The Reserve Bank of India on Friday issued the final framework for credit derivatives, allowing resident non-retail users to freely use credit default swaps (CDS) and total return swaps (TRS) without restrictions on end-use, while permitting insurance companies, pension funds, mutual funds, alternative investment funds (AIFs) and foreign portfolio investors (FPIs) to act as protection sellers. The framework, effective immediately, also permits FPIs to trade credit index futures with safeguards against excessive speculation, marking a significant step towards deepening India's credit derivatives market.
The move aligns with the government's Budget proposal to deepen the credit derivatives market and strengthen risk management tools available to market participants.
"The rules are applicable with immediate effect," the RBI said in the Master Direction issued on Friday.
Under the framework, resident Indian non-retail users can deploy CDS and TRS without any restrictions on the end-use or purpose of the transaction. However, non-resident users will be permitted to use these instruments only for hedging purposes.
The central bank defines hedging as undertaking a credit derivative transaction to reduce credit risk associated with a particular debt instrument or a portfolio of debt instruments.
The RBI also said resident retail users, except individuals, will be allowed to use CDS only for hedging. "A resident retail user, other than an individual, shall be allowed to buy protection only for the purpose of hedging," the directions said.
Credit derivative contracts involving non-residents may be settled in either rupees or foreign currency. The final norms also make insurance companies, pension funds, mutual funds, AIFs and FPIs eligible to act as protection sellers, broadening market participation.
The RBI said it had revised the draft directions after considering stakeholder feedback before issuing the final framework.
The central bank has also mandated prior approval for exchange-traded CDS products. Exchanges may offer standardised single-name CDS contracts and CDS contracts on credit indices with guaranteed settlement only after obtaining RBI approval.
"Exchanges must obtain prior RBI approval before launching any CDS product, including for its design, subsequent changes to the product, eligible participants, and other contract specifications," the RBI said.
Additionally, the RBI has allowed FPIs to trade credit index futures, subject to safeguards aimed at preventing excessive speculation. FPIs will not be allowed to take excessive short positions or trade credit index futures linked to very short-term debt instruments.
