Will be allowed to hedge, not as market makers, say draft norms.
The Reserve Bank of India (RBI) is in favour of allowing foreign institutional investors (FIIs) in the credit default swap (CDS) market for corporate bonds when the product is launched.
In the draft guidelines on CDS released on Wednesday, RBI decided to include FIIs after receiving feedback on the draft report placed in August last year. Further comments have been invited up to March 8 before final guidelines are put in place.
“FII participation will help the CDS market to pick up in India as they are well versed with the product,” said a senior official of a public sector bank.
However, FII participation should be restricted only to buying credit protection to hedge their credit risk, says RBI. They have been kept out of the category of ‘market makers,’ who are permitted to quote both buy and/or sell CDS spreads.
Market makers include banks, standalone primary dealers, financially strong non-bank finance companies and any other institution approved by RBI.
CDS will be allowed only on listed corporate bonds. However, keeping in mind the need for infrastructure financing, CDS can also be written on unlisted but rated bonds of infrastructure companies.
CDS cannot be written on interest receivables and on securities with original maturity up to one year.
In terms of risk management, market participants are required to take the various risks associated with CDS into account and build robust risk management architectures.
RBI said market makers and users would have to report CDS trades on the reporting platform of the CDS trade repository within 30 minutes of the deal.
A CDS is a swap contract wherein the protection buyer, who has exposure to a bond or loan, makes regular payments to the protection seller, who assumes the risk if there is a default. RBI had earlier issued two drafts on CDS but deferred introduction due to the global financial crisis.
