NFRA Proposes Review Of Valuation Methodology Of AT-1 Bonds

The National Financial Reporting Authority has proposed a review of the valuation methodology for AT-1 bonds issued by banks to raise capital, where they need to be revisited every three years at the very least, to consider changes in accordance with market practices.

Banks are allowed to issue AT-1 bonds, which are perpetual debt instruments, featuring loss absorption mechanisms and offer higher coupon rates due to their inherent risks. These bonds serve as a crucial source of quasi-equity capital for banks worldwide. Investors in AT-1 bonds include mutual funds, corporations, and various institutional investors.

The authority has prepared a report on the valuation methodology for AT-1 bonds following a reference from the government.

In January this year, Ministry of Corporate Affairs referred to NFRA a proposal of Department of Economic Affairs, for deliberation and recommendation on the methodology for valuation of AT-1 bonds.

The NFRA cited Ind AS 113 and how it emphasises valuation based on market practice, to explain how their recommendations are based on the current market behaviour, which they described as 'dynamic'.

"Hypothetically, it may happen that market practice becomes such that most AT-1 bonds are not called by the issuers. The market in that case may value these bonds at YTM (Yield To Maturity) or yield to worst. Therefore, it will be necessary to monitor market practice and see whether there is any change over time. It is therefore recommended that at least once in three years, the valuation methodology may be revisited to consider for the changes in market practice, if any," the report said.

NFRA considered the valuation methodology for the bonds in sync with Indian Accounting Standard 113. The theme underpinning the fair value measurement in Ind AS 113 is a market-based measurement considering the traded/quoted prices, data and information observed from the markets and the assumptions and practices of market participants.

The fair value principles of Ind AS require determination of valuation assumptions or approaches generally used by the market participants.

In March 2021, markets regulator SEBI had issued a circular that stipulated prudential investment limits for mutual funds for AT-1 bonds. Among others, it was stipulated that the maturity of all perpetual bonds be treated as 100 years from the date of issuance of the bond for the purpose of valuation.

Against this backdrop, NFRA has prepared the report on the valuation methodology.

(With Inputs From PTI)