SEBI concludes deliberations on allowing MFs in credit default swap arena

The statement by the SEBI member comes less than three months after the capital market watchdog released a discussion paper, proposing allowing mutual funds to invest in CDS.

The Securities and Exchange Board of India (Sebi) is expected to soon come out with the regulatory framework for allowing mutual funds in the credit default swap (CDS) segment as deliberations on this matter have concluded.

While speaking at the Moneycontrol Mutual Fund Summit, SEBI whole-time member Amarjeet Singh said that the deliberations have concluded on allowing funds flexibility in the credit default swap or CDS arena.

“We have recently concluded consultations on allowing (mutual funds) greater flexibility in participation by local funds in credit default swaps,” said Singh while delivering the keynote address at the seminar.

The statement by the SEBI member comes less than three months after the capital market watchdog released a discussion paper, proposing to allow mutual funds to invest in CDS.

Under the proposed framework, an MF scheme can buy CDS only from programmes that are rated by credit rating agencies and they can buy CDS for both investment grade and below-investment grade debt securities. Also, an MF may be permitted to sell CDS only as investors in synthetic debt securities, or in other ways, sell CDS as a reference obligation covered with cash or government securities or treasury bills. Therefore, overnight and liquid schemes will not be allowed to sell CDS contracts.

Sebi has proposed this following the RBI's revised CDS framework dated February 10, 2022, which sought to increase the base of protection sellers including selling of protection by all major non-bank regulated entities, including mutual funds.

"Under the current regulatory framework, Mutual Funds in India are permitted to participate in CDS transactions only as users i.e, to buy credit protection only to hedge the credit risk on corporate bonds held by them," said the SEBI discussion paper.

A CDS is a credit derivative contract in which one counterparty (protection seller) commits to pay to the other counterpart (protection buyer) in the case of a credit event with respect to a reference entity and in return, the protection buyer makes periodic payments (premium) to the protection seller until the maturity of the contract or the credit event, whichever is earlier.