Efforts Underway to Revive AT1 Bond Market Amid Valuation and Regulatory Debates

Key Takeaways:

1. Financial market authorities are examining a possible change in the way AT1 securities are valued to stoke investor interest in these quasi-equity papers.
2. The Securities & Exchange Board of India (SEBI) has introduced new valuation regulations that require investing funds to treat AT1 bonds as securities with a 100-year maturity, leading to concerns among banks and mutual funds.
3. There is a contentious subject with banks and fund houses differing in views, with banks calling for a change in the valuation technique and mutual funds arguing about the risk associated with AT1 bonds.
4. The Yes Bank AT1 bond write-down in March 2020 sparked debates and court battles, leading to questions about the treatment of these complex securities.
5. Stakeholders are calling for a solution to address the challenges faced by the AT1 bond market, as many banks would find it tough to raise capital in the coming years without these bonds.

The current state of the AT1 bond market in India and the efforts being made by the government, financial market regulators, banks, and asset managers to revive this market. AT1 bonds, also known as additional tier-1 bonds, are a type of quasi-equity instrument that banks issue to raise capital. These bonds are considered complex securities and have sparked debates and court battles. The article highlights the challenges faced by the AT1 bond market and the differing views of banks and mutual funds regarding the valuation and risk associated with these bonds.

The key points and issues discussed in the article:

1. AT1 Bonds and Valuation:

• AT1 bonds are perpetual bonds with a call option that allows the issuing bank to redeem the bonds at the end of five years or later.
• The Securities & Exchange Board of India (SEBI) has introduced new valuation regulations that require investing funds to treat AT1 bonds as securities with a 100-year maturity, which has led to concerns among banks and mutual funds.
• Banks believe that the new valuation rules have lowered the appetite for AT1 bonds, while mutual funds argue that the bonds are treated worse than equities in the financial hierarchy, affecting investor interest.

2. Differing Views:

• There is a contentious subject with banks and fund houses differing in views. Banks believe that a change in the valuation technique, by lowering the bond tenor from 100 years to the year of the call option, would improve AT1 bond valuation in investors’ books and rekindle institutional demand. On the other hand, fund managers argue that investor interest would not be adequately restored as long as troubled banks can unilaterally write down the bonds without touching their equity.

3. Regulatory Issues:

• A fierce tussle broke out between bondholders and Yes Bank in March 2020 when the bank wrote down AT1 bonds but spared equity shareholders to save itself. This led to court battles and questions about the treatment of AT1 bonds.
• SEBI’s direction in March 2021 to treat the perpetual paper as a security with 100-year maturity for valuation purposes has further complicated the situation.

4. Call for Change:

• There is a growing feeling among stakeholders that a solution must be found for AT1 bonds, as many banks would find it tough to raise capital in the coming years without these bonds.
• Both banks and mutual funds are calling for a change in the valuation method and regulatory rules to address the challenges faced by the AT1 bond market.

In summary, the article highlights the challenges and debates surrounding the valuation and treatment of AT1 bonds in India. It underscores the need for regulatory changes and a concerted effort to revive the market for these complex securities.

FAQ:

Q1: What are AT1 bonds?

A1: AT1 bonds, also known as additional tier-1 bonds, are a type of quasi-equity instrument that banks issue to raise capital. These perpetual bonds have a call option that allows the issuing bank to redeem the bonds at the end of five years or later.

Q2: What are the regulatory challenges facing the AT1 bond market?

A2: The Securities & Exchange Board of India (SEBI) has introduced new valuation regulations that require investing funds to treat AT1 bonds as securities with a 100-year maturity, leading to concerns among banks and mutual funds. This has sparked debates and differing views on the valuation and risk associated with these bonds.

Q3: Why is there a debate between banks and mutual funds regarding AT1 bonds?

A3: Banks believe that a change in the valuation technique, by lowering the bond tenor from 100 years to the year of the call option, would improve AT1 bond valuation in investors’ books and rekindle institutional demand. On the other hand, fund managers argue that investor interest would not be adequately restored as long as troubled banks can unilaterally write down the bonds without touching their equity.