SEBI has relaxed valuation norms for AT-1 bonds, following its March 10th Directive, – brining a relief to Mutual funds, the largest investors in perpetual debt instruments.
What are AT1 bonds
- · Unsecured bonds which have perpetual tenure (treated as 100-year bonds) — or no maturity date.
- · They have a call option, which can be used by the bond issuers to buy these bonds back from investors.
- · AT1 bonds are subordinate to all other debt and only senior to common equity.
SEBI’s Directive & Impact
- · It asked mutual funds (MFs) to value AT-1 bonds as a 100-year instrument (redeemable after a period of 100 years).
- MFs have treated the date of the call option on AT1 bonds as maturity date. If these are treated as 100-year bonds, it raises the risk as they become ultra-long-term instruments.
- High risk factor could lead to volatility in bond prices – yields will increase, reducing bond prices and thereby decreases the net asset value of MF schemes.
- In turn, panic redemptions among MF investors may happen – creating a loss.
- AT1 bonds are primary capital instrument choice for banks – with investments from Mutual Funds reducing, banks might face challenges to raise their capital.
- State banks have raised around $2.3 billion in AT1 instruments in 2020-21.
- · It also asked MFs to limit ownership of the bonds at 10% of the assets of a scheme, as these could be riskier than other debt instruments.
Impact of the New Directive
- · SEBI has provided a temporary relief to MF (phasing the exit period) – thereby reducing the rush for redemptions and prevent losses to MFs.
- · However, SEBI has withheld its direction on 100-year bond period and 10% cap on ownership of bonds
