Mutual funds have been given a new opportunity to enhance their investment options by participating in the Credit Default Swaps (CDS) market. The Securities and Exchange Board of India (Sebi) has made changes to allow mutual funds to buy and sell CDS, expanding their flexibility in managing credit risk.
Previously, mutual funds were only allowed to use CDS transactions to buy protection against the credit risk of corporate bonds they held, but now they can actively engage in the CDS market. CDS act as insurance against the risk of a borrower defaulting on their debt obligations, providing a way for investors to protect themselves from potential losses.
When a buyer (protection buyer) enters into a contract with a seller (protection seller) for a CDS, they pay a regular premium to the seller. If the underlying debt issuer defaults, the seller is obligated to pay the buyer a specified amount, similar to an insurance payout. This new opportunity allows mutual funds to manage credit risk more effectively and diversify their investment portfolios.
It is important to note that mutual funds can only buy CDS from sellers with an investment-grade rating or higher. The total CDS exposure for a scheme cannot exceed 10% of its assets, ensuring that risks are managed responsibly. Additionally, mutual funds must disclose details of their CDS transactions, including the seller’s rating and any related-party transactions, to promote transparency and accountability.
The Sebi order will be effective immediately, giving mutual funds the green light to explore this new investment option. By participating in the CDS market, mutual funds can enhance their risk management strategies and potentially improve the overall performance of their portfolios. This move by Sebi is expected to boost liquidity in the corporate bond market and provide investors with more opportunities to navigate the complexities of credit risk.
Overall, the decision to allow mutual funds to buy and sell CDS is a significant development that will shape the future of investment strategies in India. Investors and fund managers alike can now take advantage of this new tool to protect their portfolios and maximize returns in an ever-changing market environment.
