Mutual Funds Urge Sebi to Relax 100-Year Maturity Norm for AT-1 Bonds to Boost Investment

Mutual funds are preparing to request the Securities and Exchange Board of India (Sebi) to relax the stringent 100-year maturity requirement for Additional Tier-1 (AT-1) bonds, a move that could significantly boost fund houses' investment in these high-yielding debt instruments. AT-1 bonds, which are perpetual in nature, have become a crucial tool for banks to shore up their equity capital. However, the long maturity period imposed by Sebi has deterred many mutual funds from investing in these securities.

Sebi had introduced the 100-year maturity requirement as a safeguard for retail investors following the Yes Bank crisis, which saw significant losses on AT-1 bonds. These bonds, being perpetual, do not have a fixed maturity date, but Sebi’s mandate required them to be valued as 100-year instruments starting from April 2023. Before this change, these bonds were valued based on their call options, typically around 10 years.

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"The maturity requirement of 100 years for AT-1 bonds continues to be a hurdle for mutual fund investments, even though Sebi has provided some leeway regarding valuation norms," said a source familiar with the ongoing discussions between mutual funds and the regulator. "A committee from the Association of Mutual Funds in India (AMFI) is expected to suggest reducing the maturity closer to the call option, making these bonds more attractive for mutual funds."

Sebi’s decision to shift the valuation method to yield-to-call was initially aimed at reducing volatility in the Net Asset Values (NAVs) of mutual funds investing in AT-1 bonds. While this change offered some stability, the 100-year maturity rule still limits the scope of investment, especially for funds with shorter-duration mandates. "A lot of mutual funds have mandates that restrict duration, such as short-term funds limited to 1 to 1.5 years," said another source. "Even a small investment in an AT-1 bond under the current rules can sharply increase the average maturity of the portfolio, leaving little room for further investment."

The impact of these regulations has been evident in the dwindling mutual fund investments in AT-1 bonds. As of December 2023, the total investment value in AT-1 bonds by mutual funds had dropped to ₹2,123 crore, a steep decline from ₹25,057 crore in January 2020, just before the Yes Bank crisis. This decline has raised concerns about the long-term viability of AT-1 bonds as a funding mechanism for banks, especially as they continue to face pressure to raise capital amidst slower deposit growth.

In response to these challenges, banks have significantly reduced their issuance of AT-1 bonds. Data from CRISIL Market Intelligence and Analytics revealed that in FY24, banks issued AT-1 bonds worth ₹17,657 crore, compared to ₹34,394 crore in FY22. So far in FY25, only one AT-1 bond issuance has taken place, with Canara Bank raising ₹3,000 crore through such instruments in August.

AT-1 bonds are considered riskier than traditional debt instruments due to the provision that allows banks to write off these securities in the event of financial distress. However, when issued by highly-rated banks with strong financials, the risk perception is mitigated, making them an attractive option for investors seeking higher yields. Despite these benefits, the current maturity norms have made it difficult for mutual funds to include these bonds in their portfolios without significantly altering their risk profiles.

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Mutual funds are now hoping that Sebi will consider their request to reduce the maturity requirement, aligning it closer to the call option period. Such a move could rejuvenate interest in AT-1 bonds, providing banks with a reliable source of capital and offering investors a viable option for higher returns.

Source: ET