The recent introduction of credit default swaps (CDS) by the
Reserve Bank of India (RBI) augurs well for the development of
India’s bond markets. CDS will lead to a gradual deepening of
the corporate bond market as CDS can enhance the bond market
investors’ appetite for lower rated issuers, beyond their
traditional favorites in the high-safety category. CDS are
instruments that provide buyers with protection against credit
losses, just as insurance products do.
CRISIL believes that as investors can buy CDS protection against
potential credit losses, they will be more open to invest in
instruments rated lower than ‘AA’ category, which is
critical for the growth of India’s bond markets. Increased
use of CDS, over the medium term, has potential to impart
additional liquidity to the bond markets, which have so far been
predominantly illiquid. It will help lower rated borrowers
diversify their funding sources by accessing the bond markets.
CDS also holds promise of providing a thrust to the much-needed
infrastructure financing. RBI has allowed dealing in CDS for
infrastructure companies even on unlisted bonds, rather than only
on the listed ones. A coordinated action by the other regulators
can allow insurance companies, pension funds, and provident funds
to also participate in this space through the CDS route.
“This is an opportune time for the introduction of CDS in
India. Expansion in the number of rated entities, across rating
categories, has enabled increased availability of information in
the public domain, of independent opinion on the quality of credit,
and of reliable default and transition data," said Pawan Agrawal,
Director, CRISIL Ratings.
CRISIL, for instance, has ratings outstanding on more than 500
entities in the ‘A’ category alone, and has published
its default and transition statistics, based on the performance of
its ratings for nearly 25 years.
“Market participants are, therefore, better equipped today
than ever before to take well-informed decisions on an
issuer’s credit quality. This will encourage them to sell CDS
protection," added Agrawal.
CRISIL believes that the RBI guidelines incorporate learnings
from the CDS markets worldwide. Systemic safety and stability
remain the regulator’s priority, even while it has introduced
such an innovative product. The guidelines ensure that CDS is not
used for speculative purposes. Moreover, participants who can offer
CDS protection need to maintain adequate capital against potential
risks.
As per Somasekhar Vemuri, Head, CRISIL Ratings, “Of the
variants of CDS that are traded globally, RBI has permitted only
one variant in India—single-name CDS. Additionally, RBI has
restricted users from buying CDS without underlying exposure, and
disallowed use of CDS for structured products. These measures
ensure not only that product complexity risk is minimized, but also
that undue risk build-up from speculative trading is
pre-empted.”
This will, therefore, facilitate orderly development of the
market for CDS in India.
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