The finance ministry has advised the Securities and Exchange Board of India (SEBI) to withdraw the new regulation that requires treating perpetual bonds as 100-year maturity debt papers for the purpose of valuation.
The ‘office memorandum’ addressed to SEBI chairman said the “clause on valuation was disruptive in nature”. However, it said that the directions that could reduce concentration risk in such bonds could be retained as MFs had “adequate headroom even within 10 percent ceiling”.
Also read: Mutual funds plan to approach SEBI to relax new rule on perpetual bonds
Limiting option for banks to raise capital
In India, perpetual bonds are usually issued by banks to meet their capital requirements. In banking parlance, such bonds are called additional tier-1 (AT-1) bonds.
According to the finance ministry's memorandum, MFs are one of the largest investors in the perpetual bonds market and currently hold more than Rs 35,000 crore worth of AT-1 bond issuances, of the Rs 90,000 crore outstanding.
SEBI’s move has got the finance ministry worried that banks’ ability to raise capital through perpetual bonds will get impacted.
“AT-1 bonds were valued hitherto on basis of a short-term instrument of similar tenor G-Sec. They will now be valued as 100 year bonds for which no benchmark exists. Mark to market loss will be very high, effectively reducing them to near zero,” the memorandum by the finance ministry said.
It added that the abrupt drop in valuations is likely to lead to large NAV swings and potential disruption in debt markets as MFs will seek to sell these bonds anticipating investor redemptions, causing panic debt markets.
“This measure will also take away the appetite for mutual funds for investing in such instruments given the valuation norms,” the memorandum said.
Further, PSU banks will end up needing more capital from government if other options of raising capital fade away. Banks might also be forced to raise more capital by selling equity, which could depress valuations of banks’ equity shares.
Impact on corporate bond market
The note also highlighted how this move can have an impact on overall corporate bond market, as MFs may also be forced to sell other bonds to generate liquidity, to handle any spike in investor redemptions.
All this could lead to higher cost of borrowing for corporates.
AMFI in discussion with SEBI
In a press statement on March 12, the Association of Mutual Funds in India (AMFI) said that it was in discussion with SEBI on making sure there is smooth implementation of SEBI’s circular.
"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,” the release said.
The industry body also said that it 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, grandfathering is kindly permitted by SEBI to ensure that there is no unnecessary market disruption,” it read.
The industry body said that it recognises that the risk profile of such instruments is higher than regular bonds. “The regulator has always been concerned about any potential mispricing of risk in any kind of instrument. 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,” AMFI said.
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