SEBI’s perpetual bonds diktat protects retail investors, but fallout could have been anticipated
The Securities Exchange Board of India’s circular to streamline ownership and valuation of Additional Tier-1 bonds and other perpetual instruments by debt mutual funds has stirred up an avoidable controversy. It tightens the screws in two ways. One, it specifies that no debt fund should invest more than 10 per cent of its Net Asset Value (NAV) in perpetual bonds and over 5 per cent in a single issuer from April 1. This is fair . With features that allow issuers to skip interest payouts and write-down principal, perpetual bonds are closer to equities in risk profile than debt. In fact, it is questionable if they belong in debt fund portfolios at all. With some funds burning their fingers in YES Bank and Lakshmi Vilas Bank, SEBI appears right in curbing their future exposures, while grandfathering their legacy holdings. Two, SEBI has also introduced new valuation rules that require funds to value perpetual bonds on traded prices, or if not traded, treat them as if they carry a 100-year maturity. The industry’s present practice of valuing perpetual bonds based on their call dates unrealistically plays down risks and inflates fund NAVs.
A workable solution could be for SEBI to allow mutual funds to launch new categories of high-yield or hybrid schemes for corporates and high net worth investors which have more liberal exposure limits. The fund industry, on its part, needs to stop constantly testing the regulatory boundaries with its sharp practices and adhere to some self-discipline. The IL&FS, DHFL and Franklin Templeton episodes have already dealt a body blow to the reputation of debt funds from which the industry will take a long time to recover.