Reserve Bank of India Introduces Credit-Default Swaps, Limits Market Scope

India introduced trading in credit- default swaps and set rules limiting the scope of the market, eight years after first proposing the derivatives to lure investors to the nation’s corporate bond market.

Local lenders and units of foreign banks will be allowed to buy CDS contracts to “hedge” assets and trading positions effective immediately, the Reserve Bank of India said in a notification yesterday. The central bank postponed a decision in 2003, citing the need for banks to improve risk management, and held off again in 2008 as global credit markets seized up following the financial crisis.

Confining trading in the derivative contracts to lenders based in India may not help attract capital needed to build roads, ports and power plants, and policy makers need to throw open the market to overseas traders, according to Bank of America Corp. Prime Minister Manmohan Singh plans to spend $1 trillion by 2017 to upgrade the nation’s infrastructure and boost growth.

“The guidelines are restrictive in the first phase,” Jayesh Mehta, the Mumbai-based managing director of the Indian unit of Bank of America said in an interview yesterday. “The market needs to open to foreign investors for CDS to be more effective.”

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point, or 0.01 percentage point, equals $1,000 a year on a contract protecting $10 million of debt for five years.

State Bank CDS

In privately negotiated markets overseas, the cost of protecting the debt of State Bank of India (SBIN) against non-payment has more than doubled this year on concern the government may miss its budget-deficit target.

Five-year credit-default swaps on State Bank, viewed as a proxy for the nation, costs 358 basis points on Nov. 29, compared with 161 basis points at the end of last year, according to data provider CMA, which is owned by CME Group Inc.

The RBI said it introduced default-swaps “to provide market participants a tool to transfer and manage credit risk associated with corporate bonds.”

India has been easing rules to lure investors to the debt market. The government this month raised the limit on rupee- denominated debt foreigners can purchase. The finance ministry increased the cap on government and corporate debt by $5 billion each to $15 billion and $45 billion respectively.

The Reserve Bank, which was expected to start CDS on Oct. 24, delayed the start pending setting up of infrastructure including “trade repository, documentation, publication of CDS curve for valuation and standardization of contracts,” it said on Oct. 20.

The central bank said banks shouldn’t sell CDS on corporate bonds on the issue date and these contracts can’t be used as a bank guarantee.

To contact the reporter on this story: Anurag Joshi in Mumbai at ajoshi53@bloomberg.net

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net

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