SEBI concludes deliberations on allowing MFs in credit default swap arena

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.