Credit default swaps to be allowed in India

Credit default swaps, an insurance instrument partly blamed for the credit crisis and the near sinking of US insurer AIG, will be permitted in India from October with banks, primary dealers and non-banking financial companies’ participation and some strict rules to prevent abuse.
The instrument, popularly known as CDS, which promises the holder payment of money to the insured amount of bond holding in case of a default, is aimed at developing the domestic corporate bond market.
The new guidelines that will come to force from October 24, is framed with safeguards to prevent abuse of position by financial intermediaries to boost their revenues as it happened with currency derivatives that sank many small companies.
Only the market makers or commercial banks will be allowed to buy and sell credit default swaps while the ‘users’ can only buy credit protection, but will not be allowed to sell them. Users may be insurance companies, housing finance companies, provident funds, listed corporates and foreign institutional investors. RBI, which received comments from public, has built-in protection for naive and put the onus on the sellers of CDS to ensure that they educate the buyer on what they are getting into.
The users cannot hold these contracts without having eligible underlying bonds, though the market makers can buy protection without having the underlying bond. The users cannot buy CDS for amounts higher than the face value of the corporate bonds held by them.
Though credit default swaps is only allowed on listed corporate bonds, the central bank has made an exception for rated but unlisted bonds of infrastructure companies.