MONEY
SEBI lets mutual funds buy and sell CDS, move helps fund houses to manage risks
- IBJ Bureau
- Sep 21, 2024
The SEBI has allowed mutual funds to both buy and sell Credit Default Swaps (CDS), a move aimed at increasing liquidity in the corporate bond market.
This flexibility to participate in CDS will serve as an additional investment product for mutual funds, the market regulator has said in a circular.
Earlier, mutual funds were only permitted to use CDS transactions to buy protection against the credit risk of corporate bonds they held. These transactions were limited to fixed maturity plan (FMP) schemes with duration of more than one year.
“Now, it has been decided to allow greater flexibility to mutual funds to both buy and sell CDS with adequate risk management,” the SEBI has said.
In market parlance, CDS is like an insurance contract that protects against default by a borrower.
For mutual funds, CDS helps manage the risk of debt securities they hold. When a mutual fund purchases a CDS, it pays a premium to the seller in exchange for protection if a specific bond (the reference entity) defaults.
Under the new framework, the SEBI has said that mutual funds can buy CDS to hedge the credit risk of debt securities they hold.
However, the CDS exposure cannot exceed the value of the debt security being protected.
The regulator has added that mutual funds can only buy CDS from sellers with an investment-grade rating or higher.
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