RBI On Challenge To Yes Bank AT-1 Bond Write-Off: At Best An Investment Decision Gone Wrong

The arguments came in an affidavit filed by RBI in Madras High Court in response to a petition filed by 63 Moons Technologies.

A customer exits a Yes Bank branch in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A customer exits a Yes Bank branch in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

The Reserve Bank of India has defended its decision to write off additional tier-1 bonds issued by Yes Bank Ltd., saying the decision was in keeping with regulations governing such securities and the information memorandum issued to investors at the time of investment. It was “at best an investment decision gone wrong” for which investors can neither blame the regulator nor seek compensation from the lender, the regulator has argued.

The arguments came in an affidavit filed by the RBI in the Madras High Court in response to a petition filed by 63 Moons Technologies Ltd. challenging the decision. 63 Moons Technology had invested Rs 300 crore in AT-1 bonds issued by Yes Bank. AT-1 bonds worth Rs 8,415 crore were completely written off after a scheme of reconstruction for the bank was approved by the government and the RBI.

BloombergQuint has reviewed a copy of the affidavit.

The petitioner’s case is undeserving of any relief, interim or final, as it is contrary to both the Basel-III Circular and the terms of the Information Memorandum. It amounts to seeking interference with an economic policy decision of experts. Further, it is submitted that even the principle of estoppel and public interest are opposed to any relief being granted.
RBI Affidavit Filed In Madras High Court

The principle of estoppel is a legal principle which prohibits a person from arguing or asserting a right which contradicts something they previously agreed upon. In this case, the RBI argues, the bondholders agreed to the conditions specified in the information memorandum.

AT-1 Bonds Fall Under Basel-III Norms

A key argument made by the RBI is that AT-1 bonds fall under the Basel-III regulations, issued by the central bank in 2015. The RBI argues that the Basel-III circular has statutory force and there is no challenge to that circular.

According to Basel-III rules, such AT-1 bonds are required to absorb losses as per the specified trigger and at point of non-viability (PONV). The banks issuing such AT-1 bonds have discretion to even skip payment of coupon payment when capital falls below a specified trigger.

To compensate for the higher risks, these bonds carry a higher interest rate.

It is clear that the AT-1 bonds carry higher risk for which interest rate is also on the higher side. Investors in such financial instruments are by nature savvy, with risk appetite and cognizant of the high reward – high risk principle.
RBI Affidavit Filed In Madras High Court

Separately, the RBI argued that since the decision to reconstitute Yes Bank under Section 45 of the Banking Regulation Act itself triggered the PONV, allowing for the write-off of the AT-1 bonds.

Information Memorandum

Continuing its arguments that the bondholders were aware of the risks associated with investing in the AT-1 bonds, the risk factors were included in the information memorandum.

Yes Bank had raised funds by issuing AT-1 bonds through two tranches: Rs 3,000 crore worth of bonds issued in December 2016 and Rs 5,415 crore in October 2017.

According to the affidavit, Yes Bank had circulated a detailed information memorandum. This document clearly indicated that if the bank reaches a point of non-viability, it retains the right to either fully or partially write-off the investment or convert the bonds into shares.

In particular, the provision of conversion to equity was missing in the 2017 information memorandum, which only provided for their write-off, the RBI said.

Whereas, the terms of the Information Memorandum dated 17.10.2017 issued by the 3rd Respondent i.e. Yes Bank, for the issue of AT-1 Bonds in the year 2017 provided only for the write-off of the AT-1 Bonds and the provision to convert the AT-1 Bonds into common equity was absent. Thus both the Information Memorandum provided for writing off the AT-1 Bonds.
RBI Affidavit Filed In Madras High Court

No Provision To Write Off Equity Prior To AT-1 Write-Off

In the aftermath of the RBI’s decision, there has been a debate about whether equity should have been written down before the write-off of AT-1 bonds. In response to this argument, the RBI once again points to provisions in the information memorandum.

These documents, the RBI said, specify that “the write-off of any common equity or any other regulatory capital, whether senior or pari passu or subordinate, and whether a Tier-1 capital or otherwise shall not be required before the write-off of any of the bonds.”

The memorandum adds that “there is no right available to the bondholder or any other person claiming for or on behalf of or through such holder to demand or seek that any other regulatory capital be subject to prior or simultaneous write-off or that the treatment offered to holders of such other regulatory capital be also offered to the bondholders.”

Further, the information memorandum has no provisions for compensation of any loss incurred on account of a decision to write off such bonds.

....neither the bank nor any other person on the bank’s behalf shall be required to compensate or provide any relief, whether absolutely or contingently, to the bondholder or any other person claiming for or on behalf of or through such holder and all claims and demands of such persons, whether under law, contract or equity, shall stand permanently and irrevocably extinguished and terminated.
RBI Affidavit Filed In Madras High Court (Citing Provisions In Yes Bank AT-1 Bond Information Memorandum)

Why AT-1 Bond Write-Off Wasn’t In Notified Scheme

Questions had also been raised as to why the scheme of reconstruction notified by the government did not specifically mention the write-off of AT-1 bonds. The write-off had been mentioned in the RBI’s draft scheme but was not specified in the final notification.

Addressing this concern, the RBI said the power to write off AT-1 bonds is contractually governed between the debenture holders and Yes Bank. Additionally, it's provided for in the Basel-III master circular which continues to apply. “Hence the central government in its wisdom thought it fit not to include such provisions in the notified scheme.”

It added that the notified scheme postulates that the provision of contracts, bonds will have effect in the same manner as it existed prior to the commencement of the notified scheme. “As already mentioned in earlier paragraphs, the action for writing off has been rightly taken under the provisions of contract between Yes Bank and AT-1 bondholders,” the RBI said.

Protecting Depositors

The RBI said in its affidavit that the AT-1 bonds were a liability on Yes Bank’s books. As part of the resolution plan approved by the regulator, eight domestic lenders led by State Bank of India were investing more than Rs 10,000 crore worth equity in Yes Bank.

A large investment by SBI and other lenders in Yes Bank would bring in confidence from other investors and would also restore the operations of the private sector lender, the RBI said. This would essentially protect the interest of over two lakh depositors of Yes Bank.

If the AT-1 bonds had not been written off, the equity infusion would have gotten diluted in servicing these bonds, according to the RBI.

The regulator further specified that the bank’s financial position had worsened significantly.

According to the affidavit, Yes Bank’s liquidity coverage ratio as of February 26 was only at 26.88%, as compared with regulator requirement of 100%. Its statutory liquidity ratio for the bank had dropped to 6.99% in February, as compared with the regulator requirement of 18.25%.

Miss-Selling Issue Not Addressed

The affidavit filed in response to the 63 Moons petition does not go into the issue of miss-selling of these bonds.

A petition on behalf of institutional investors, which also includes the allegation of miss-selling, has been filed by Axis Trustee Services, the bond trustee, in the Bombay High Court.