Finance Ministry asks SEBI to withdraw revised valuation norms for perpetual bonds
MFs hold about Rs 35,000 crore in AT1 bonds, which would possibly become zero as the proposed valuation norms can lead to high MTM losses
Markets regulator SEBI’s revised norms for valuing perpetual bonds like Additional Tier-1 (AT1) bonds has caused fears in markets. MFs hold about Rs 35,000 crore in AT1 bonds. While SEBI has asked mutual funds to treat maturity of perpetual bonds as 100 years compared to current practice of short-term instrument of similar tenure G-Sec, mutual funds say such a change will result in high mark to market loss, abrupt drop in NAVs, panic redemptions and overall corporate bond market being hit. So, the Finance Ministry has asked the SEBI to withdraw the revised perpetual bond valuation norms, as the clause on valuation is “disruptive in nature”.
Referring to the SEBI circular, which we have covered in detail here, the Finance Ministry said the revised norms ask funds to value AT1 bonds as 100 year bonds for which no benchmark exists.
“Mark to market (MTM) loss will be very high, effectively reducing them to near zero. The abrupt drop in valuation is likely to lead to large NAV swings and potential disruptions in debt markets as MFs will seek to sell those bonds anticipating investor redemptions, causing panic in debt markets. This measure will also take away appetite away from mutual funds for investing in such instruments given the valuation norms,” said a March 11 office memorandum from Finance Ministry addressed to SEBI chairman and Department of Economic Affairs secretary. The SEBI circular was disclosed on March 11.
The Finance Ministry also feared that panic redemptions by mutual funds would impact overall corporate bond market as MFs may resort to selling other bonds to raise liquidity in debt schemes. This could lead to higher borrowing cost for corporates at a time when the economic recovery is nascent, the Ministry said.Also, the Finance Ministry feared that capital raising by PSU banks 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 PSU banks as AT1 and Tier 2 would need to (be) replaced by core equity,” said the office memorandum referred above. Over the long run, for all banks, not just PSU banks, more equity dilution will take place, which will lead to depressed valuations.
“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 years tenor be withdrawn…,” it said.
Separately, AMFI in a statement released to media said that perpetual bonds or Additional Tier I Bonds are issued without any maturity date but are usually issued with call option(s) and qualify for Tier I capital. Banks have been majority issuers of Perpetual bonds. Perpetual Bond market is reasonably active with regular trades in Large and Higher rated issuances. Most trades in Perpetual Bonds happen on a yield to call basis. “This is based on the established market convention, locally as well as globally, that the issuer will exercise the call option on the due date,” AMFI said.
The statement said that the SEBI had engaged with Association of Mutual Funds in India (AMFI) on treatment of Perpetual Bonds as it is a hybrid instrument and carries a differentiated risk reward ratio than a normal debt instrument. Treatment of Perpetual Bonds was discussed in Mutual Fund Advisory Committee (MFAC) where several members of AMFI participated.
“AMFI fully supports the need and spirit of the circular in 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,” the MF lobby said.
The above referred SEBI circular continues the tradition of the primacy of traded prices. Perpetual bond market sees active participation from various players viz. Banks, Corporates, Mutual Funds and Individual Investors. “Only in the event of lack of traded prices, the question arises as to whether the bond should be valued to call or to maturity. Given a reasonably active market with regular trades, the issue is narrower than it appears,” AMFI said.