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SEBI will soon allow mutual funds to sell a new investment product - credit default swaps (CDS). However, if a fund house sells CDS, they will have to buy a secured instrument like government securities or treasury bills.
SEBI said, “In order to provide additional investment products for the mutual funds, SEBI is considering to allow mutual funds to sell credit default swaps (CDS) for the purpose of taking exposure in synthetic corporate bonds, i.e., a position created by selling credit default swap and buying G-Sec/ T-bills.”
CDS is basically buying an insurance by paying a small premium against exposure in a corporate bond. For instance, if an MF holds corporate bond of XYZ company yielding 7.75% per annum, they can sell CDS against this security by buying an insurance by paying a premium of let’s say 0.50 bps. In case of default in this instrument, the insurance company will pay principal amount along with the interest.
However, experts say that CDS doesn’t work in Indian context as insurance companies are not interested in writing such a contract. A CEO of a fund house requesting anonymity said that while the move is well intended, it has to be thought through and requires involvement of multiple regulators like RBI and IRDAI.
The above cited CEO said, “Credit default swaps were popular in US before the global economic crisis when a top insurance company wrote such a contracts against housing loans. However, due to a fall in US home prices, the company faced financial distress. CDS is very complex and SEBI should look at developing legal framework first.”
