RBI guidelines on Credit Default Swap operational from today

CDS norms were originally scheduled to be operationalised from 24th October, but the RBI deferred it to give market participants like banks and other financial institutions more time to clarify details on documentation and operational aspects

Mumbai: The Reserve Bank of India (RBI) today operationalised new guidelines on credit default swap (CDS), directing market participants to report such trades within 30 minutes to the Clearing Corporation of India’s (CCI) online repository, reports PTI.

“It is advised that all market makers shall report their CDS trades in corporate bonds within 30 minutes of the trade to the CCIL trade repository CCIL Online Reporting Engine (CORE) beginning 1 December 2011,” the RBI said in a circular.

CDS provides credit protection to corporate bond buyers, as the sellers of the swaps guarantee the credit-worthiness of the product. Thus, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.

The RBI observed that the objective of introducing CDS on corporate bonds is to provide market participants a tool to transfer and manage credit risk in an effective manner through redistribution of risk.

In October, RBI issued a formal notification specifying that CDS is a derivatives instrument.

The apex bank had finalised the guidelines in May to allow corporate entities including insurers, FIIs and mutual funds to hedge against the risk of default in the corporate bonds to which they subscribe.

The RBI had said a credit event (a default on a previously agreed financial obligation) will cover restructuring approved under the Board for Industrial and Financial Reconstruction (BIFR), including corporate debt restructuring and corporate bond restructuring.

“Since CDS have benefits like enhancing investment and borrowing opportunities and reducing transaction costs while allowing risk-transfers, such products would increase investors’ interest in corporate bonds and would be beneficial to the development of the corporate bond market in India,” the central bank had said.

The RBI guidelines come at a time when the quantum of bad loans in the banking system appears to be gradually building up.

The guidelines take effect after a delay of over a month.

They were originally scheduled for 24th October, but RBI deferred it to give market participants like banks and other financial institutions more time to clarify details on documentation and operational aspects.

The users of CDS include commercial banks, primary dealers, non-banking finance companies (NBFCs), mutual funds, insurance companies, housing finance companies, provident funds, listed corporates and foreign institutional investors (FIIs).

RBI had announced in its second quarter review of the monetary policy in October 2009 that it would introduce a plain over-the-counter single name CDS for resident entities.

Following this, it had appointed an internal working group to finalise the operational framework in consultation with market participants.

The final report of the working group was presented to the RBI in February, following which it sought public comments.

As part of measures to enable more financial market reforms, RBI also increased the period of short sale in government securities from the existing five days to a maximum of three months.

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