Credit derivatives likely in corporate debt mart

The Reserve Bank of India (RBI) is in favour of introducing credit derivatives in the corporate debt market.

According to market sources, the technical advisory committee of the RBI is learnt to have recommended credit derivatives as one of the most important instruments to widen and deepen the corporate debt market.

This is because bond market investors need to have proper hedging instruments when they run risk of default from companies whose bonds they have invested in.

Credit derivatives are two-way and at times even three-way financial contracts that isolate specific aspects of credit risk from an underlying asset (usually a bond or a loan) and transfer that risk between the parties to a contract.

In corporate debt, sources said, the investor is primarily taking a risk by lending money to a corporate by investing in bonds issued by it. The investor always runs the risk of corporate defaulting.

Since the yield on a corporate bond is a spread over the comparable government security, the investor can deal on the spread over the gilts without actually buying the bond through credit derivatives.

Credit derivatives as a tool can be used mostly by institutional investors - banks, broker-dealers, institutional investors, money managers, hedge funds, insurers, re-insurers and corporate treasurers.

Moreover, the group has also suggested listing of mortgage-based and asset-based securities so that securitised instruments could get traded on the exchanges. This would help in generating liquidity to the securitised debt market and diversify risk.

Credit derivatives operate in the form of various options "" credit swap, credit default swap, total return swap and credit option. The government as well as the RBI have initiated measures to develop the corporate debt market.

While the recent budget has reiterated the need for drawing a roadmap for the development of the debt market, former RBI deputy governor Rakesh Mohan had set up technical committees for reviewing the corporate debt market.

The Securities and Exchange Board of India in 2003 had brought in a slew of reforms to streamline the private placement market. Under the current procedures, bonds privately placed with institutional investors could only get traded on the exchanges if they are listed with proper offer document.

Meanwhile, State Bank of India, the largest commercial bank in the country, has already started offering credit derivatives as part of its treasury activities.