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Debt MFs ' reported duration may rise following Amfi guidelines on AT1 bonds

Several categories of mutual funds are required to maintain their Macaulay duration within certain bounds. It is 1-3 years for short duration funds. It is unclear whether mutual funds breaching the limits will have to sell off their excess AT1 paper.Premium
Several categories of mutual funds are required to maintain their Macaulay duration within certain bounds. It is 1-3 years for short duration funds. It is unclear whether mutual funds breaching the limits will have to sell off their excess AT1 paper.

  • The reported Macaulay duration of the scheme will increase and every investor will have to take a call on whether he or she wants to continue with this type of scheme

On 24 March, The Association of Mutual Funds in India (Amfi) issued a circular on the valuation of Additional Tier 1 (AT1) bonds and Tier 2 bonds issued by banks. A key provision of the guidelines is a requirement for funds to consider the Macaulay duration of the AT1 bonds according to a Sebi-mandated glide path. This is likely to shoot up the reported Macaulay duration of debt funds which in some cases may breach category rules. Several categories of mutual funds are required to maintain their Macaulay duration within certain bounds, for instance 1-3 years for short duration funds. It is unclear whether mutual funds breaching the limits will have to sell off their excess AT1 paper.

A Sebi circular on 10 March had mandated that these bonds were to be valued as if they had maturity of 100 years. However, following an outcry from the mutual fund industry apprehensive about write downs and a letter from the Department of Financial Services (DFS) concerned about its effects on fundraising by PSU bank bonds, the regulator had diluted its original circular. Sebi introduced a ‘glide path’ asking for the bonds to be valued at 10 years maturity, which would gradually be hiked to 20, 30 and then 100 years maturity (from 31st March 2023). The regulator also asked Amfi to come up with detailed guidelines on valuation, following which the industry association issued yesterday’s circular. "In case of schemes with maturity limits stipulated by Sebi where AT1 bonds are breaching the limits due to revaluation it is not clear whether the funds will have to sell off the AT1 paper or whether the exposure is grandfathered. But in either case, the reported Macaulay duration of the scheme will increase and every investor will have to take a call on whether he or she wants to continue with this type of scheme," said Mahendra Kumar Jajoo, chief investment officer, Mirae Asset Mutual Fund.

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According to the Amfi circular, valuation of AT1 bonds is to be done according to traded prices. However, if the bond is not traded, then trades of similar issuers will be taken into account for valuation. There will be multiple groups of similar issuers and maturities for valuation purposes. The deemed residual maturity of AT1s will be 10 years till 31 March 2022, 20 years from 1 April 2022 to 31 September 2022, 30 years from 1 October 2022 to 31 March 2023 and 100 years after 31 March 2023. For Tier 2, it will be lower of 10 years and contractual maturity till 31 March 2022 and contractual maturity thereafter. Mutual Fund schemes will have to use the deemed residual maturity of the individual bond (ISIN) while calculating Macaulay duration. They will have to disclose both Yield-to-Call and Yield-to-Maturity of debt papers.

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