New Delhi: Capital markets regulator Sebi on Friday proposed to allow mutual funds more flexibility in buying and selling investment product credit default swaps (CDS) in a bid to further develop the debt market in the country.
Under the current framework, mutual funds are allowed to participate in CDS transactions only as users – only to purchase credit protection to reduce the credit risk on corporate bonds held by them.
Further, this transaction can be undertaken by the mutual fund only in the portfolio of Fixed Maturity Plan (FMP) schemes with a tenure of more than one year.
In its consultation paper, the regulator has suggested allowing participation of mutual funds in CDS purchases as well as CDS sales for all schemes except overnight and liquid.
The proposal comes after the Reserve Bank of India (RBI) on February 10, 2022, specified the revised regulatory framework for CDS to further develop the debt market in the country.The guidelines seek to provide the necessary impetus for the growth of the CDS market by expanding the base of security sellers including selling of security by all major non-bank regulated entities, including mutual funds.
The Securities and Exchange Board of India (SEBI) has sought comments on the proposal till July.
In market parlance, CDS means a credit derivative contract in which one counterparty (protection seller) commits to make a payment to another counterparty (protection buyer) in case of a credit event and in return, the protection buyer makes periodic payments. (Premium) does. The security seller till the maturity of the contract or credit event, whichever is earlier.
Accordingly, buying a CDS is similar to buying insurance.If a debt security on which a CDS has been purchased defaults, the security seller (the seller of the CDS) pays the notional amount (the amount of the debt security) and takes over the debt security in default. .
According to the consultation paper, SEBI has suggested that mutual fund schemes should be allowed to purchase CDS only to reduce their credit risk on debt securities held in all the schemes. If a protected debt security is sold, schemes should ensure that the related CDS position is closed out within 7 days of selling such protected debt security.
MF schemes should purchase CDS only from CDS programs rated by credit rating agencies.
On selling CDS, SEBI has suggested that mutual fund schemes should be allowed to sell CDS only as investors in synthetic debt securities – sell CDS on reference obligation covered with cash, government-securities and treasury bills.Overnight and liquid schemes should not be allowed to sell CDS contracts.
Additionally, the regulator has suggested that mutual funds should ensure a two-way credit support annex (CSA) as part of the CDS contracts. Two-way CSA reduces counterparty risk – the risk that the security seller is unable to pay, given a default on the reference obligation – because margin is kept by both parties.
Under the current framework, mutual funds are allowed to participate in CDS transactions only as users – only to purchase credit protection to reduce the credit risk on corporate bonds held by them.
Further, this transaction can be undertaken by the mutual fund only in the portfolio of Fixed Maturity Plan (FMP) schemes with a tenure of more than one year.
In its consultation paper, the regulator has suggested allowing participation of mutual funds in CDS purchases as well as CDS sales for all schemes except overnight and liquid.
The proposal comes after the Reserve Bank of India (RBI) on February 10, 2022, specified the revised regulatory framework for CDS to further develop the debt market in the country.The guidelines seek to provide the necessary impetus for the growth of the CDS market by expanding the base of security sellers including selling of security by all major non-bank regulated entities, including mutual funds.
The Securities and Exchange Board of India (SEBI) has sought comments on the proposal till July.
In market parlance, CDS means a credit derivative contract in which one counterparty (protection seller) commits to make a payment to another counterparty (protection buyer) in case of a credit event and in return, the protection buyer makes periodic payments. (Premium) does. The security seller till the maturity of the contract or credit event, whichever is earlier.
Accordingly, buying a CDS is similar to buying insurance.If a debt security on which a CDS has been purchased defaults, the security seller (the seller of the CDS) pays the notional amount (the amount of the debt security) and takes over the debt security in default. .
According to the consultation paper, SEBI has suggested that mutual fund schemes should be allowed to purchase CDS only to reduce their credit risk on debt securities held in all the schemes. If a protected debt security is sold, schemes should ensure that the related CDS position is closed out within 7 days of selling such protected debt security.
MF schemes should purchase CDS only from CDS programs rated by credit rating agencies.
On selling CDS, SEBI has suggested that mutual fund schemes should be allowed to sell CDS only as investors in synthetic debt securities – sell CDS on reference obligation covered with cash, government-securities and treasury bills.Overnight and liquid schemes should not be allowed to sell CDS contracts.
Additionally, the regulator has suggested that mutual funds should ensure a two-way credit support annex (CSA) as part of the CDS contracts. Two-way CSA reduces counterparty risk – the risk that the security seller is unable to pay, given a default on the reference obligation – because margin is kept by both parties.
