RBI permits Credit Default Swaps in unlisted corporate bonds

Jan 07 2013, 22:20 IST
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SummaryRBI today allowed CDS for unlisted rated corporate bonds in addition to listed ones.

In order to better the manage credit risk by the fund managers, the RBI today allowed Credit Default Swaps (CDS) for unlisted rated corporate bonds in addition to listed ones.

"In addition to listed corporate bonds, CDS shall also be permitted on unlisted but rated corporate bonds even for issues other than infrastructure companies," RBI said in a notification.

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The CDS is a guarantee in which the buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.

Users shall be allowed to unwind their CDS bought position with original protection seller at mutually agreeable or FIMMDA price, it said.

If no agreement is reached, then unwinding has to be done with the original protection seller at FIMMDA (Fixed Income Money Market and Derivatives Association of India) price.

CDS shall be permitted on securities with original maturity up to one year like Commercial Papers, Certificates of Deposit and Non Convertible Debentures with original maturity less than one year, it said.

The CDS market was introduced for corporate bonds to provide market participants a tool to transfer and manage credit risk through redistribution. CDS as a risk management product offers the participants the opportunity to hive off credit risk and also to assume credit risk, which otherwise may not be possible.

Since it helps enhance investment and borrowing opportunities and reduces transaction costs while allowing risk-transfers, such products are expected to increase investors' interest in corporate bonds.

In order to develop the corporate bond market, RBI through a separate notification revised downward the haircut rate for bonds. The haircut rates are different for different rated bonds.

Haircut is the difference between prices at which a market maker can buy and sell a security.

For AAA rated bonds, the revised minimum haircut is at 7.5 per cent from 10 per cent; 8.5 per cent (12 per cent) for AA+ rating and 10 per cent (15 per cent) for AA rating.

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