A Securities and Trade Board of India (SEBI) round relating to valuation of Further Securities Tier 1 (AT-1) bonds on March 11 had despatched shock waves by means of debt fund managers of mutual fund homes. A Finance Ministry notice to SEBI at the moment advising it to drop the 100-year maturity clause is soothing their frayed tempers. However whereas the Finance Ministry intervention could calm the nervousness of debt fund managers, the SEBI round would in all probability have introduced extra transparency and real looking valuation of those bonds regardless of the brief time period panic it might need triggered.
AT-1 bonds are perpetual unsecured bonds that banks problem as a part of their capital base. They first burst into the consciousness of the typical debt fund investor through the Sure Financial institution fiasco. The choice by Sure Financial institution to jot down down the AT-1 bonds made the typical investor realise that these devices could have been referred to as bonds however have been extra of a quasi-equity instrument with a far increased threat profile. That was a 12 months in the past.
However the market confidence for these devices slowly got here again as a result of many of the huge banks with rock stable reputations had issued AT-1 bonds. And given the publicity norms for debt funds to those devices, the danger was restricted. Most debt fund managers have been anyway cautious about their portfolio’s publicity to such bonds.
The SEBI round of March 11 was additionally not significantly contentious apart from one clause. Whereas a lot of the round centered on the publicity limits of funds to such bonds, the clause that triggered panic was on the valuation norms that debt fund managers needed to observe from April 1 for these bonds.
Whereas these funds have been perpetual in nature, debt fund managers tended to worth them based mostly on their name dates—the date at which the issuer might make a proposal to name again the bonds and repay the traders. It was not incumbent on the financial institution issuing it to take action, however it was valued as if it have been. In observe, these bonds pay solely curiosity or coupon in perpetuity whereas the capital quantity stays with the issuer.
The SEBI round stated that since these bonds have been perpetual in nature, they need to be valued as if their tenures have been for 100 years and never based mostly on the decision date. Valuing at name date assumes that each the capital and curiosity was being paid again by that date, which was not what occurred in observe.
Debt fund managers have been in a panic after the round as a result of they realised that they wanted to revalue the AT-1 bonds values of their portfolio to adjust to the brand new norms and these would inevitably be valued downwards. Whereas this may basically be within the nature of a paper adjustment and wouldn’t have an effect on the precise returns of the fund in the long term, within the brief run it might create a panic, particularly amongst huge traders who park a good 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 wind up six debt funds final 12 months. Whereas the larger fund homes would trip it out, the smaller ones must resort to panic promoting of fine debt to satisfy redemption pressures.
For the federal government there was a much bigger fear. A second spherical of unhealthy publicity about AT-1 bonds might fully kill off investor urge for food for such devices simply when many public sector banks have been seeking to elevate extra capital. They’d be compelled as an alternative to depend on core fairness dilution for elevating extra capital, thus dampening the worth of their shares. This in flip was not a prospect the federal government was trying ahead to in a 12 months when it hoped to lift some cash by promoting some shares within the banks that it owned. The federal government’s letter was in all probability triggered extra by this than some other consideration.
From a long run perspective although, the SEBI’s logic on valuing the AT-1 bonds as 100 12 months bonds would in all probability have resulted in a extra correct illustration of their values in fund portfolios. SEBI can, in session with the federal government, maybe carry these norms again later—in a 12 months when the financial system is on a sounder footing.