With the Finance Ministry pressuring SEBI to withdraw the AT1 bond rules, what do you think SEBI would do?

Let us first understand why the objections are coming to this new AT1 bond rule. Remember that Banks rely on AT1 bonds as easy means of boosting Tier-1 capital. For these banks, the debt mutual funds have been a huge captive market for AT1 bonds and this rule would mean that the appetite of mutual funds for AT1 paper would sharply come down. SEBI limits on investment in AT1 bonds and the 100-year tenure will discourage MFs from AT1s.

To begin with, MFs will have to take huge provisions for such AT1 bond holdings if the 100-year tenure rule is implemented. Banks worry that such a move would discourage MFs from participating in the future AT1 bonds, even if current holdings are grandfathered. Hence, banks have lobbied hard with the Finance Ministry to get this SEBI circular repealed.

Interestingly, nobody really denies that the SEBI circular on AT1 bonds is the need of the hour. Classifying AT1 bonds like government securities, as they are being done now, is conceptually erroneous as it does not reflect the risk. It is good to make provision rules stringent as it would also make MFs more wary about investing in AT1 bonds due to the provisioning cost entailed. It would be good for debt fund investors overall.

In 2020, we saw two major AT1 bond defaults by Yes Bank and LVB; and both were with the approval of the RBI. have highlighted the risks in AT1 bonds and SEBI is right in trying to ensure that MF investors are protected. Even apart from AT1 bonds, there are enough cases where debt fund investments have come under a cloud. While it may be diluted now to avoid disruption, it would be best to have these rules in the interest of MF investors.