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May 21, 2007
India : RBI introduces Credit Default Swaps
In a significant move that can mark a critical shift in india's booming credit market, on 16th May, 2007, the Reserve Bank of India (RBI) issued draft Guidelines on Credit Default Swaps. The draft guidelines follow the RBI's announcement in its Annual Policy Statement 2007-2008 that it would permit single-name credit default swaps (CDS) in India, as part of the gradual process of financial sector liberalisation in India.The RBI said the move to allow the trading of CDS’ followed an increase in the sophistication of the domestic banking sector.
“The risk management architecture of banks has strengthened and banks are on the way to becoming Basel II compliant, providing adequate comfort level for the introduction of such products,” the RBI said in its annual policy statement for 2007-2008.
But it said that because of the complexities involved in the valuation, accounting and risk management aspects of credit derivatives and the “evolutionary skills” of eligible participants, it would limit the range of CDS allowed for now to instruments where the reference entity is a single entity. The contracts traded are also required to be denominated and settled in Indian rupees.
The draft guidelines regulate credit derivative transactions by Indian resident commercial banks and primary dealers. The guidelines only allow parties to enter into 'plain vanilla' credit default swaps, which have the following key features:
Single reference entity only,
which must be an Indian resident;
The protection buyer must be in a position to identify a specific credit exposure which it is hedging, and this exposure may have to be referenced in the CDS;
and The reference obligation and, if different, the deliverable obligation must be rated and denominated in Indian Rupees.
It must be a tradable financial security, a 'fund-based credit exposure' (which should include a loan) or exposure under another CDS or, for inter-dealer trades, a corporate debt security.
Further points to note from the draft guidelines are:
Both cash and physical settlement are permitted;
The 1992 or 2002 ISDA Master Agreement and the 2003 Credit Derivative Definitions (as supplemented) are recommended to document the transactions;
A party may not buy or sell protection in respect of itself or any of its related parties; and
The CDS must be denominated and settled in Indian Rupees.
Any credit derivative transactions will also be subject to the Comprehensive Guidelines on Derivatives published by the RBI in April, 2007. The Comprehensive Guidelines impose obligations on market-makers with regard to the suitability of derivative transactions, which extend to the disclosure of pricing and valuation models, due diligence on the counterparty's authority to enter into the derivative and a statement as to the appropriateness of the derivative for the counterparty.
Links:
- The RBI's announcement in respect of the draft guidelines
http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3521&Mode=0
- The draft guidelines
http://rbidocs.rbi.org.in/rdocs/content/PDFs/77380.pdf
Posted by sunandoroy at May 21, 2007 12:57 PM
