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SEBI Amended the Valuation Norms on Perpetual Bonds

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Sebi amends 100-yr valuation rule for AT-1 bonds

On March 22, 2021, the Securities and Exchange Board of India (SEBI) amended the valuation rule of Perpetual Bonds (Additional Tier-1(AT-1) and Tier-2 Bonds), under the intervention of the Finance Ministry, to modify its recent framework on Perpetual Bonds.

  • As per the amendments, the deemed residual maturity of Basel III additional tier-1(AT-1) bonds are to be 10 years until March 31, 2022, and would be increased to 20 and 30 years over the subsequent six-month period.

Note – AT-1 Bonds are the perpetual bonds issued by banks without any maturity date but they have a call option.

Background:

  • On March 10, 2021, SEBI came out with a framework to modify Mutual Fund’s investment and perpetual bonds maturity.

About the Framework 

  • It capped debt mutual fund exposure to perpetual bonds, which include AT-1 bonds and tier-2 bonds.
  • It had also said that the maturity of all perpetual bonds should be treated as 100 years from the date of issuance for valuation.
  • There is no change in the imposition of the 10 per cent capping of ownership of bonds in a particular mutual fund. Click here for more detail

SEBI’s Amendments:

  • Deemed residual maturity for valuation of existing & new bonds issued under the Basel III framework is as given below,

Period

Deemed Residual Maturity of Basel III
AT-1 Bonds(Years)

Deemed Residual Maturity of Basel III

Tier 2 Bonds(years)

Till March 31, 2022  

10

10 years/ Contractual Maturity, whichever is earlier
April 01,2022-September 30,2022 20 Contractual Maturity
October 01,2022 – March 31,2023 30 Contractual Maturity
April 01, 2023, onwards 100

(From the date of issuance of the bond)

Contractual Maturity

  • If the issuer does not exercise the call option for any ISIN then the valuation  and calculation of Macaulay Duration shall be done considering the maturity of 100 years from the date of issuance for AT-1 bonds and contractual maturity for tier-2 bonds, for all bonds of the issuer.
  • For banks, this latest circular does not provide much relief as they are likely to find it difficult to get investors for their AT-1 bonds.

Note – A call option is a contract between a buyer and a seller to purchase a certain stock at a certain price up until a defined expiration date. The buyer of a call has the right, not the obligation, to exercise the call and purchase the stocks.

What is Macaulay Duration?
Macaulay duration, named after Frederick Macaulay who developed the concept, is a measure of how long it takes for the price of a bond to be repaid by the cash flows from it. In layman terms, it is the time an investor would take to get back all his invested money in the bond by way of periodic interest as well as principal repayments.

Key points on Mutual Funds:

  • Mutual funds are one of the largest investors in perpetual debt investments and currently hold Rs 35,000 crore of the outstanding Additional Tier (AT1) issuances of about Rs 90,000 crore.
  • Mutual fund industry body Association of Mutual Funds in India (AMFI) has been advised to issue detailed guidelines concerning the valuation of bonds issued under the Basel III framework, which shall be implemented by April 1, 2021.

Recent Related News:

On March 10, 2021, The Securities and Exchange Board of India (SEBI) in its circular set a limit for Mutual Funds (MF’s) investment to 10% in debt instruments with special features such as Additional Tier-I (AT1) bonds and 5% for single issuers and stated the maturity for perpetual bonds as 100 years.

About Securities and Exchange Board of India (SEBI):

Establishment – 1992
Headquarters – Mumbai, Maharashtra
Chairman – Ajay Tyagi