Perpetual Bond Valuation: Mutual Funds Vs SEBI Vs Finance Ministry

On Thursday, the Finance Ministry wrote to the Securities and Exchange Board of India, asking it to withdraw guidelines issued by the securities regulator a few days earlier on valuing perpetual bonds, such as additional tier-1 securities issued by banks, as 100-year bonds.

Here’s what securities regulation and financial sector experts made of the move.

- Uttara Kolhatkar, Partner, J Sagar Associates

SEBI issued a circular directing that the maturity of all perpetual bonds shall be treated as 100 years from the date of issuance of the bonds for the purpose of valuation. This caused an upheaval in the corporate bond markets where AT-1 bonds or perpetual bonds are traded frequently. The particular directive has been issued without providing any rationale for newly introducing such a ‘100-year’ norm, where such AT-1 bonds otherwise have no fixed maturity.

This directive would have had a cascading effect on the bond market and increase volatility. Potential redemptions on account of this new rule would lead to mutual fund houses engaging in panic selling of the bonds in the secondary market leading to widening of yields. AT-1 bonds have in the past been fraught with troubles. This brings to mind the Yes Bank AT-1 bonds debacle.

The Ministry of Finance has acted quickly and issued a memorandum to SEBI for withdrawal of this new 100-year norm. The Ministry’s move is in the right direction, especially to ensure stability in the corporate bond markets, as the new norm will entail losses for mutual funds. This capital instrument will not find favour as an investment option, as it will lose its value. Public sector banks relying on AT-1 bonds (being quasi-equity) as a fund-raising capital instrument, will not get the desired capital and will increase reliance on additional capital infusions by the Government of India.

- Swarup Mohanty, ‎Chief Executive Officer, ‎Mirae Asset Global Investments (India)

We don’t have any exposure. But till the time SEBI comes out with a revised valuation matrix in response to govt request for withdrawing 100-year maturity assumption, there would be volatility. Fact remains, since there are no buyers at the moment, there would be no near-term impact. We have to see how the redemptions play out. That could change things.

- Amit Tandon, Managing Director, Institutional Investor Advisory Services

This is one of those classic instances where the government and one of its arms are viewing the issue from different lenses. SEBI is looking at it in terms of how to minimise and mitigate the risk for bond investors. We’ve seen what happened with the Yes Bank AT-1 bonds. As things stand, there’s a large corpus in the market being picked up by mutual funds. MFs are the largest holders of these bonds. SEBI wants to minimise that risk to the MF unitholders, and also simultaneously signal that these are high-risk instruments. Debt funds were seen as alternates to fixed deposits and SEBI wants to signal that is not so.

Meanwhile, the Finance Ministry is seeing these bonds as the owner of the business. The banks, particularly the government-owned ones need to raise capital. Given that government-ownership needs to remain above a minimum threshold. Additionally, as owner the Ministry of Finance wants to see growth in the banking system and as the steward of the economy, it wants stability in the banking system (through a higher capital buffer) and the broader markets These bonds serve that purpose. These bonds are helping achieve all these goals.

The question is how you reconcile the two views. Both are right in their own way. These issues need to be thought through in a balanced manner. The choice is whether it gets done on April 1, 2021, or give the market enough time to digest it and make changes. If you do it with a 2-3-week window, it will be disruptive. If you give a 2-3-year window, it gets digested and the capital parameters also get met. You don’t want volatility in the short term. But you also cannot afford to kick the can down the road.

What triggered this thinking? There are three developments that followed in quick succession, that may have caused a rethink. First was the issue with the Yes Bank bonds, the second was the Franklin Templeton issue, with creative use of put and call options to fit into regulatory norms, and finally the challenge with valuing certain bonds which came up recently when RBI raised concerns over the calculation of the net present value of zero-coupon bonds, following Punjab & Sind Bank’s capital raise of Rs 5,500 crore last year by issuing zero-coupon bonds of six different maturities.

- PN Prasad, Former Deputy Managing Director, State Bank of India

The AT-1 bonds were looked at as a good way for public sector banks to boost their capital adequacy ratio without relying on share sales or government infusions. Recent events such as the Yes Bank debacle had caused some apprehension against this product. It is likely that by putting restrictions on mutual fund investments and valuing these bonds with 100-year tenor, more apprehensions will come in. This would not only affect future fund-raising plans for public sector banks, but also affect those banks which were looking to use the call option and reprice their past issues. Further, by putting more restrictions on AT-1 bonds we reduce space for weaker public sector banks to raise capital. This would result in higher government capital infusions and create more capital issues for the sector.