PremiumMUMBAI : When news emerged in March 2020 that the restructuring of fraud-hit Yes Bank would involve the write off of ₹8,415 crore worth of a special category of bonds called additional tier one, or AT-1 bonds, investors rubbed their eyes in disbelief.
This ran counter to the conventional understanding of what happens in the worst-case scenario for a company—insolvency or bankruptcy. Bondholders are treated as creditors and their claims are deemed more urgent in the waterfall mechanism of India’s insolvency proceedings. Equity shareholders come last and expect to get wiped out when a company goes bust. But Yes Bank did not get liquidated, it was restructured. Equity holders got diluted, but did not get wiped out, unlike the AT-1 bondholders. While AT-1 is a special category of bonds, they were sold to investors without adequate disclosures about the risk they carried. So investors who were sold the bonds as an alternative to fixed deposits were suddenly told their money had vanished.
Nearly two years later, the debris from the implosion is still littered over India’s legal and financial regulatory landscape. The decision is being contested in courts by the bondholders and mutual funds that have taken a ₹8,000 crore hit. The market for AT-1 bonds in India is now as good as gone. Banks that have since issued AT-1 bonds—HDFC and Axis Bank—have gone overseas to raise capital. And two of India’s top financial regulators—banking regulator RBI (Reserve Bank of India) and markets regulator Sebi (Securities and Exchange Board of India) can’t seem to agree on what actually happened to Yes Bank’s AT-1 bonds.
Amid this train wreck, Mint is today reporting two developments key to the saga.
The first reveals how the RBI changed its stance on AT-1 bonds after a nudge from the ministry of finance. The second is that the markets regulator has commenced an investigation into the mutual funds that subscribed to Yes Bank’s AT-1 bonds.
Spokespersons at RBI, Sebi and the ministry of finance did not respond to a request for comment.
“Possible Litigation"
The department of financial services at the ministry of finance, in response to a Right to Information (RTI) filing by L.V. Srinivasan, an RTI activist from Chennai, said the RBI was not originally in favour of the write-off of AT-1 bonds. In subsequent public pronouncements and judicial pleadings, however, it threw its weight behind the decision. The RTI response shows the RBI’s stance as being that AT-1 bonds of Yes Bank should not be written off and only “write down" or “conversion" (to equity) should be done to reduce the possibility of litigation.
This reply has been reviewed by Mint.
In a secret internal note on Yes Bank restructuring by the Department of Financial Services (released as part of the RTI response), the RBI’s stance is captured thus:
“RBI guidelines on BASEL-III capital regulations, write-off/ conversion of AT-1 capital has to happen before write-off of common equity of tier-1 capital. RBI has further stated that it is seen that the term sheet of AT-1 bonds provide multiple options providing only write down or conversion or write down which could lead to possible litigation."
By conversion, the RBI meant converting the bonds into equity and write down meant reducing the value of AT-1 bonds to a certain level rather than reducing it to zero. RBI had further taken the suggestion of AT-1 bond trustees to convert a fraction of their bonds into equity and suggested modifications to the draft reconstruction scheme.
However, these changes were dropped on DFS’ urging that it may not be appropriate to modify. “Accordingly, related provisions in draft scheme furnished by RBI may be dropped," said the DFS note.
The contradictory RBI stance
RBI’s public stance versus what it said privately to DFS makes for an interesting case.
In July 2020, RBI stated in a filing in the Madras High Court that these bonds carry higher interest rates in lieu of risks that these can be written off. It further added that the bondholders cannot enjoy higher returns and cry foul when the instrument fails.
But the file noting obtained through RTI shows the RBI as saying the term sheet of AT-1 bonds only envisaged ‘a write down’ or ‘conversion’.
The note added that to prevent any further present and future litigations, the bond trustee of AT-1 bonds suggested conversion. The bonds would have been converted at ₹51 (these bonds were giving returns as high as 9.5%), which would be tantamount to 20% value of their investment with the possibility of upside in the future.
Axis Trusteeship (trustee of the AT-1 bonds) representing the interest of large creditors, including Nippon Mutual Fund, Franklin Templeton India, Barclays and Kotak Mutual Fund, by then had already filed a case in the Bombay High Court for a stay on the restructuring scheme. Till late March 2020, the court had not granted a stay.
As per the file notes, RBI had considered the trustee’s suggestion for converting their holding into equity.
“RBI has informed that the suggestion has been suitably considered and incorporated in the revised reconstruction scheme," said DFS.
“The whole purpose of writing-off the AT-1 bonds is to ensure that the capital infused by the public sector i.e. SBI and other investors should not be diluted. The AT-1 bonds are a liability and hence, the same should be written off for the effective implementation of the notified scheme, which is made in the interest of the general public and to regain the confidence of the depositors," the RBI said in an affidavit in the Madras High Court in July 2020, in a case filed by 63 Moons Technologies Ltd (formerly Financial Technologies India Ltd), which had made an investment of ₹300 crore in Yes Bank’s AT-1 bonds.
Axis Trusteeship is still fighting a legal battle in the Bombay High Court on behalf of the bondholders. The trustee has claimed that this write-off discriminates against AT-1 bondholders as compared to erstwhile 51% shareholders.
“Respondent Nos. 1 to 3 (RBI and the RBI-appointed administrator) failed to appreciate that in view of a prima facie discovery of fraud within Respondent No. 4 bank (Yes Bank), it was not open to Respondent No. 4 to exercise its contractual and/or statutory rights to write down the debt of Respondent No. 4 towards the bondholders while keeping intact the shares of the persons who are said to have been committed a fraud," said the AT-1 bondholders in the petition.
Yes Bank’s founder and former chief, Rana Kapoor is presently in jail in a case of alleged money laundering and cheating at the bank. The bondholders have also been claiming that, considering that a case of fraud has been detected at the bank, the framework for write-off should not have been applied at all.
The Sebi stance
By now it is already established that the AT-1 bonds were miss-sold to many investors as super fixed deposits.
Consider the 12 April 2021 order issued by Sebi. In the order, the regulator levied a penalty of ₹25 crore on the bank and three other officials. Vivek Kanwar, head of Yes Bank’s private wealth management, was asked to pay ₹1 crore in penalty, while two of his juniors—Jasjit Singh Banga and Ashish Nasa—were asked to pay ₹50 lakh each.
The matter has currently been stayed by Securities and Appellate Tribunal (SAT).
Undeterred by the stay, the market regulator has started a probe against the mutual fund houses who invested in these bonds. The regulator has started examining violations of model code of conduct and for compromising on the interest of retail investors who invested in the funds having Yes Bank’s AT-1 bonds in their portfolio, regulatory officials told Mint, declining to be named.
These include Kotak Mutual Fund, Nippon Mutual Fund, Franklin Templeton India and UTI Mutual Fund.
“The fund houses knew since the beginning that these bonds are risky and carry risk equivalent to equity, so why did the funds not apply their prudence while investing in them through debt funds. Debt funds are supposed to carry lower risk than equity," said a Sebi official, declining to be named.
Further, the buying by these mutual funds was used by the Yes Bank wealth management team to sell this risky instrument to individual investors, he added.
But the original order by the market regulator, which called the sale of AT-1 bonds by former Yes Bank management as miss-selling, is contradictory to RBI’s approach.
Sebi received over 12 complaints in 2020, all alleging that the bonds were sold to gullible investors through fraud and by hiding facts. However, the RBI has been steadfast in not acknowledging any miss-selling. In its July 2020 affidavit in Madras High Court, the Central Bank said that the investors invested in these bonds with their eyes open.
Sebi in its order, to the contrary, observed that Yes Bank and its wealth management arm had facilitated sale of AT-1 bonds of Yes Bank and individual investors were not informed about all the risks involved in subscription of AT-1 bonds. This made the sale fraudulent, the regulator argued.
There was a considerable push from Rana Kapoor to down-sell the AT-1 bonds to individual investors which led to private wealth arm acting recklessly, said Sebi.
“AT-1 bonds were compared with fixed deposit on rate differential only, but omitted the risk differentials which led the investors to look only at the higher interest rate on the AT-1 bonds without realising that these bonds have inherent risk associated with it," said the market regulator in its order.
“The bank cited interest of institutional investors in the product to down-sell the same to individual investors which were unsuitable/ comparatively risky for them. The same also led the investors to believe that since such big institutions are buying the product, the same shall also be suitable for them without realising that risk taking capacity of institutional investors and individual investors are quite different," the regulator added.
The order is currently stayed by SAT on the grounds that Yes Bank’s relationship managers who sold these bonds to individual investors ought to be made party to the order.
Course correction
“It is the bondholders who are facing the brunt of poor regulations, regulatory checks and a fraud whereas the equity shareholders have been kept safe. This is contrary to almost all prevalent legal checks. In cases of financial stress, equity is the last to be saved and in case of fraud, the victims are compensated," said a senior regulatory researcher, who asked not to be named.
The Insolvency and Bankruptcy Code (IBC) also gives the first right of recovery against fraudulent transactions to the creditors including bondholders.
Even in the Dewan Housing Finance Ltd bankruptcy case, the bondholders had to fight an uphill battle to get a fraction of their investment back. These bondholders include Army Group Insurance Fund, Capgemini Business Employee Provident Fund Trust, Yes Bank, 63 Moons Technologies Ltd, Mudra Fincorp Pvt Ltd, L&T Finance Ltd, Uttar Pradesh Power Corporation Contributory Provident Fund Trust, Leprosy Foundation, Uttar Pradesh State Power Sector Employees Trust and the fixed deposit holders.
It is only now that investors who had invested less than ₹2 lakh are getting the entire amount back, while the other fixed deposit holders are receiving only 23% to 46% of their principal.
However, in the case of Yes Bank, there has been no such relief. Mutual Funds who invested in the AT-1 bonds did not lose their own money but of their customers and individual retail investors.
In October 2020, the markets regulatory course-corrected and said only qualified institutional buyers could purchase such bonds. In March 2021, Sebi said mutual funds cannot invest more than 10% of their debt assets in such bonds and not more than 5% in the issuance of a single entity.
For investors who might have been mis-sold an instrument and now see little hope of getting their money back, this might seem too little too late.
