The Securities and Exchange Board of India (SEBI) has decided to permit mutual funds to participate in the credit default swap (CDS) market and in repos of corporate debt securities, subject to certain conditions.
Mutual funds, however, could participate in CDS transactions only as users (protection buyer), ie, they are permitted to buy credit protection only to hedge their credit risk on corporate bonds they hold. They will not be allowed to sell protection and hence not permitted to enter into short positions in the CDS contracts.
However, they will be permitted to exit their bought CDS positions if the cumulative gross exposure through credit default swap in corporate bonds along with equity, debt and derivative positions does not exceed 100 per cent of the net assets of the scheme.
Mutual funds can participate as users in CDS for the eligible securities as reference obligations, constituting from within the portfolio of only fixed maturity plans (FMP) schemes having tenor exceeding one year.
Mutual funds should buy CDS only from a market maker approved by the RBI and enter into master agreement with the counterparty as stipulated under RBI guidelines. Exposure to a single counterparty in CDS transactions should not exceed 10 per cent of the net assets of the scheme.
The total exposure related to premium paid for all derivative positions, including CDS, should not exceed 20 per cent of the net assets of the scheme.
Before undertaking CDS transactions, mutual funds should put in place a written policy on participation in CDS approved by the board of the asset management company and the trustees as per the guidelines specified by RBI and SEBI. The policy should be reviewed by mutual funds, at least once a year.