Listen to this article
SEBI has proposed allowing mutual funds to buy and sell a new investment product - credit default swaps (CDS).
CDS is basically buying an insurance by paying a small premium against exposure in a corporate bond. For instance, if an MF holds a corporate bond of XYZ company yielding 7.75% per annum, they can sell CDS against this security by buying insurance by paying a premium of let’s say 0.50 bps. In case of default in this instrument, the insurance company will pay the principal amount along with the interest.
Currently, fund houses are allowed to buy CDS against corporate bonds held FMPs having maturity of at least a year.
SEBI has now proposed to allow debt funds to buy CDS (all schemes) and sell CDS (except overnight and liquid funds).
Here are some key proposals
MFs as buyer of CDS
- MFs can buy CDS purely for hedging their debt securities. Such an exposure should not be added to the gross exposure of the scheme
- If the fund manager sells a particular debt which was hedged with CDS, the fund manager will have to close CDS position within 7 days of selling
- MFs can buy CDS only from credit rating agencies
- MFs can buy CDS for both investment grade and below investment grade debt securities. This also indicates that MF will be allowed to invest in below investment grade securities only if hedging is available
MFs as seller of CDS
- If a fund house sells CDS, they will have to buy a secured instrument like government securities or treasury bills
- The exposure to such synthetic debt exposure will be added to single issuer, group issuer and sectoral limit
- Debt index and ETFs can also take such a position
Other conditions
- MFs have to follow RBI norms if they buy or sell CDS
- MFs can participate in CDS only through standard contracts prescribed by Fixed Income Money Market and Derivatives Association of India (FIMMDA)
- CDS can be transacted through request for quote (RFQ) platform
- MFs have to make periodic disclosure of CDS
- Exposure to CDS should not exceed 10% of the total AUM of scheme
- AMFI will issue detailed guidelines on valuation and accounting
