Additional Tier (AT)-1 bonds, popularly known as perpetual debt instruments are issued by banks to raise money and build up their core equity capital. Banks have a call option that permits them to redeem these bonds after a certain period. Prior to the report on valuation of AT-1 bonds issued by the National Financial Reporting Authority (NFRA), the valuation of the bonds was prescribed in the following manner:
- By SEBI: AT-1 bonds were required to be valued basis Yield To Maturity (YTM), where the maturity of these bonds was considered 100 years. This valuation was applicable to mutual funds and insurance companies19 The Insurance Regulatory Development Authority of India (IRDAI) vide a master circular required insurance companies to comply with the valuation directions issued by SEBI for mutual funds. .
- By RBI: Banks were required to value AT-1 bonds on Yield to first Call (YTC) basis20 Yield to Call is the expected return an investor gets if they buy a bond and hold it until the issuer repurchases it on call date, before maturity. . These valuation norms were in accordance with the principles of Ind AS 113, Fair Value Measurement.
Considering the divergence in the valuaton requirements by SEBI and RBI, the Ministry of Corporate Affairs (MCA) requested NFRA to suggest a methodology for valuation of AT-1 bonds, which would be in sync with Ind AS 113
Based on market consultation and its study, in July 2024, NFRA issued a report on ‘Valuation methodology for Additional Tier (AT)-1 bonds’ (valuation report), which recommended that valuation of AT-1 Bonds should be on YTC basis (adjusted with appropriate risk spreads)21 The rationale for such valuation is that based on market practice, AT-1 bonds have been observed to trade at or quote prices closer to YTC basis- accordingly, this basis of valuation is in line with the principles of valuation stipulated by Ind AS 113. . However, NFRA also clarified that the issue of deemed maturity date for other purposes is outside NFRA’s remit.
Subsequent clarification by SEBI
Subsequent to the issuance of the valuation report by NFRA, on 5 August 2024, SEBI issued a circular clarifying the following:
- Valuation of AT-1 Bonds by Mutual Funds should be based on YTC basis
- For all other purposes, deemed maturity of all perpetual bonds would continue to be as per the earlier circulars.
Action points for auditors
- Given that IRDAI requires insurance companies to follow the valuation rules prescribed by SEBI from time to time. Accordingly, insurance companies should also take heed of the circular issued by SEBI on 5 August 2024.
- Auditors would need to review the revaluation of AT-1 bonds held as investments by mutual funds and insurance companies based on the revised circular issued by SEBI. Also, auditors should discuss with management on how they would disclose the adjustments on revaluation of such investments.