Reverse Proposed AT-1 Standards for Mutual Funds, Treasury Department Tells Sebi

DFS said, however, that Sebi may retain instructions to cap investment limits in perpetual bonds to reduce concentration risk.

A day after the Securities and Exchange Board of India (Sebi) proposed that mutual funds (MFs) value AT-1 bonds as instruments with a duration of 100 years, the Ministry of Finance asked the regulator to withdraw the revised standards.

The Department of Financial Services (DFS), argued in a memorandum to Sebi, that the standards would negatively impact public sector banks’ capital-raising plans. “Given the capital needs of banks in the future and the need to source from the capital markets, it is requested that the revised valuation standards to treat all perpetual bonds as a 100 year term be withdrawn,” DFS wrote. The Association of Mutual Funds in India (Amfi) has supported Sebi’s standards on bond valuation.

Sebi’s March 10 circular prohibited MFs from holding more than 10% of AT-1 bonds from a single issuer, in all regimes. In addition, MFs were not permitted to invest more than 10% of the net asset value of the debt portfolio in such instruments. The bonds were to be valued as 100-year instruments from April 1. Yields on AT-1 bonds rose on Thursday due to some market uncertainty. The value of outstanding AT-1 bonds is estimated at Rs 58,000 crore, with MFs holding around Rs 38,000 crore.

DFS said, however, that Sebi may retain instructions to cap investment limits in perpetual bonds to reduce concentration risk. Sebi set these limits with the understanding that these bonds have loss absorbing characteristics, which can be risky investments for MF plans.

Amfi said it supported the need to limit exposure to perpetual bonds, saying most schemes’ exposure was well below the cap. He called for grandfathering to avoid unnecessary market disruption. MF industry executives believe the change in standards – for example, the 100-year maturity rather than the use of call options – was too sudden.

Last year, Yes Bank’s AT-1 bonds, of which the MFs held Rs 3,000 base, were written down and the bondholders, including the MFs, had approached the Bombay High Court. Similarly, the Reserve Bank of India had ordered a full writedown of Lakshmi Vilas Bank Tier 2 bonds as part of its resolution plan. Under existing RBI guidance, Basel III compliant AT-1 and Tier 2 instruments can absorb losses through conversion to common stock or write down.

Banks believe that if the Sebi Circular is implemented, it will hit their balance sheets due to expected price swings. A senior PSU banker said: “We are trying to analyze how many hits the banks will have to take. Since AT-1 bonds fall under the AFS (Available for Sale) category, we need to mark them for daily trading. However, banks will only report this during quarterly results, he added.

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