H R Khan: Towards vibrant debt markets - a 7iframework
Keynote address by Shri H R Khan, Deputy Governor of the Reserve Bank of India, at the
13th FIMMDA-PDAI Annual Conference on "Asian money, bond & derivatives in the new
global economy", Kuala Lumpur, 27 January 2012.
* * *
The speaker acknowledges the contributions from Shr. N.R.V.V.M.K. Rajendra Kumar, Shri Himanshu Mohanty
and Shri Surajit Bose.
It is a great pleasure to be here amidst you all for the 9th Annual meeting of the Fixed
Income Money Market Derivatives Association (FIMMDA) and the Primary Dealers
Association of India (PDAI) in this enchanting and energetic city of Kuala Lumpur. Relations
between our two great nations, India and Malaysia, date back to ancient times. Indeed the
name Malaysia is believed to have been derived from the Sanskrit root Malayadvipa which
means "peninsula of mountains". This land had attracted hordes of traders from India in the
ancient times and the exchange was not confined not merely to merchandise but also
extended to deep socio-cultural ties including customs and cuisine. The tradition continues. I
am happy to note that this meeting has attracted a different breed of traders from India and
elsewhere, the bond and derivative traders, to introspect on the challenges facing us in these
exciting times. Risks from the global macroeconomic environment remain elevated even as
growth remains subdued & unemployment high in most of the advanced economies. The
Euro-area remains under stress. Neither default by one or more of the peripheral countries
nor the severe austerity measures put in place to avoid a default forebode good tidings for
the economy or the markets. Though the emerging economies have been less bruised in the
process, funding constraints in international financial markets pose a threat to both the
availability and cost of capital and in turn on their growth prospects.
In these challenging times, the imperative from our perspective is to ensure that the funding
needs of expanding economies like India and Malaysia are met so that the growth trajectory
upon which realisation of the aspirations of millions of our underprivileged people depends is
not derailed. At the same time, the crisis has reinforced global concern for financial stability
and it is equally important to ensure that latent fault lines in the financial sector do not herald
a crisis with even greater suffering than tardy growth. Speaking here in Kuala Lumpur, one
cannot help recollect the crisis of the late 1990's which besieged the rapidly growing "miracle
economies". Most of these economies faced a substantial GDP contraction during 1998 and
moderation in the growth during the following years. The countries dealt with the crisis in
their own way but two features common to all of them are accumulation of sizeable foreign
currency reserves and development of a robust local currency bond market. The size of the
local currency bond market in the East Asian economies excluding Japan has been growing
at a rate exceeding 20 percent which is more than twice the growth rate of the global bond
market and this is evident in the corporate bond market segment as well. An interesting
observation from the data on corporate bond markets in Asia is that the value of outstanding
increased during the period of recent global financial crisis. The outstanding increased from
US$ 929 million as of end-December 2007 to US$ 1617 million as of end-December 2010
This underlines the continued attraction for investments even during the period of financial
turmoil in the global markets. In fact, post global financial crisis, the Asian bond markets are
witnessing a gradual shift away from the government bond driven to a corporate bond driven
market growth.
Indian bond and derivatives markets
Over the past two decades since we began the financial sector reforms, Indian bond markets
have come a long way. The annual gross market borrowing of the Government of India and
the State Governments increased from 122.83 billion in 1991-92 to 5,833.92 billion in
2010-11. The amount of outstanding Government of India securities increased from
780.23 billion in 1991-92 to 21569.14 billion in 2011-12. Government securities market
(G-Sec) has become broad-based in terms of participation and the sovereign yield curve now
spans up to 30 years. The monthly volume in secondary market on the electronic trading
platform - Negotiated Dealing System-Order Matching (NDS-OM), which accounts for about
90 per cent of the trading, has increased from 314.30 billion in August 2005 to
1480.86 billion in March 2011. The bid-ask spread of on-the-run securities continues to be
low at 1-2 basis points (bps) and the impact cost of the on-the-run securities is observed at
around 3 bps for a trade size of 500 million. In case of corporate bonds, trading volumes
have increased manifold from 1458.28 billion in 2008-09 to 5986.04 billion in 2010-11.
Yet we have quite some distance to traverse to catch up with our neighbours in the Far East,
let alone the advanced western countries.
The 7i framework
In this backdrop, I intend to discuss the development of the debt and the derivatives market
in India from the perspective of a central bank and a financial sector regulator with a
mandate to facilitate development of debt markets of the country. I shall briefly cover some of
the important initiatives taken so far and also draw the contours of future development. My
discussion will be structured within what I call the 7i framework - the seven I's standing for
Investors, Issuers, Instruments, Infrastructure, Intermediaries, Incentives and Innovation -
each an important and critical component of any well-functioning and vibrant financial
market.
Investors
Any discussion of development of a bond market has to begin with the investor. High savings
rate, large set of domestic institutional investors and active interest from foreign investors
can create a large and heterogeneous group that is necessary for an efficient bond market.
The traditional investor base for G-Sec in India comprised banks, provident funds, and
insurance companies. With the entry of co-operative banks, regional rural banks, pension
funds, mutual funds and non-banking finance companies, the institutional investor base has
been reasonably diversified. Notwithstanding the predominantly institutional character of the
G-Sec market, Reserve Bank of India has recognised merit in promoting retail participation
and has initiated certain policy measures to this end. Some of these include enabling small
and medium sized investors to participate in the primary auction of G-Sec through a
"Scheme of Non-competitive Bidding", improving access to the market for mid-segment
investors by permitting well-managed and financially sound Urban Cooperative Banks
(UCBs) to become members of NDS-OM and revision of authorization guidelines for the
Primary Dealers (PDs) mandating achievement of minimum retailing targets. To ease the
process of investment by retail/mid-segment investors, a web-enabled platform which would
seamlessly integrate their funds and securities accounts has been planned by the Reserve
Bank of India. Some major banks have also initiated measures like on-line trading portal for
the retail investors.
An important feature of investor profile of the G-sec market is the dominance of domestic
investors and limited foreign participation but this is an aspect of a policy framework rather
than indicative of lack of interest by overseas investors. Investment limits for the Foreign
Institutional Investors (FIIs) have been enhanced in a phased manner to US$ 15 billion in
G-sec and US$ 45 billion in the case of corporate bonds (including US$ 25 billion for
infrastructure sector bonds/units).Some observers argue that in the absence of significant
investments by foreign investors, markets are deprived of not only a large and liquid pool of
savings but also active global trading strategies which can contribute to the much needed
trading liquidity. The counter argument is that the willingness of foreign investors to take a
long-term view and remain engaged is highly sensitive to global economic factors and
possible sudden reversals arising from "hot money" strategy of foreign investors has potential
to impact the systemic stability. Let me add that the participation of foreign investor in the
domestic bond markets also needs to be examined in the light of our policy stance relating to
calibrated approach to capital account convertibility and the possibility of interest rate and
exchange rate volatility due to large scale reversal of capital flows.
A recurrent theme in the government bond market is the lack of liquidity as seen from the low
trading volumes. The daily trading volume is less than one percent of the outstanding stock.
The banks and insurance companies between themselves hold about 70 per cent of the
outstanding stock. The investment strategy of insurance companies and pension funds are
usually dictated by Asset Liability Management (ALM)/actuarial considerations. In India
because banks are mandated to hold as much as 24 per cent of their liability in the form of
government securities, under Statutory Liquidity Ratio (SLR) framework, they have been
permitted to classify these holdings as held-to-maturity (HTM) with a view to protecting their
balance sheets from volatility arising out of interest rate fluctuations. With a dominant part of
the outstanding stock thus residing in HTM portfolio and out of the market the low volume of
trading is but natural. The term HTM, however, appears to be an illusion as securities are
almost never held till they mature but are sold at an opportune time. Such an investment
strategy impacts liquidity of the security, in particular, and the market, in general. While the
changes imminent in accounting norms under the International Financial Reporting
Standards (IFRS) may force transformation of the strategies of banks, there is a need for
debate on the issue of reduction in the HTM category dispensation, albeit in a phased
manner.
In the corporate debt market, investor base is mostly confined to banks, insurance
companies, provident funds, Primary Dealers (PDs) and pension funds. Of late, the retail
investors have been showing interest in corporate bonds, especially bonds issued by the
infrastructure companies that entail tax incentive. While investors are not shy of debts issued
by the top rated firms, they are reluctant to subscribe to the lower rated instruments. This is
an anomaly because lower rated companies do have access to bank financing. Credit
enhancement by banks can perhaps make such instruments attractive to investors. But on
the flip side, credit enhancement essentially involves transfer of the credit risk to banks and
this will not only hamper the development of corporate bond market by stunting the price
discovery process but also increase the risk in the banking system. The focus must be on
derisking banking system, and at the same time, building/encouraging institutions that provide
credit enhancement.
Investor interest in the interest rate derivatives market ought to be dictated by their exposure
to the cash market. While investors' cash market exposure is substantial and has been
increasing over time, the accounting hedge through HTM classification insulates the holders
against market risk. Therefore, we observe skewed and limited participation, resulting in
shallow markets. Though the Interest Rate Swaps (IRS) was launched in 1999, the only
product where the market volumes have grown substantially is the overnight index swap
based on the overnight money market index. Here too the participation is not significantly
broad-based. Foreign banks (owning only 7 percent of the banking sector assets) are the
most dominant players in the IRS market followed by the private sector banks while the
participation of the public sector banks who own as much as 74 percent of the banking sector
assets remain miniscule. Notwithstanding the large trading volume and value of contracts
outstanding, the skewed participation leads to pricing anomalies and also puts a question
mark on the economic utility of the product.
Issuers
Sovereign securities dominate the fixed income markets almost everywhere. In India too, the
central and state governments remain the main issuers. Two observations are in order.
Traditionally, marketable securities of the Central and the State Governments constituted
only a part of their respective liabilities and, therefore, the size of the government bond
market as measured by the outstanding stock was relatively small compared to the
debt-toGDP ratio. Secondly, if one excludes the securities held by the Reserve Bank under the
Open Market Operations (OMO) and other buy-and-hold entities, the market size becomes
even smaller.
In recent times, market borrowings have emerged as the largest source of financing fiscal
deficit. The auction based issuance process is transparent with publication of auction
calendars well in advance enabling the market participants to plan their investments. The
large supply of securities, due to enhanced borrowings, has enabled creation of benchmark
securities with sufficient outstanding stock and issuances across the yield curve. The
issuances across the risk-free yield curve in turn have provided benchmarks for valuation of
other bonds/financial assets.
Despite economic recovery in 2010-11 and resumption of fiscal consolidation path, the
market borrowing of the Government has remained at elevated levels in India. The Union
Budget of India 2011-12 estimated gross fiscal deficit (GFD) at 4128.17 billion and
budgeted gross market borrowings of 4170.00 billion. The market borrowings, however,
through dated securities for the current year has been increased by about 930.00 billion
due to shortfall in other financing items, primarily due to moderation in the growth rate of the
economy and increased expenditure. Besides inflationary implications, such large overhangs
of debt and increasing annual borrowings have impeded the growth of flow of resources to
the private sector by way of both loans and bonds. More importantly, lack of fiscal flexibility
has not facilitated creation of limited number of benchmarks and active consolidation of
illiquid securities. This fragmented G-Sec market has neither been beneficial to the issuer nor
the investors.
In spite of some passive consolidation of government securities undertaken by the Reserve
Bank of India, the market remains fragmented with many stocks with relatively small size.
Nearly fifty percent of the outstanding stocks has volume less than 200 billion. There is
merit in pursuing active consolidation with focus on buy-backs and switches to build volumes
and improve liquidity. Reserve Bank is in consultation with the government to achieve some
degree of consolidation in G-Sec in the near future. Reserve Bank has recently constituted a
Working Group (Chairman: Shri. R Gandhi, Executive Director, Reserve Bank of India) to
examine ways to improve liquidity in Government securities and interest rate derivatives
market as well as suggest measures for active consolidation of the securities.
Corporates in many developed markets - predominantly in the US and increasingly in other
jurisdictions - have a marked preference to tap the bond market rather than to seek bank
loans for meeting their external finance requirements. In India, however, companies continue
to depend on the banking system for funds because of ease of availing bank finance,
absence of credit risk mitigation mechanisms and a host of other factors, such as, absence
of sound bankruptcy framework and lack of active interest of long-term investors like
insurance companies.
An examination of the issuer profile of corporate bonds reveals that issuances are dominated
by banks and public sector companies. Private sector, non-financial corporate issuers
represent a smaller proportion. As mentioned earlier, issuers with triple-A ratings raise funds
with ease from the markets as compared to firms with lower ratings. Private placements
mostly dominate the primary segment of the corporate debt market accounting for more than
98 per cent of the total issuance of corporate debt (2010-11) in India. Corporates prefer
raising funds through private placements as against public issuances because of operational
ease of issuance under private placements with minimum disclosures, low cost of issuance
and the speed of raising funds. The issuance process is also impacted by costs, such as,
stamp duties, transfer costs, etc. which needs rationalisation. Preference for private
placement is also dictated by the profile of investors which is mostly institutional and a
narrow base at that.
Instruments
For a market to meet the diverse funding and hedging needs of the participants, there is
need for a wide array of instruments and products which would also offer benefits of
diversification in the portfolio. In the process of development of new instruments, Reserve
Bank's endeavour has been to ensure calibrated and orderly development of the markets
with emphasis on prudent risk management and promotion of financial stability.
Over the years, several instruments like zero-coupon bonds, capital-indexed bonds, floating
rate bonds, STRIPS and bonds with call and put options have been introduced after wide
consultations with market participants and with product features comparable to those of the
most popular and liquid instruments elsewhere. In the case of short term instruments Cash
Management Bills (CMBs) have emerged as a new class of instrument providing
opportunities for secured, shorter term investment in sovereign paper. The size and
frequency of issuance of CMBs are likely to increase given the uncertainty in cash inflows
and outflows of the Government whose income and expenditure has been growing rapidly.
Issues, such as, very short notice for issue of CMBs, more demand for treasury bills, which
have structured tenors, may come in the way of large demand for CMBs. There is a plan to
launch a new long-term instrument - the Inflation Indexed Bonds (IIBs) wherein both capital
and interest would be provided protection against inflation. It is expected that institutional
investors, such as, pension funds and insurance companies would exhibit interest in
investing in the IIBs. The expectation is based on the fact that the IIBs give investors
longterm assets with a fixed long-term real yield, insulating them against inflation as their real
yields are indexed to actual inflation. Further, it is also being contemplated to increase the
non-competitive portion for IIBs to have significant participation of retail investors in these
instruments.
Plain vanilla fixed coupon bonds, however, remain the mainstay of issuances. With the
exception of an innovative product like Collateralized Borrowing and Lending Obligations
(CBLO), the market has not displayed any appetite for instruments with varied structure. A
similar response pattern has been observed in respect of products such as interest rate
futures (IRFs) (based on 10-year bond and 91-day T-Bill), repo in corporate bonds and new
issuance of Floating Rate Bond (FRB). One plausible reason for lack of interest is illiquidity in
the underlying bond market. The dilemma is that while participants do not want to trade till
liquidity improves, liquidity will not improve till the participants trade giving rise to the typical
"chicken and egg problem". The bottomline is that the market participants need to be more
active in trading across the yield curve and across products and this requires an urgent and
serious introspection by them.
Recently, the guidelines on the interest rate futures of two and five year tenors have been
issued. These futures will be cash settled with settlement price computed through a polling
process managed by the FIMMDA. As the product design has been finalised after due
consultation with the market participants and the issue of illiquidity in underlying cash market
has been dealt with by permitting cash settlement, it is expected that the product will attract
active interest. Another significant step is the extension of the period of short sale to three
months, effective from February 1, 2012. This will enable the participants to express their
interest rate views more effectively and is expected to give fillip to term repo market.
Similarly, the Credit Default Swap (CDS) on corporate bonds has been introduced to
facilitate hedging of credit risk associated with corporate bonds. Introduction of credit
enhancement for corporate bonds through CDS may also increase investors' interest in
corporate bonds.
Several episodes in international markets underscored the importance of risk management in
the use of financial products. Learning from these episodes, the approach of the Reserve
Bank of India towards regulation and risk management has been oriented to ensure orderly
development of financial markets and products. This objective is achieved by establishing
efficient infrastructure, addressing systemic stability issues and also supporting market
development. The pre-dominant motivation has been to strike a balance between systemic
stability and financial market development.
Infrastructure
Market infrastructure is a comprehensive term that includes the entire gamut of
arrangements for the transactions to be carried out and settled in an efficient and safe
manner. Infrastructure plays an important role in development of markets and want of an
efficient, transparent and robust infrastructure can keep market participants away on one
extreme or cause market crisis on the other. Reserve Bank of India has pursuing a strategy
for creation of an efficient market infrastructure to enhance market activity and also to create
a supporting institutional framework. In the government bond market, a state of the art
primary issuance process with electronic bidding and fast processing capabilities, an
efficient, completely dematerialized depository system, Delivery-versus-Payment (DvP)
mode of settlement, Real Time Gross Settlement (RTGS), electronic trading platforms
(Negotiated Dealing Systems and Negotiated Dealing Systems-Order Matching) and a
separate Central Counter Party (CCP) in the Clearing Corporation of India Ltd (CCIL) for
guaranteed settlement are among the steps that were taken by the Reserve Bank over the
years towards this end. In fact, thanks to these efforts, India can boast of being one of the
few emerging countries with such a state of the art financial market infrastructure for the
GSec market. Creating a robust risk management structure for the CCP to mitigate its
increasing concentration risk and enabling an assured liquidity support framework for
meeting its emergency liquidity needs are some of the challenges before the Reserve Bank
of India. We are closely monitoring how the international consensus is evolving on these
areas.
To strengthen the market infrastructure for corporate bonds Reserve Bank of India, in
consultation with the Securities and Exchange Board of India (SEBI), has permitted the
clearing houses of the exchanges to have a transitory pooling account facility with the
Reserve Bank. This will facilitate settlement of OTC corporate bond transactions on a DvP-I
basis. The infrastructure has been bolstered by support of the market bodies with FIMMDA
establishing and operating reporting platforms for corporate bonds, Commercial Papers
(CPs)/Certificates of Deposit (CDs). This collaboration between the regulator and the market
participants has laid the foundation for enhanced transparency and vibrancy in the market.
The financial crisis in 2008 revealed several deficiencies of the OTC derivatives market. The
importance of improving transparency, mitigating systemic risks and protecting against
market abuse came to the forefront. In September 2009, the G-20 leaders mandated that
OTC derivative contracts should be reported to trade repositories; all standardised OTC
derivatives contracts should be traded on exchanges or electronic trading platforms, where
appropriate; and all standardised OTC derivatives contracts should be cleared through the
CCPs. In this regard, a considerable amount of work on infrastructure to make OTC
derivatives trades transparent has been done in India. As early as in 2007, Reserve Bank
had mandated the reporting of all inter-institution OTC interest rate derivatives on a platform
developed for the purpose by the CCIL. Introduction of CDS was accompanied by putting in
place a reporting arrangement simultaneously. On the basis the recommendation of a
working group, a comprehensive and efficient single point reporting arrangement for all
interest rate and foreign exchange derivatives is also in the process of implementation.
Intermediaries
Intermediaries play an important role in development of the market by facilitating the
transactions, providing value-added services and increasing efficacy of the processes. With
regard to bond markets in India, I would like to elucidate the role of four major intermediaries
viz. PD system, industry associations like FIMMDA/PDAI, Gilt Mutual Funds and the
Infrastructure Development Funds (IDFs), which are in the offing.
The system of Primary Dealers (PDs) was established to provide support to the market
borrowing programmes of the Government and also to impart liquidity in the secondary
markets. Subsequent to the withdrawal of the Reserve Bank of India from the primary
market, as mandated by Fiscal Responsibility and Budget Management Act 2003, the PD
System has been underwriting the entire Government of India market borrowing. PDs have
actively supported the bond issuances and their role in successful completion of sizeable
issuance programmes over the past three years has been commendable. Recently, Reserve
Bank has revised the guidelines on authorisation of PDs with focus on their market
experience as well as increase in retail/mid-segment investor participation so as to widen the
investor base. The revised guidelines prescribe a seasoning requirement of at least one year
prior to submission of application, reasonable experience in G-Sec market with at least
15 per cent of their assets and turnover in G-Sec and a commitment to achieve a minimum
turnover of 75 per cent of their minimum NOF in G-Sec on behalf of retail/mid segment
clients. We expect the PDs would continue to support the market borrowing programmes, act
as market makers by providing fillip to secondary markets and retail investors and proactively
deal in the financial products such as CDS, IRF, etc. Reserve Bank is also exploring the
possibility of enabling banks/PDs to make markets in corporate bonds through appropriate
supportive measures.
Changing nature of financial markets necessitate that organisations, such as, FIMMDA and
PDAI, play a more proactive role in bringing orderliness in market activities and desired level
of discipline amongst market participants. Reserve Bank of India regularly engages with
FIMMDA and PDAI on various issues of policy and provides inputs and perspectives of the
market participants. FIMMDA has been entrusted with responsibilities, such as, publishing
model prices for G-Sec and non-G-Sec to be used in valuations, formulation of model code
of conduct for market participants, development and operationalization of critical market
infrastructure like reporting platform for corporate bonds, repo in corporate bonds, CPs and
CDs, accreditation of brokers in the OTC interest rate derivatives market, development of the
daily CDS curve for valuation of open positions, etc. The entrusted responsibilities and
activities/functions of FIMMDA in the underlying market clearly indicate its potential for
self-regulatory role. There is, however, an urgent need for FIMMDA to further strengthen
itself, build competencies, both technical and financial, and broaden its mission to carry out
tasks commensurate with the developments in the market and to undertake additional
responsibilities as Self Regulatory Organization (SRO). I suggest that FIMMDA may draw up
an action plan in this direction with clear goals to be achieved with appropriate time lines.
Gilt Mutual Fund industry has grown manifold but the Mutual Funds (MFs) continue to invest
predominantly in short-tenor fixed income assets, thereby exhibiting low demand in the
G-Sec market. This is a cause of concern and requires an urgent need to examine ways for
Huge requirement of investment in infrastructure sector underscores the importance of the
IDFs. Reserve Bank of India has, as a special case, has permitted several prudential
relaxations for setting up IDFs including enhanced exposure norms, assigning lower risk
weights for capital adequacy purposes, etc. Reserve Bank of India has also allowed
investment on full repatriation basis by new class of eligible non-resident investors (viz.
Sovereign Wealth Funds, multilateral agencies, pension funds, insurance funds, endowment
funds) in Rupee and Foreign Currency denominated bonds to be issued by IDF-NBFCs
registered by the Reserve Bank of India and Rupee denominated units issued by IDF-MFs
set up as SEBI registered Mutual Funds. Given our calibrated approach towards opening up
of our debt markets to foreign investors, all such investments (excluding those by NRIs) will,
however, be within an overall cap of US$ 10 billion (which would be within the overall cap of
US$ 25 billion for FII investment in infrastructure debt). IDFs will, in days to come, act as a
major source of channelizing huge quantum of funds from long term domestic and foreign
investors to the corporate debt markets in the critical infrastructure sector of the country and
will indeed be a gamechanger with a potential of redefining various facets of the markets.
Incentives
Incentives, both positive and negative, play a major role in shaping human behaviour and
markets are no exception to this rule. For illustrative purposes, I would like to cite a few
instances where incentives played important role in shaping the development of the debt
markets. Existence of easy access to bank loans incentivised corporates to approach banks
rather than rely on corporate bond market. This excessive reliance on bank finance
hampered the development of deep and liquid bond markets and was partly responsible for
the financial instability during the Asian crisis.
The illiquidity in the Indian corporate bond markets can be attributed to the apparent
preference of the corporates to finance their requirements through private placement and rely
on external commercial borrowings. The level and complexity of stamp duty on corporate
bonds encourages an arbitrage-based approach to corporate finance and decisions are often
tax-driven rather than strategy-driven. Differential tax treatment further complicates the
matter as it tends to incentivise certain investors, e.g., insurance companies and mutual
funds who are exempt from TDS on interest income from corporate bonds.
The regulatory dispensation of HTM classification has protected balance sheets of the banks
and encouraged them to invest in G-Sec but promoted illiquidity in government bonds.
Different incentive structures in treasuries of public sector banks and private/foreign bank
treasuries partly explains the level of participation in derivative markets in spite of existence
of similar risks on the balance sheets. While differences in incentives in public and private
banks with regard to treasury operations exist, the reasons for lack of interest shown by most
of the public sector in spite of the fact that they hold very high interest rate sensitive portfolio
and have the balance sheet capability to participate in the market needs to be examined in
depth and debated.
An understanding of the incentives is essential for both policy makers and market
participants so that the market activities can be directed towards attainment of objectives of
efficiency and effectiveness. While Reserve Bank tries to align incentives by regulation and
supervision, regulation itself could create unintended incentives/disincentives as in the case
of requirement regarding "HTM". For instance, the ability to buy CDS without an underlying
has resulted in perverse incentives in the developed markets. Reserve Bank, while framing
the CDS policy, has designed regulation to curb such skewed incentives by restricting users
to buy CDS only to hedge an underlying exposure. Physical settlement has been mandated
after the credit event. A nuanced understanding of the incentives would help in design of
regulation that promotes market development without jeopardising financi