Mutual funds in India face a cap on their investments in perpetual bonds issued by banks after new rules were issued by the country’s financial regulator.
However, the move has met some opposition from the country’s ministry of finance amid concern that it could damage investor appetite for the fixed income assets.
The circular issued by the Securities Exchanges Board of India (SEBI) states that a mutual fund cannot invest more than 10% of its capital on additional tier 1 (AT1) and tier 2 (AT2) bonds from a single issuer. Nor can a mutual fund hold more than 10% of its net asset value in the asset class.
Closed-ended funds or funds with a definite maturity date are prohibited from investing in the perpetual bonds.
The move is designed to provide more protection to retail investors should banks default on their debt repayments. The perpetual nature of the bonds mean there is no maturity date and allows issuing banks more leeway on repayment obligations.
The issue came to prominence in 2020 when investors in Yes Bank’s AT1 bonds saw their entire holdings in these bonds wiped off as part of the Reserve Bank of India’s rescue plan for the bank.
The finance ministry has agreed to the caps but has asked the SEBI to withdraw its provision that perpetual bonds have a 100 year tenor for the purpose of valuation.
The ministry has argued that this measure would reduce the net asset value (NAV) of the bonds, lead to mark to market losses and panic buying in the market as mutual funds sell the instruments in anticipation of a rush of redemptions by investors.
© 2021 funds global asia 
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