SEBI has allowed mutual funds to buy and sell a new investment product - credit default swaps (CDS). CDS is basically buying insurance by paying a small premium against exposure in a corporate bond. For instance, if an MF holds a corporate bond of XYZ company yielding 7.75% per annum, they can sell CDS against this security by buying insurance by paying a premium of let’s say 0.50 bps. In case of default in this instrument, the insurance company will pay the principal amount along with the interest.
Currently, fund houses are allowed to buy CDS against corporate bonds held by FMPs having maturity of at least a year.
With this, SEBI has now allowed debt funds to buy CDS (all schemes) and sell CDS (except overnight and liquid funds).
This has come into effect with immediate effect.
Here are some key highlights of the new circular on CDS:
MFs as buyer of CDS
MFs can buy CDS purely for hedging their debt securities. Such an exposure should not be added to the gross exposure of the scheme
If the fund manager sells a particular debt which was hedged with CDS, the fund manager will have to close CDS position within 15 days of selling
MFs can buy CDS only from sellers having instruments with lowest long-term rating of investment grade and above
MFs can buy CDS for both investment grade and below investment grade debt securities. This also indicates that MF will be allowed to invest in below investment grade securities only if hedging is available
MFs as seller of CDS
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