Kotak and Nippon Halt Fresh Investments After Supreme Court Ruling on Yes Bank AT1 Bonds

Kotak Mahindra Asset Management and Nippon Life India Asset Management have paused fresh investments in certain funds following the Supreme Court’s decision to overturn Yes Bank’s ₹8,415-crore Additional Tier-1 (AT1) bond write-off from 2020. The ruling has triggered a reassessment of the securities’ valuation, with fund managers waiting for greater clarity on the financial implications.

The court’s October 15 decision upheld an earlier Bombay High Court judgment that invalidated the write-off carried out during Yes Bank’s restructuring. The bonds had previously been valued at zero after being extinguished as part of the bank’s rescue plan.

The immediate concern for mutual fund companies is how the judgment will affect the value of their holdings and, consequently, the net asset values (NAVs) of the schemes that own these securities.

Why Mutual Funds Have Paused New Investments

Kotak Mahindra Asset Management has temporarily suspended fresh subscriptions in its Kotak Medium Term Fund and Kotak Credit Risk Fund, both of which hold Yes Bank AT1 bonds.

Nippon Life India Asset Management has also paused fresh investments in certain funds with exposure to the securities while assessing the ruling’s implications.

The restrictions are intended to give fund managers time to evaluate how the restored bonds should be valued. If the securities receive a higher valuation, the change could affect the NAVs of the schemes holding them. Accepting substantial fresh investments before the valuation process becomes clearer could create complications for existing and incoming investors.

The suspensions do not necessarily mean that the affected funds have suffered losses because of the ruling. Instead, the managers are reviewing how the legal development could change the valuation of assets that had been carried at zero.

Investors should distinguish between a temporary suspension of fresh subscriptions and restrictions on withdrawals. The precise terms applicable to each scheme depend on the fund house’s official notice.

What the Supreme Court Decided

The dispute centres on Yes Bank’s decision in March 2020 to write off AT1 bonds worth ₹8,415 crore during its financial reconstruction.

AT1 bonds are financial instruments that banks use to strengthen their regulatory capital. They are designed to absorb losses when a bank faces financial stress and carry significant risks for investors. Unlike conventional bonds, these instruments can be subject to permanent write-downs under specified circumstances.

Bondholders challenged Yes Bank’s decision, arguing that the write-off was not authorised under the approved reconstruction scheme. The Bombay High Court ruled in their favour in January 2023, setting aside the action. Yes Bank, the Reserve Bank of India and the central government subsequently challenged that decision.

The Supreme Court has now upheld the High Court’s judgment, strengthening the position of investors who contested the write-off.

However, the ruling does not by itself settle every practical question surrounding the securities, including their valuation and the financial adjustments required to implement the judgment.

Potential Impact on Yes Bank and Investors

The decision could have consequences for both Yes Bank’s capital position and the investors who held the bonds before they were written off.

For the bank, restoring the securities could create additional financial obligations and affect its capital ratios. The lender has indicated that reinstating the bonds could reduce its core capital ratio by around 250 basis points.

For mutual fund investors, any upward revision in the bonds’ valuation could increase the NAV of schemes holding them. The eventual impact will depend on how the judgment is implemented, the valuation assigned to the securities and the funds’ exposure.

The episode also raises broader questions about the treatment of AT1 bonds during bank rescues and the balance between financial stability and investor protection.

For now, Kotak and Nippon are reviewing their positions as the market awaits greater clarity. The next steps in implementing the ruling will determine how the decision translates into changes in bond valuations, mutual fund NAVs and Yes Bank’s financial position.