Finance Ministry, through the Department of Financial Services (DFS), has allegedly sent a memorandum to the SEBI asking the latter to withdraw a circular on AT1 bonds. The circular mandates converting perpetual AT1 bonds into bonds with a 100-year maturity.
According to a report by Mint, the memorandum was sent on Thursday.
On March 10, the securities regulator had issued the circular to mandate the treatment of AT1 bonds as having 100-year maturity. AT-1 bonds, short for Additional Tier-1 bonds, are unsecured and perpetual in nature issued by banks to shore up their core capital to meet the Basel-III norms. (Basel-III norms were implemented after the global financial crisis that impacted the banking industry severely.)
The rules also capped the scheme exposure to a single issuer at 5 percent. While the schemes holding these bonds in excess of 10 percent were allowed to continue as is.
These rules were expected to take effect from April 1.
While mutual funds regulator "supports the need and spirit of circular in capping exposure to perpetual bonds," it is in "discussion with SEBI to further smoothen the process of implementation of this circular."
What are AT-1 bonds?
Banks issue additional Tier-1 bonds, and they are unsecured, subordinated (ranking below other bonds wrt claims), perpetual (with no maturity date), and non-convertible bonds. The concept was brought in after the global financial crisis bruised the banking industry. To protect the banks from busting again under pressure, the regulators brought about the Basel III norms.
These norms allowed the banks to raise their own capital before they raised external deposits and loans.
As per these norms, banks must split their total capital ratio of 11.5 percent into two parts: 9.5 percent in tier 1 capital and 2 percent in tier 2 capital. Tier 1 capital includes equity and reserves, and tier 2 includes supplementary reserves and hybrid instruments.
Why are they important?
AT-1 bonds are not like your regular bonds. Consider:
Why is the industry against the SEBI law?
In its latest regulations, SEBI mandated that such bonds be treated as if their maturity is 100 years. As soon as the SEBI released the circular, mutual fund body AMFI wrote to the former asking it to withdraw the provision.
AMFI voiced its concerns saying, “Considering the capital needs of banks going forward and the need to source the same from the capital markets, it is requested that the revised valuation norms to treat all perpetual bonds as 100-year tenor be withdrawn.”
“The clause on valuation is disruptive in nature,” it said. In recent years, such bonds have been sold to retail investors as fixed deposits or NCD substitutes. Due to their complex nature, they were ideally meant for institutions to decipher the terms and assess the risk.
Now due to these regulations, the potential swings in valuation could spark mass withdrawals from retail investors. At a time when interest rates and yields are rising, this could be risky (long-term bonds are sensitive to interest rates). And if the exits are massive in number, the fund houses would be forced to sell such bonds.
Mutual funds regulator is also worried this step might force the PSU banks to rely on the government for capital.
“AMFI recognizes that mispricing of risk is not in the best interest of its investors and is therefore committed to working with SEBI to ensure fair valuation of its investments,” AMFI said in a press release.
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