Markets regulator Sebi has allowed mutual funds to both buy and sell Credit Default Swaps (CDS), a move aimed at increasing liquidity in the corporate bond market.
This flexibility to participate in CDS would serve as an additional investment product for mutual funds, Sebi said in a circular.
Earlier, mutual funds were only permitted to use CDS transactions to buy protection against the credit risk of corporate bonds they held. These transactions were limited to Fixed Maturity Plan (FMP) schemes with a duration of more than one year.
Now, “It has been decided to allow greater flexibility to mutual funds to both buy and sell CDS with adequate risk management,” Sebi said.
In market parlance, Credit Default Swaps are like insurance contracts that protect against default by a borrower.
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 exchange for protection if a specific bond (the reference entity) defaults.