The Securities and Exchange Board of India (Sebi) has allowed mutual funds to participate in the credit default swaps (CDS) market as well as in the repo in corporate debt securities segment.
“Mutual funds shall participate in CDS transactions only as users (protection buyer). Thus, mutual funds are permitted to buy credit protection only to hedge their credit risk on corporate bonds they hold. They shall not be allowed to sell protection and, hence, not permitted to enter into short positions in the CDS contracts,” stated a Sebi circular issued on Thursday.
According to the capital market regulator, MFs will have to buy CDS only from a market maker approved by the Reserve Bank of India (RBI) and enter into a Master Agreement with the counterparty as stipulated under RBI guidelines. “Exposure to a single counter-party in CDS transactions shall not exceed 10% of the net assets of the scheme,” added the release.
Further, the cumulative gross exposure through credit default swap in corporate bonds, along with equity, debt and derivative positions, cannot exceed 100% of the net assets of the scheme, while the total exposure related to premium paid for all derivative positions, including CDS, should not exceed 20% of the net assets of the scheme.
Meanwhile, in order to encourage growth of the corporate bond market, Sebi has expanded the base of eligible securities for mutual funds to participate in repo in corporate debt securities, from AAA rated to AA and above rated corporate debt securities.
“Directionally, it’s a positive step and will help develop the corporate bond market. The move may especially assume significance if the infra debt fund market activity picks up pace. Having said that, the impact will be limited in the immediate to medium term,” said a fixed income fund manager.