Flexibility in participation of Mutual Funds in Credit Default Swaps (CDS)
Summary
This circular modifies the regulatory framework to allow Mutual Funds in India to both buy and sell Credit Default Swaps (CDS) for hedging and synthetic debt investments. It establishes specific conditions for CDS transactions, including eligibility criteria, risk management requirements, and exposure limits relative to Assets Under Management. The provisions aim to enhance liquidity in the corporate bond market while ensuring adequate investor protection through standardized contracts and disclosures.
Text
Schemes may buy CDS only for the purpose of hedging their credit risk on debt securities they hold in various schemes. The exposure of CDS shall not exceed respective debt security exposure, and such exposure may not be added to gross exposure of the scheme.
In case the protected debt security is sold, schemes shall ensure that the respective CDS position is closed within fifteen working days of selling the above protected debt security.
The exposure of any protected debt security... shall be considered as exposure to either issuer of debt security (reference entity) or seller of CDS, whichever has higher credit rating... In case of same rating... exposure shall then be considered on reference entity and not on seller of CDS.
MF schemes shall buy CDS only from such sellers that have instruments with lowest long-term rating of investment grade and above.
Schemes may buy CDS for investment grade and existing below investment grade debt securities in the portfolio, if any.
MF Schemes may sell CDS only as part of investment in synthetic debt securities, i.e., sell CDS on a reference obligation covered with Cash/G-Sec/T-bills. Overnight and Liquid schemes shall not sell CDS contracts.
Cash, G-Sec and T-bills can act as cover. Government securities with maturity within +/- 6 months of the maturity of respective debt security (reference obligation) shall act as cover and such cover may be used for maintaining margin requirements on respective CDS.
The required amount of cover shall be enough to ensure that notional amount does not exceed the value of cover kept... The buffer shall be atleast equal to three times the daily haircut applicable for the said G-sec instrument in case of repo transactions on Clearing Corporation of India Limited.
The value of cover kept shall be reviewed on a daily basis.
The cover shall be earmarked to CDS sell position and can be used for maintaining margin requirements on respective CDS. However, investment in aforesaid instruments as cover shall not be considered as part of Liquidity Ratio – Redemption at Risk (LR-RaR) and Liquidity Ratio - Conditional Redemption at Risk (LR-CRaR) eligible instruments...
The exposure of synthetic debt security (notional amount) shall be considered in respective single issuer, group issuer and sectoral limits. Such exposure to the issuer, group and sector of the issuer shall be equal to the notional amount.
For the purpose of computing gross exposure of scheme investing in synthetic debt security, the exposure due to such investment shall be computed as follows: Notional amount (+) Buffer (i.e., cover kept over and above notional amount)
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Source: SecMarx — Flexibility in participation of Mutual Funds in Credit Default Swaps (CDS). Verbatim text is public record; SecMarx structuring (linkage to applying orders) is cited to us.