Capital market regulator Securities and Exchange Board of India (SEBI), on Friday, allowed mutual funds to buy and sell credit default swaps (CDS) to improve liquidity in the corporate bond market.
In a circular, SEBI stated, “It has been decided to give mutual funds more latitude to buy and sell CDS while maintaining appropriate risk management.”
“This additional investment product for mutual funds and help to increase liquidity in the corporate bond market will be provided by the flexibility to participate in CDS,” the market watchdog stated. Prior to this, CDS trades could only be completed by mutual funds holding fixed maturity plans (FMPs) with durations longer than a year.
The regulator wrote in the circular that mutual funds in India are only allowed to engage in CDS transactions as users, that is, to purchase credit protection in order to mitigate the credit risk associated with the corporate bonds that they own. The value of the securities that a mutual fund company is protecting shouldn’t be greater than its CDS exposure.
Fund schemes are only permitted to purchase CDS against securities that have an investment grade rating of at least, according to SEBI. The regulator believes that the synthetic debt security, or CDS, should have the same credit risk rating as the security it is meant to cover.
Mutual funds have the ability to offer CDS as a component of synthetic debt investments that are backed by Treasury bills, cash, or government securities.