Stringent norms on Credit Default Swap (CDS) for corporate bonds, as prescribed by the Reserve Bank of India (RBI), may limit development of the market, bankers said. Other than some technical fine-tuning, the instrument may also face the problem of regulatory overlap.
“For market makers, there are possibilities of overlap and arbitrage due to multiplicity of regulators,” said a senior official with a public sector bank. Also, the CDS market will have to wait for the regulators to come up with eligibility norms for participants falling under their purview, which may take a lot of time.
Eligibility norms prescribed by RBI for Primary Dealers and Non-Banking Finance Companies require minimum of 15 per cent capital adequacy and Rs 500 crore of net owned funds. “Such stringent eligibility criteria will restrict participation and limit the number of market makers,” the official added.
The draft says restructuring shall not be permitted as credit event. “This may need further deliberation since in the current environment restructuring is often opted and is rampant,” said a senior official from a foreign bank. The credit events specified in the CDS contract covers bankruptcy, failure to pay, repudiation/moratorium, obligation acceleration and obligation Default. There is no leverage ratio limit fixed in the draft norms. “There could be a possibility of outstanding value of the swap being much larger than the value of underlying which would pose systemic risk,” said the official.
In terms of documentation, bankers suggest it should be unified for both users and market makers, thus, making it easy for migration from OTC to exchange trading.
Market makers are supposed to assess the genuineness of the underlying exposure of the user. “The onus of responsibility to prove eligibility for exposure should be on the user instead,” said a senior public sector banker.
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According to the draft norms, users can unwind their positions with the original seller only and assignment is allowed but only when the underlying bond is sold. “This clause may put users in the disadvantageous position while negotiating price for unwinding the contract,” said a private sector banker.
RBI accommodated recommendations from the market players on allowing participation of foreign institutional investors, but limited it to only buying credit protection to hedge their credit risk. Feedback has been again invited by March 8 before the final guidelines are put in place. Even after the above alterations are made, the credit default swaps market will have a dull start as the corporate bond market is illiquid, bankers said.