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SEBI issues new directive on capping mutual fund exposure to perpetual bonds

The SEBI move on perpetual bonds is towards better risk management and diversification in debt funds and should help make such funds more secure.

What’s the news?

SEBI issues circular on capping exposure to perpetual bonds and also changes the valuation methodology of these bonds

What does that mean?

Perpetual bonds are fixed-income securities with no maturity date. These instruments are usually issued by Banks and NBFCs to augment capital and meet prudential capital requirements. A regular coupon, which is typically higher than other debt instruments like corporate bonds or debentures, is paid on these bonds by issuers.

SEBI also capped investments by a mutual fund house under all its schemes in bonds with special features at not more than 10% from one issuer. It also specified that no MF scheme can hold more than 10% of its net asset value (NAV) of its debt portfolio in such bonds, and not more than 5% of the NAV of the debt portfolio should be in such bonds from one issuer.

The limits will apply only to new investments beginning 1 April 2021. SEBI in its circular also clarified that the maturity of all perpetual bonds shall be treated as 100 years from the date of issuance of the bonds for the purpose of valuations. 

The Ministry of Finance through a memorandum has requested SEBI to withdraw a provision of its circular to value perpetual bonds at 100 years.

The Ministry cited that there is currently no benchmark for valuing perpetual bonds at 100 years and the move could result in mark-to-market losses, panic redemptions in debt markets and thereby result in higher borrowing costs for banks at a time when the economy is still trying to recover from the throes of a pandemic.  As per MOF, mutual funds currently hold more than 35,000 Cr of the outstanding AT1 issuances of Rs 90,000 Cr.

Why does this matter?

These measures taken by SEBI are in the interest of investors and ensure that prudent risk management systems are in place. The diversification of risk and limiting exposure levels are practices that will bear fruit in the long run.

How does that affect your wealth?

After looking into the scripbox current recommended debt funds’ exposure to perpetual bonds, only ICICI Pru Saving Fund (G) has 7.25% exposure into the same. This Fund’s NAV may experience short-term volatility. However, in the long-term, fundamentals of prudent investing will prevail.

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