Market regulator Sebi allows MFs to buy, sell credit default swaps

Sebi has set conditions for the flexibility to ensure risk management

The Securities and Exchange Board of India (Sebi) on Friday allowed mutual funds to participate as buyers and sellers in the credit default swap (CDS) segment and allowed greater flexibility to boost liquidity in the corporate bond market.

The mutual funds (MFs) were previously only allowed as buyers in the CDS segment — with negligible participation owing to restrictions.

The MFs could take such transactions only in the portfolios of fixed maturity plans (FMP) schemes having 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.

Sebi specified that MF schemes may sell CDS only as part of investment in synthetic debt securities, which means sell CDS on a reference obligation covered with cash, g-sec or T-bills. Overnight and liquid schemes will not be allowed to sell CDS contracts.

The schemes can buy CDS only for hedging their credit risk on debt securities.

MF schemes may sell CDS only as part of investment in synthetic debt securities. Overnight and liquid schemes shall not sell CDS contracts.

“The exposure through CDS (Notional amount of both CDS bought and sold) shall not exceed 10 per cent of AUM of scheme and shall be within the overall limit of derivatives exposure as prescribed in Scheme Information Documents,” Sebi noted.

The Association of Mutual Funds in India has been directed to issue guidelines for the valuation and accounting of CDS by MF schemes. 


Decoding the move

Mutual funds were only allowed as buyers, were subject to many other restrictions

Flexibility provided now to buy and sell CDS, with measures to keep risk in check

Exposure through CDS (notional amount of both CDS bought and sold) to not exceed 10% of AUM of scheme  

Amfi to formulate guidelines for valuation and accounting