India Eases ‘Disruptive’ Rules That Sparked Bank Bond Selloff

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India’s markets regulator eased proposed rules on bank bonds after the government pushed back on the steps that would have made it harder for lenders to raise fresh capital.

The Securities & Exchange Board of India said in a statement Monday that mutual funds can treat Additional Tier 1 debt as 10-year bonds for the financial year starting April 1.

That’s a shift from the previous plan that stipulated that the so called CoCo bonds, which have voluntary call options, be valued as 100-year debt. India’s Finance Ministry asked Sebi in a memo earlier this month seen by Bloomberg to ease the regulations partly by withdrawing what it called the “disruptive” 100-year valuation rule.

Treating such securities as shorter term helps mutual funds, one of the biggest holders in India, book them at higher valuations. That’s because longer term bonds tend to have lower prices given they are exposed to more interest rate risk. Fund managers had previously valued the notes considering the maturity as the dates on which the lender could exercise the call options.

CoCo, or contingent convertible notes, were designed following the global financial crisis to ensure that creditors, not the general public, would foot the bill when banks stumble. But in the real world, investors have often focused instead on the extra yield the notes offer over plain vanilla bonds.

That changed last year when Indian investors were again reminded of the risks, after authorities seized beleaguered Yes Bank and announced an unprecedented move to permanently write down its AT1 securities.

New rulesDeemed residual maturity of AT1 bondsDeemed residual maturity of Tier 2 notes
12 months starting April 1, 202110 years10 years or contractual maturity, whichever is earlier
6 months starting April 1, 202220 yearsContractual maturity
6 months starting October 1, 202230 yearsContractual maturity
From April 1, 2023100 years (from the date of issuance)Contractual maturity

Lenders in India are saddled with one of the world’s worst bad debt piles and need to boost capital buffers in anticipation of more soured loans amid the pandemic. Prime Minister Narendra Modi needs them to be able to easily raise money in the debt market and channel funds to help revive the economy. That’s all the more important given that weakened public finances are limiting the government’s ability to inject cash into the lenders.

Yields on AT1 debt issued by India’s biggest banks had surged after Sebi initially proposed the rules earlier this month.

©2021 Bloomberg L.P.

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