Impact of SEBI new perpetual bond norms on MFs

Impact of SEBI new perpetual bond norms on MFs

Henil Shah

Securities & Exchange Board of India (SEBI) last week asked mutual funds to treat perpetual bonds similar to the bonds having a maturity of 100 years. Further, to restrict exposure to such bonds, SEBI capped exposure to such bonds with an allocation of not more than 10 per cent of the fund’s assets. So, what impact does it have on mutual funds? We shall find it out in this article. However, before we begin to understand its impact, let us first know more about perpetual bonds.  
 
 

What are perpetual bonds? 

Perpetual bonds or additional Tier 1 (AT–1) bonds are the bonds that banks issue to avoid erosion of their capital in case of losses. Say for instance, if the non-performing assets (NPA) number questions the financial viability of a bank, these AT–1 bond bear loss even before the other maturity bondholders get hit. Though AT-1 bonds are perpetual in nature, it doesn’t have any maturity, which means that they do have callable feature wherein, banks can repay them at a certain ‘call date’ but then, does not hold any obligation to repay on those dates. Having said, barring a few instances, banks in India have never skipped call dates. One example of such failure is AT-1 bonds issued by Yes Bank. 

Typically, AT-1 bonds are valued at price-to-call. This means that they are valued as if they are going to get paid on those call dates. Call dates are usually set for a shorter duration; say for 5 to 10 years. Therefore, while valuing the bonds, their maturity is assumed to be at the call dates. 


Impact on mutual funds

According to the estimates of CRISIL, around 36 mutual fund schemes have more than 10 per cent exposure to AT-1 and Tier 2 bonds.

 


* Data as of January 31, 2021
Source: CRISIL

With SEBI’s changed norms, mutual funds now would need to cap their exposure to perpetual bonds to 10 per cent and also need to value bonds, assuming the maturity of such bonds as 100 years. This norm will increase the interest rate sensitivity of such bonds, which would indeed risk funds holding such bonds. Further, such a revaluation could lower the net asset value (NAV) of the fund and also, lead to redemptions. Therefore, if you are a conservative or a moderate investor, then moving out of schemes having higher exposure to such bonds would make much more sense.

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