The Securities and Exchange Board of India (Sebi) on Friday allowed mutual funds to participate as both buyers and sellers in the credit default swap (CDS) segment, providing greater flexibility to boost liquidity in the corporate bond market.
Till now, mutual funds were only allowed as buyers in the CDS segment—and had negligible participation owing to the restrictions. Further, mutual funds could only undertake such transactions in the portfolios of fixed maturity plan (FMP) schemes with a tenor of more than one year.
CDS facilitates risk mitigation and investments in lower-rated corporate bonds. It facilitates the swapping of the risk of default through a derivative contract and is akin to insurance. CDS allows an investor to offset their credit risk with another investor, who is willing to reimburse or pay a notional amount in case the borrower or the issuer of the bond defaults.
“Such flexibility to participate in CDS shall serve as an additional investment product for mutual funds and also aid in increasing liquidity in the corporate bond market,” said Sebi.
The market regulator has opened the segment to mutual funds with certain checks and risk management measures.
Sebi specified that MF schemes may sell CDS only as part of investment in synthetic debt securities, which means selling CDS on a reference obligation covered with cash, government securities (G-secs), or Treasury bills (T-bills). Overnight and liquid schemes will not be allowed to sell CDS contracts.
Further, schemes can buy CDS only for hedging their credit risk on debt securities.
“Exposure through CDS (notional amount of both CDS bought and sold) shall not exceed 10 per cent of the AUM of the scheme and shall be within the overall limit of derivatives exposure as prescribed in scheme information documents,” specified Sebi.
Further, the Association of Mutual Funds in India has been directed to issue guidelines for the valuation and accounting of CDS by MF schemes.
First Published: Sep 20 2024 | 7:33 PM IST
