The decision of market regulator Securities and exchange board of India (SEBI) to ease the valuation rules on AT1 Bonds or additional tier 1 Bonds will mean some relief to investors and banks looking to raise capital , but the bigger concerns triggered by the original circular still remain. Investors, mainly mutual funds, will continue to look at these instruments with extra caution. Banks, which need to raise capital, will likely struggle to find investors. SEBI relaxation has given only short-term relief.
To begin with, what are AT1 Bonds? These are a type of contingent convertible bonds designed after the financial crisis to try to ensure that investors would be on the hook if a bank runs into financial stress.
Easing the earlier rules, SEBI on Monday said the deemed residual maturity of Basel III additional tier-1 (AT-1) bonds will be ten years until 31 March, 2022. Thereafter, for the next six months, the period will be increased to 20 and 30 years, it said. From April 2023 onwards, the residual maturity of AT-1 bonds will become 100 years from the date of issuance of the bond, SEBI said. Earlier, the regulator had said AT1 Bonds will have to be treated with a maturity of 100 years, triggering fears of a revaluation.
The norms have been eased but does it mean concerns of banks and other investors are addressed? According to banking industry analysts, the market regulator has only given temporary relief to the AT1 market and investors may still remain cautious on these instruments.
“It's a relief as it prevents a disorderly unwinding of positions by funds. But in the medium-to-long term it's still negative as funds may not want to take any additional positions in at1 bonds,” said Jyoti Roy, Deputy Vice President, research, at Mumbai-based Angel Broking.
“It just kicks the can down the road as they will be treated as 100 years bond from April 2023 onwards,” Roy said, adding Mutual Funds may not want to buy any new at1 bonds. But insurance companies may still want to buy as they may get better rates. Banks can raise core equity but the markets may not be an easier one as it used to be before.
Banks periodically raise money issuing such bonds. At one point, lenders used to even pitch these to retail investors as an attractive return option, often higher than what a traditional fixed deposit would offer. There used to be significant retail interest for AT1 Bonds till Yes Bank episode.
The market for AT1 bonds, or additional tier 1 bonds, took a hit after the Rs 8,415 crore AT1 bond write-off by Yes Bank as part of the State Bank of India-led bailout in March 2020. Investors turned wary. They began to look at these instruments with caution since then.
The March 10 SEBI circular added to their worries.
What did the SEBI rules on March 10 say?
Effective April 1, SEBI asked issuers to treat AT1 bonds as having 100-year maturity. Besides, it also capped the mutual fund exposure to a single issuer to 5 percent with respect to fresh issuances and said at the scheme level, no fund shall hold more than 10 percent of its NAV of the debt portfolio in such instruments. What are the concerns here? The stipulation of 100-year maturity will lead to a re-rating of this market, bankers fear.
The longer the tenure, the higher the interest rate risk it carries. There is a fear that the SEBI rules could prompt existing investors to sell these bonds resulting in massive withdrawals on the part of retail investors. What is the exposure of investors to AT1 bonds? According to the Ministry of Finance, the exposure of mutual funds to AT1 bonds is around Rs 35,000 crore. The overall market is around Rs 90,000 crore. Banks have significant exposure to these instruments.
Finmin questions
The SEBI circular drew the ire of the Finance Ministry. The North Block wrote to the market regulator seeking to review the AT1 bonds circular citing the potential impact it could have on the market, especially banks. The Finance Ministry has raised a few key points:
One, with the new limits in place, the incremental ability of MFs to buy bank bonds will be constrained. This will result in an increase in coupon rates.
Two, with the tenure fixed at 100 years, and with no benchmark to mark these bonds against, the MTM (mark to market) losses on these instruments will be high and the abrupt drop in valuations will lead to large NAV swings as MFs will rush to sell these bonds fearing large redemptions.
Third, panic redemptions by MFs will lead to an impact on the corporate bond market and hence will lead to higher borrowing costs for corporations.
Fourth, capital raising by banks will get adversely impacted due to lower investor appetite. Citing the above reasons, the Finmin has asked SEBI to review the circular on AT1 bonds.
What now?
With the SEBI finally easing the norms following government intervention, there will not be an immediate meltdown in the AT1 Bonds market. The MFs may not see large scale panic-driven redemptions now. Banks may still be able to raise money. But, AT1 bonds may not regain the lost confidence of investors in the medium-to-long term. This could particularly impact banks looking to raise money using these instruments.
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