In what appears to be expediency getting the better of regulation, the finance ministry is reported to have directed market regulator Securities and Exchange Board of India (Sebi) to withdraw its directive to cap the maturity of perpetual or Additional Tier-1 bonds at 100 years.
Earlier this week, Sebi also issued a directive to mutual funds to limit their exposure to perpetual bonds to less than 10 per cent of the entire assets under management.
Sebi said that effective 1 April, mutual fund schemes cannot have more than 10 per cent of their assets under management in perpetual or Additional Tier-1 (AT1) bonds.
Sebi has also capped the scheme level exposure to a single issuer at 5 per cent and mandated that the maturity of all such bonds would be treated as 100 years. Those schemes which were holding AT-1 bonds in excess of 10 per cent were permitted to 'grandfather' them or continue as is.
At stake is Rs90,000 crore of outstanding AT-1 bond issuances in the market, of which mutual funds have exposure to Rs35,000 crore.
The finance ministry has now stepped in asking Sebi to withdraw the revised valuation norms in terms of maturity, in order to keep the fund flows smooth. The ministry has cited that maturity curbs could cause large market swings and bring market-to-market losses to mutual funds.
The finance ministry also noted that the revised norms would severely impact capital raising by PSU banks, leading to an increased reliance by banks on the government.
However, the exposure norms could continue, the ministry stated.
The ministry noted that the Sebi circular restricting maturity of the AT1 bonds would lead to forced selling by mutual funds causing market restrictions. This, the ministry noted, would adversely affect the debt market and capital raising by PSU banks, leading to an increased reliance by banks on the government.
AT-1 bonds are issued by banks to comply with Basel III norms and these are in great demand as they are high-yielding although these have no fixed maturity date.
The issuance of perpetual bonds that followed the 2008 global financial crisis, which led to the collapse of a few banks and pushed many others to the brink, had caused a capital draught to financial institutions globally. These high-yielding bonds were needed for banks to rase enough capital to comply with the norms and reduce the risk of insolvency.
AT-1 bonds are issued with call options, which means that he interest on bonds have to be paid till its call date, ie, the date on which the issuer bank can call back the bond and pay back the lender.
If interest rates are falling, the issuing bank will want to redeem the existing bonds and issue fresh bonds at a lower rate of interest.
There is no put option for bondholders who cannot choose to redeem at will. They can only sell it in the secondary market, but with possible loss of value.
Also, if the common equity Tier-1 of the borrower bank drops below a specified level (6.125 per cent as of March 2019), the AT-1 bonds can be written off or converted into common equity.