In News
- Recently, the regulator Securities and Exchange Board of India (Sebi) allowed alternative investment funds (AIFs) to participate in the Credit Default Swaps (CDS) market.
New Norms
- For Buying:
- Under the new norm, Category-I and Category-II AIFs can buy CDS on underlying investment in debt securities only for the purpose of hedging.
- Category-III AIFs can purchase CDS for hedging or otherwise, within permissible leverage.
- For Selling:
- Category-II and Category-III AIFs may sell CDS by earmarking unencumbered government bonds or Treasury bills equal to the amount of the CDS exposure.Â
- Significance:
- The new norms will allow business entities to hedge risks associated with the bonds market.
- These norms will facilitate deepening of the domestic corporate bond segment.Â
Credit Default Swaps (CDS)
- About:
- A CDS is a type of derivative that transfers the credit exposure of fixed income products.
- CDS is a specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to another.
- CDS can be used for speculation, hedging, or as a form of arbitrage.
- Credit default swaps played a role in both the 2008 Great Recession and the 2010 European Sovereign Debt Crisis.
- Process:
- In a credit default swap contract, the buyer pays an ongoing premium similar to the payments on an insurance policy.Â
- In exchange, the seller agrees to pay the security’s value and interest payments if a default occurs.
Source: ET
