Sebi directive?

On March 10, the Sebi ordered mutual funds to value these perpetual bonds as a 100-year instrument. Essentially, this means that MFs will have to assume that these bonds will be repaid in 100 years. The regulator also asked MFs to limit bond ownership to 10 percent of a plan’s assets, as these instruments could be riskier than other debt instruments. The Sebi likely made the move after the Reserve Bank of India (RBI) authorized a write-off of Rs 8,400 crore on AT1 bonds issued by Yes Bank Ltd after its bailout by the State Bank of India (SBI).

How MFs would have been affected by the Sebis directive of March 10

Generally, mutual funds have treated the date of the call option on AT1 bonds as a maturity date. Now, if these bonds are treated as 100 year bonds, it increases the risk of these bonds as they become very long term instruments. It could also lead to price volatility for these bonds. As the risk increases, the yields on these bonds increase. Bond yields and prices move in opposite directions, therefore, a higher yield will lower the bond price, which in turn will cause the net asset value of the MF plans holding those bonds to decrease. There would have been panic buyouts and losses for the MFs. In addition, these bonds are not liquid and it will be difficult for MFs to sell them to cope with repayment pressure. With the Sebi relaxing the standards, there will be orderly liquidation of AT1 bond holdings.

What is the impact on the banks?

AT1 bonds have become the capital instrument of choice for state-owned banks as they strive to consolidate capital ratios. If there are restrictions on mutual fund investments in such bonds, banks will find it difficult to raise capital at a time when they need funds as a result of the surge in bad assets. A large portion of AT1 bonds are purchased by mutual funds. State-owned banks collected around $ 2.3 billion in AT1 instruments in 2020-2021, against a background of virtually no such issuance by private banks (except in one case) following the AT1 depreciation from Yes Bank in March 2020. For banks, Sebi’s latest easing does not provide any major relief as they will likely have difficulty attracting investors for AT1 bonds.

Why did the Ministry of Finance ask Sebi to review the original decision?

The Ministry of Finance has called for the withdrawal of the AT1 bond valuation standards prescribed by the Sebi for mutual fund companies, as this could lead mutual funds to incur losses and exit from these bonds, affecting PSU banks fundraising plans.

The government does not want any disruption in the banks’ fundraising exercise at a time when two PSU banks are on the privatization block.

Banks have yet to receive the proposed FY21 capital injection, although they will need more capital to address asset quality challenges for the foreseeable future. Fitch’s own estimate puts the sector’s capital needs at between $ 15 billion and $ 58 billion under various stress scenarios for the next two years, of which state banks account for the bulk.

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