SEBI permits mutual funds to buy and sell credit default swaps

Mumbai: The Securities and Exchange Board of India (SEBI) said on Friday that mutual funds can now both buy and sell Credit Default Swaps (CDS), a move aimed at enhancing liquidity in the corporate bond market, media reports said.

IBNS • 20 Sept 2024, 09:35 pm

This new flexibility allows mutual funds to participate more actively in CDS, adding an additional investment option for them, Sebi stated in a circular, reported news agency PTI reported.

Previously, mutual funds were only allowed to use CDS to buy protection against the credit risk of corporate bonds they held, and this was restricted to Fixed Maturity Plan (FMP) schemes with durations longer than one year.

Now, SEBI has decided to grant mutual funds "greater flexibility" to both buy and sell CDS, provided they adhere to proper risk management practices.

In financial terms, CDS function as insurance contracts that protect against the risk of a borrower defaulting. 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 return for protection if the underlying bond (known as the reference entity) defaults.