The new rules, which are aimed at reducing concentration risk in MFs bond portfolio and trying to accurately price risk in light of recent defaults by some banks on AT-1 bonds (Additional Tier 1), will kick in from April 1.
The Finance Ministry has sought withdrawal of valuation norms prescribed by the Securities and Exchange Board of India (Sebi) for mutual fund (MF) houses on AT-1 perpetual bonds, as these could be disruptive leading to sudden mark-to-market losses and affecting capital raising plans of PSU banks. The new rules, which are aimed at reducing concentration risk in MFs bond portfolio and trying to accurately price risk in light of recent defaults by some banks on AT-1 bonds (Additional Tier 1), will kick in from April 1.
“Considering the capital needs of banks going forward and the need to source the same from capital markets, it is requested that the revised norms to treat all perpetual bonds as 100-year tenor be withdrawn. The clause on valuation is disruptive in nature,” the Department of Financial Services said in a letter to Sebi on Thursday.
However, the government said Sebi’s proposal to cap MFs exposure in such instrument at 10 per cent can be retained, as they have adequate investment headroom even within this ceiling. On Wednesday, Sebi directed fund houses to make maturity of all perpetual bonds as 100 years, from the date of issuance of the bond for the purpose of valuation — sparking concerns of steep MTM (mark-to-market) losses that funds may have to take on their existing portfolio of such bonds. This is because currently such bonds are valued as short-term papers, but categorising them as a 100-year maturity paper will lead to drop in valuation due to high discount rate on future coupons.
Mutual funds are among the largest investors in perpetual debt instruments, and hold over Rs 35,000 crore of the outstanding additional tier-I bond issuances of Rs 90,000 crore, as per the Finance Ministry’s letter to Sebi. “With new limits, the incremental ability of MFs to buy bank bonds would be constrained. This will result in increase in coupon rates,” the Ministry said.
“The abrupt drop in valuation is likely to lead to large NAV (net asset value) swings and potential disruption in debt markets as MFs will seek to sell these bonds anticipating investor redemptions, causing panic in debt markets,” the Ministry said.
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