After govt's intervention, Sebi eases valuation norms for AT-1 bonds

The Securities and Exchange Board of India (Sebi) on Monday eased the norms for valuation of perpetual bonds. The market regulator said the deemed residual maturity of Basel III additional tier-1 (AT-1) bonds will be 10 years until March 31, 2022. It will be increased to 20 and 30 years over the subsequent six-month period. And from April 2023 onwards, the residual maturity of AT-1 bonds will become 100 years from the date of issuance of the bond.

Meanwhile, Deemed Residual Maturity of Basel III tier-2 bonds will be considered 10 years or contractual maturity whichever is earlier until March 2022. Post that, it will be as per the contractual maturity, Sebi has said.

On March 15, Sebi had issued a circular capping debt mutual fund (MF) exposure to perpetual bonds, which includes AT-1 bonds and tier-2 bonds. It had also directed MFs to use the 100-year valuation norms for pricing such bonds. The circular was to come into effect from April 1, 2021.

The finance ministry had taken strong objection to Sebi’s proposal on the valuing perpetual bonds, which are primarily issued by public sector banks to meet their capital requirement under the Basel III regulations.

“Capital raising by PSU banks from the market will be adversely impacted due to limited appetite from other investors. These would lead to increased reliance on government for capital raising by PSU banks as AT1 and Tier 2 would need to be replaced by core equity,” the finance ministry had written in a letter to Sebi.

Industry players said deferring the 100-year valuation norm by two years will give fund managers and banks time to recalibrate their investments and bond issuances.

Sebi said the new valuation methodology is based “on the representation of the MF industry to consider a glide path for implementation of the policy and request of other stakeholders.”

Sebi has further said if the issuer does not exercise call option then the valuation and calculation of duration shall be done considering maturity of 100 years from the date of issuance for AT-1 Bonds and Contractual Maturity for Tier 2 bonds. Also, if the non-exercise of call option is due to the financial stress of the issuer or if there is any adverse news, the same shall be reflected in the valuation.

Yields of perpetual bonds issued by banks such as State Bank of India (SBI) and Bank of Baroda (BoB), had gone up by as much as 90 basis points following Sebi’s March 15 circular. Some banks had even deferred issuance of AT1 bonds to avoid paying of high yield.

According to an estimate, banks have issued AT-1 and tier-II bonds worth Rs 3.5 trillion. A fifth of these bonds is held by MFs. Of the outstanding AT1 issuance of Rs 90,000 crore, more than Rs 35,000 crore are held by MFs, according to a note by the finance ministry.

In absence of specified valuation norms, MFs used to consider the call-option date on such bonds as the deemed maturity date.

“Debt market was anticipating a similar announcement from the regulator. This will still provide much-needed relief to the MF industry. Given the situation, the regulator has done a decent job as risk will be curtailed at the same time it has given time to MF industry to adjust to the new regulations. There will be some short-term volatility, but the impact now will not be as severe as the old circular,” said a head of fixed income from leading fund house.