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The RBI has permitted foreign institutional investors as ‘users' in Corporate Default Swaps, in the draft guidelines on introduction of CDS.
In the draft report by the RBI's Internal Working Group, which was issued in August 2010, FIIs were not allowed as users.
The central bank released the draft guidelines and has invited public comments on these draft guidelines, by March 8.
A CDS is a swap contract in which the protection buyer, who has exposure to a bond or loan, makes regular premium payments to the protection seller and in return the seller assumes the risk if there is a default.
Users are entities permitted to buy credit protection (buy CDS contracts) only to hedge their underlying credit risk on corporate bonds.
Therefore, they are not permitted to hold credit protection without having eligible underlying as a hedged item.
Users are also not permitted to sell protection and are not permitted to hold net short positions in the CDS contracts. However, they are permitted to exit their bought CDS positions by unwinding them with the original counterparty or by assigning them in favour of buyer of the underlying bond.
The RBI has permitted unlisted but rated bonds of infrastructure companies as eligible underlying securities for CDS.
The RBI has also permitted unlisted or unrated bonds issued by special purpose vehicles set up by infrastructure companies as eligible underlying.
Infrastructure companies
The guideline says, credit default swaps will be allowed only on listed corporate bonds. “However, CDS can also be written on unlisted but rated bonds of infrastructure companies. Besides, unlisted/unrated bonds issued by the SPVs set up by infrastructure companies are also eligible as reference obligation,” the guideline said.
In the case of banks, the exposure on account of such CDS should be within the limit of 10 per cent of investment portfolio prescribed for unlisted or unrated bonds as per extant guidelines issued by the RBI.
According to an official with a public sector bank, the RBI has allowed unlisted but rated bonds of infrastructure companies in view of the importance of this sector and to deepen the infrastructure bond market.
The guidelines also impose responsibility on banks' boards with regard to margin requirements, and strategy such as if the CDS is to be used for trading or hedging.
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