What’s the hubbub round Sebi and AT-1 bonds?
On March 11, a round from the Securities and Alternate Board of India (SEBI) relating to the valuation of Tier 1 (AT-1) bonds of extra securities despatched a shockwave by debt fund managers of debt corporations. mutual fund. A word from the Ministry of Finance to SEBI as we speak advising them to drop the 100-year maturity clause soothes their frayed moods. But when the intervention of the Ministry of Finance can calm the considerations of debt fund managers, the SEBI round would in all probability have introduced extra transparency and a sensible valuation of those bonds regardless of the short-term panic it might have brought about.
AT-1 bonds are perpetual unsecured bonds that banks concern as a part of their capital base. They first broke into the consciousness of the typical debt fund investor throughout the Sure Financial institution fiasco. Sure Financial institution’s determination to put in writing down AT-1 bonds made the typical investor notice that these devices might be referred to as bonds, however fairly it was a quasi-equity instrument with a threat profile. a lot greater. It was a yr in the past.
However market confidence in these devices slowly returned as a lot of the massive, respected banks had issued AT-1 bonds. And given the publicity requirements of debt funds to those devices, the danger was restricted. Most debt fund managers have been cautious about their portfolios’ publicity to those bonds anyway.
The SEBI round of March 11 was not notably contentious both, except for one clause. Whereas a lot of the round handled limits on the funds’ publicity to those bonds, the clause that triggered the panic was in regards to the valuation requirements debt fund managers have been to comply with from April 1. for these obligations.
Whereas these funds have been perpetual in nature, debt fund managers tended to price them primarily based on their reimbursement dates – the date on which the issuer might make a proposal to name again the bonds and repay traders. It was less than the issuing financial institution to do that, nevertheless it was valued as if it was. In follow, these bonds solely earn curiosity or coupons in perpetuity whereas the quantity of capital stays with the issuer.
The SEBI Round said that since these bonds have been perpetual in nature, they need to be valued as if their time period was 100 years and never primarily based on the reimbursement date. Valuation on the reimbursement date assumes that the principal and curiosity have been repaid by that date, which has not occurred in follow.
Debt fund managers have been in panic after the round as they realized they needed to re-value the AT-1 bond values of their portfolio to adjust to the brand new requirements and these would inevitably be priced decrease. Whereas that is basically within the nature of an adjustment on paper and wouldn’t have an effect on the precise returns of the fund over the long run, within the quick time period it might create panic, particularly amongst massive traders who make investments a superb amount of cash. in debt. funds. They may begin redeeming their funds earlier than April 1, inflicting a liquidity disaster of the sort that compelled Templeton to liquidate six debt funds final yr. Whereas the bigger fund homes would get by, the smaller ones must resort to panic promoting of excellent money owed to cope with reimbursement pressures.
For the federal government, there was higher concern. A second wave of unhealthy publicity about AT-1 bonds might fully kill investor urge for food for such devices simply as many public sector banks regarded to lift extra capital. Reasonably, they’d be compelled to depend on the dilution of core shares to lift extra capital, thereby amortizing the worth of their shares. This, in flip, was not a prospect the federal government regarded ahead to in a yr when it hoped to lift funds by promoting sure shares within the banks it owned. The federal government’s letter was in all probability triggered extra by this than by another consideration.
From a long-term perspective nonetheless, SEBI’s logic of valuing AT-1 bonds as 100-year bonds would possible have resulted in a extra correct illustration of their values in fund portfolios. SEBI can, in session with the federal government, maybe convey these requirements again later – in a yr when the economic system is on a more healthy footing.