The Reserve Bank of India (RBI) will issue fresh guidelines on credit default swaps (CDS).
The development of CDS is considered critical for deepening India’s bond markets and the government believes that the enactment of the Bilateral Netting of Qualified Financial Contracts law should pave the way for an active CDS market.
What are credit default swaps (CDS)?
- It is a financial derivative instrument to hedge risks in bond investments.
- The objective of introducing Credit Default Swaps (CDS) on corporate bonds is to provide market participants a tool to transfer and manage credit risk in an effective manner through redistribution of risk.
- Actually it is a contract between two parties, called protection buyer and protection seller.
- Under this contract, the protection buyer is compensated for any loss emanating from a credit event in a reference instrument. In return, the protection buyer makes periodic payments to the protection seller.
- In the event of a default, the buyer receives the face value of the bond or loan from the protection seller. From the seller’s perspective, CDS provides a source of easy money if there is no credit event.
- It was introduced by JP Morgan.
(Source: The Hindu and ET)
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