Capital market regulator SEBI has directed mutual funds to value their investment in the AT-1 bonds issued by banks on Yield to Call basis as suggested by the National Financial Reporting Authority.
The National Financial Reporting Authority has recommended that since the market practice for AT-1 bonds has been observed to trade at or quote prices closer to Yield to Call basis, valuation of AT-1 Bonds on Yield to Call basis (adjusted with appropriate risk spreads) will be consistent with the principles of market-based measurement under Ind AS 113.
In order to align the valuation methodology with the recommendation of NFRA, SEBI said it has been decided that the valuation of AT-1 Bonds by Mutual Funds shall be based on Yield to Call.
For all other purposes, since liquidity risk of perpetual bonds is required to be suitably captured, deemed maturity of all perpetual bonds will continue to be in line with the Master Circular, it added.
Additional Tier 1 or AT1 bonds are perpetual bonds with no maturity date. Investors of these bonds do not get their principal back. However, the interest continues forever. Due to the perpetual nature of AT1 bonds, these are often treated and viewed as equity, not debt.
In 2020, MFs lost about ₹2,400 crore after the turbulence in Yes Bank led to the RBI supersede the bank’s board and write off the AT-1 bonds issued by it. After the Yes Bank episode, SEBI provided a timeline for MFs to value AT-1 bonds as 100-year instruments, starting April 2023.
Prior to this, AT-1 bonds were valued according to the call options on the papers, which were 5 years or 10 years. The new norms led to a sharp decline in MF investments as valuation of ultra-long-duration securities implies tremendous volatility for NAV.
Anil Gupta Senior Vice President and Co Group Head Financial Sector Ratings, ICRA Ltd, said, “The proposed change is likely to reduce the volatility in NAV of the schemes which invests in such bonds, thereby making such instruments attractive for mutual funds.”
However, as the maturity of the instrument remains at 100 years, any investments in such instruments could only be made by schemes which have mandate for high Macaulay Duration. Hence the appetite of the investors remains to be watched for, he added.
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