Thread by @MFkiRani

(1/n) Among many things addressed today in Finance Minister's Meet with Press, she addressed there will be development of Credit Default Swap (CDS) Markets in consultation with @SEBI and @RBI RBI. This step was taken following the credit events of IL&FS, DHFL etc in past yr

@sebi @RBI (2/n) Now what is Credit Default Swap (CDS)/ Markets?
CDS is kind of an insurance against a risk of default on a loan by a company. Company – reference entity, default – credit event.

@sebi @RBI (3/n)Why will a seller do that? Coz under such contract buyer will pay a regular amt to seller 4 protection he has bought for his bond, incase of a credit event. Seller will gain incase there is no credit event since he has got regular payment from buyer for his ‘protection’.

@sebi @RBI (4/n)Okay so is everything should be hunky-dory after this in case of credit event right? No. Biggest Risk is CDS seller defaults at the same time borrower defaults. This was primary causes of 2008 credit crisis. sellers like Lehman, AIG, etc defaulted on their CDS obligations.

@sebi @RBI (5/n) Another problem. Eg – If Buyer of CDS believes X company will default. He can buy CDS from a seller who will pay him the value of bond when the X defaults. CDS can be purchased even if the buyer does not own the bond/underlying itself.

@sebi @RBI (6/n) So instead of insurance the instrument was profit making for him! You can apply the reverse logic as well for the seller.

@sebi @RBI (7/n) Coming to India CDS market so far
CDS market structure of any country includes sovereign spread (incase a country defaults, currency might drop) and single name CDS for corporates/banks. RBI first introduced CDS plain vanilla OTC single name CDS for corporate bonds

@sebi @RBI (8/n) In Dec 2011, Indian market sees first INR-denominated CDS trades (REC & India Railway). Deal between ICICI bank and IDBI bank. Market Makers - Commercial Banks, Primary Dealers, NBFCs - subject to restrictions. Users - Market Makers, HFCs , Listed Companies, FIIs

@sebi @RBI (9/n) Restrictions/ Issues in Indian Markets
Only banks, PDs and strong NBFCs can sell protection, while FIIs and Hedge funds who have a big appetite 4 credit risk not allowed to sell protection. Buyer/ user cannot buy CDS for amounts higher than the face value of corp bond.

@sebi @RBI (10/n) No user can maintain naked CDS protection, i.e. CDS position without any underlying bonds. Although RBI has allowed insurance companies and mutual funds to be sellers, this is subject to IRDA and SEBI permitting them. This is not likely until the market develops somewhat

@sebi @RBI (11/n) - Entities permitted to quote both buy and sell CDS spreads need a minimum CAR (Capital Adequacy Ratio) of 11% and net NPA of < 3%. CDS is mainly an OTC product and the parties have to agree upon the terms & conditions of the CDS individually.

@sebi @RBI (12/n) - For transactions involving users, physical settlement is mandatory. • Market-makers shall report their CDS trades with both users/investors and other market-makers on the reporting platform of CDS trade repository within 30 minutes from the deal time.

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