Sebi revamp makes AT1 perpetual bonds suitable only for QIBs, savvy investors3 min read . Updated: 20 Oct 2020, 09:01 PM IST
There are some leading private sector banks in the country with decent fundamentals
Yes Bank’s additional tier 1 (AT1) perpetual bond write down—worth ₹8,415 crore—is being debated in the court of law. What we will discuss here, is the change in turf rules notified by the Securities and Exchange Board of India (Sebi) on 6 October. While AT1 bonds are issued by banks and the banks are regulated by the Reserve Bank of India (RBI), this circular has been issued by Sebi as the regulator for the secondary markets.
What we learnt from the Yes Bank episode is that these bonds stand the risk of being written off even when the bank is not being liquidated or even without writing off equity shares. The decision of writing off was taken by Yes Bank under an RBI restructuring scheme, hence the aggrieved investors do not stand much of a chance in the case. The other ground of complaint is mis-selling, as these bonds were sold to not-so-savvy individual investors as “similar to fixed deposits".
Drawing from the last point, some action was expected from the regulators, which has happened now. The Sebi circular says, inter alia: a) only qualified institutional buyers (QIBs) can participate in the issuance of AT1 instruments. The definition of QIBs includes banks, financial institutions, mutual funds and insurance companies, among others; b) minimum allotment size will be ₹1 crore; c) minimum trading lot size shall be ₹1 crore.
The thought process behind this dispensation is similar to that behind the investment vehicles of mutual funds, portfolio management services (PMS) and alternative investment funds (AIF).
The minimum investment amount in mutual funds is very affordable and it is tightly regulated, as it is meant for retail investors. The minimum ticket size for PMS is ₹50 lakh and rules are relatively lax. The ticket size for AIFs is ₹1 crore and it is subject to relatively light-touch regulations. Investors who can afford to invest ₹1 crore in one go are assumed to be having a much bigger overall portfolio, and are expected to be savvy and have the understanding of the risks involved in AIF investments. In case of AT1 perpetual bonds, apart from the minimum size of ₹1 crore, the nature of investors also has been mandated for forthcoming issuances.
Apart from the strict legal interpretation of the latest Sebi guidelines, we will look at the pragmatic interpretation.
If the secondary market transactions have to be compulsorily for QIBs for a lot size of ₹1 crore and above, then existing individual holders, mostly in exposure size less than ₹1 crore, would be stuck. Suddenly, by virtue of the Sebi circular, the investments of individual investors would turn illiquid. This would be a dis-service to investors and Sebi stands for investor protection.
As per bond dealers, the circular is applicable to fresh issuances and the secondary market trades in the fresh issuances. It is stated that “the following shall be the additional framework related to issuance, listing and trading of PNCPS and IPDIs which are proposed to be listed", in the context of the three bullet points mentioned earlier. PNCPS stands for perpetual non-cumulative preference shares, while IPDI means innovative perpetual debt instruments. The existing stock of bank AT1 perpetual bonds may still be traded in a lot size of less than ₹1 crore and non-QIB investors can trade as well.
Another aspect of the new regulation is that large corporates, who may not be part of the definition of QIBs, would not be eligible to invest or trade in these bonds. However, there are many corporates with sizeable treasury investments and the bandwidth to manage investments. The interpretation there is that a QIB would bid in the primary issuance in lot sizes of ₹1 crore and above and subsequently sell it to corporate treasuries or other non-QIB investors.
From an individual investor perspective, if you are holding a lot size of less than ₹1 crore, going by the practical interpretation, it may be possible to sell. So, you are not stuck with it till maturity. If you are considering purchasing AT1 bonds, either in a lot size of ₹1 crore or less, you have to be aware of the risks. For example, non-payment of coupon in case of losses at the bank and write off in an extreme case.
There is still a case for investment in these bonds, in spite of the risks, in the leading banks in India. Banks are the backbone of the financial system. There are leading private sector banks with decent fundamentals and public sector banks have implied government support. Sebi, on its part, has conveyed the message that it is meant for QIBs or investors who are savvy to understand the product.
Joydeep Sen is an author and corporate trainer (debt markets)