SEBI’s Big Move: Mutual Funds Get Green Light to Buy and Sell Credit Default Swaps—Boost for India’s Bond Market Liquidity

The Securities and Exchange Board of India (SEBI) has allowed mutual funds to buy and sell credit default swaps (CDS) to improve the liquidity of the corporate bond market. This move gives mutual funds more flexibility in how they manage risk.

SEBI explained that this flexibility will offer mutual funds a new investment option and help increase liquidity in corporate bonds. Previously, only mutual funds with fixed maturity plans (FMPs) of more than one year were allowed to use CDS.

Under the current rules, mutual funds in India could only buy CDS to protect against credit risk in the bonds they held. The new guidelines allow mutual funds to also sell CDS, as long as it’s backed by cash, government securities, or treasury bills. However, overnight and liquid mutual fund schemes cannot sell CDS.

SEBI stated that the total exposure to CDS should not exceed the value of the bonds being protected and should remain below 10 per cent of the mutual fund’s assets under management (AUM). Additionally, mutual funds can only buy CDS for bonds that have an investment-grade credit rating or higher, and the credit rating of the CDS must match the rating of the bond.

What is a credit default swap?

A credit default swap is a financial product that helps reduce risk in bond investments. It acts like insurance for investors—if a bond issuer fails to repay their debt, the CDS compensates the investor for the loss. In return for this protection, the buyer of the CDS pays regular premiums.

For mutual funds, CDS can help manage risks in their bond portfolios, and SEBI’s decision allows mutual funds to use CDS to reduce credit risk in the corporate bond market.