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SEBI has proposed introduction of credit default swaps (CDS) in mutual funds. The market regulator has proposed that debt funds should be allowed to buy and sell CDS against their holdings in corporate bonds.
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.
Simply put, CDS is hedging the corporate bonds against the risk of default. The move is expected to make debt funds especially credit risk funds safer.
According to SEBI norms, the scheme has to pay premium to buy such an insurance. Also, fund houses can buy or sell CDS to the extend of 10% of the total AUM.
Cafemutual spoke to industry experts to understand how will the CDS help the fund houses make their debt funds more attractive.
Dwijendra Srivastava, CIO, Fixed Income, Sundaram MF is of the opinion that the move will improve liquidity in debt funds. He, however, believes that debt funds are already safer and CDS may not find takers easily. Citing an example ,he said that while MFs are allowed to use overnight index swaps and interest rate features, the demand is yet to pick up.
Jalpan Shah - Fund Manager , Fixed Income , TRUST Mutual Fund, "I think that this is a step in the right direction as the use of derivatives will further help in development of the corporate bond market, especially in bonds with slightly lower credit ratings. Mutual fund schemes can hedge certain part of their portfolios by buying CDS. Mutual fund schemes also have the flexibility to earn premiums by selling CDS. International experience has been that CDS trading has in general lowered the cost of issuing bonds and enhanced liquidity in the bond markets."
Mahendra Jajoo, CIO-Fixed Income, Mirae Asset MF is hopeful that CDS will make corporate securities more liquid. He said that it will give an opportunity to investors to exit from undesirable securities.
Pankaj Pathak, Fund Manager - Fixed Income, Quantum MF thinks that CDS may find few takers as only a few players have credit risk funds. CDS will gain traction only if supply of risky bonds increases.
