CIRCULAR
SEBI/HO/IMD/PoD2/P/CIR/2024/125 September 20, 2024
All Mutual Funds/
All Asset Management Companies (AMCs)/
All Trustee Companies/ Board of Trustees of Mutual Funds/
Association of Mutual Funds in India (AMFI)
Sir / Madam,
Subject: Flexibility in participation of Mutual Funds in Credit Default Swaps
(CDS)
1. Under the existing regulatory framework, Mutual Funds in India are permitted to
participate in CDS transactions only as users i.e, to buy credit protection only to
hedge the credit risk on corporate bonds held by them. Furthermore, such
transactions can be currently undertaken by Mutual Funds only in the portfolios
of Fixed Maturity Plans (FMP) schemes having tenor of more than one year.
2. Reserve Bank of India has issued a revised regulatory framework for CDS on
February 10, 2022 “Master Direction – Reserve Bank of India (Credit Derivatives)
Directions, 2022” in order to provide the necessary impetus for the development
of CDS market by, inter alia, expanding the base of protection sellers including
selling of protection by all major non-bank regulated entities including by Mutual
Funds.
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3. In view of the above, after taking into consideration the recommendations of the
Working Group set up to deliberate on the issue, recommendations of Advisory
Committee on Mutual Funds (MFAC), inputs by AMFI and feedback received on
the consultation paper on this issue, it has been decided to allow greater
flexibility to Mutual Funds to both buy and sell CDS with adequate risk
management. Such flexibility to participate in CDS shall serve as an additional
investment product for Mutual Funds and also aid in increasing liquidity in the
corporate bond market.
4. Accordingly, clause 12.28 of the Master Circular for Mutual Funds dated June
27, 2024 stand modified as under:
12.28. Participation of Mutual Funds in Credit Default Swaps (CDS)
Mutual Fund Schemes as buyer of CDS
12.28.1. Schemes may buy CDS only for the purpose of hedging their credit risk
on debt securities they hold in various schemes. The exposure of CDS
shall not exceed respective debt security exposure, and such exposure
may not be added to gross exposure of the scheme.
12.28.2. In case the protected debt security is sold, schemes shall ensure that
the respective CDS position is closed within fifteen working days of
selling the above protected debt security.
12.28.3. The exposure of any protected debt security, for determining single
issuer, group, sectoral limits and credit risk for various purposes
including Risk-o-meter and Potential Risk Class (PRC) matrix of MF
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schemes, shall be considered as exposure to either issuer of debt
security (reference entity) or seller of CDS, whichever has higher credit
rating (lowest long term rating of instruments of seller of CDS shall be
considered for comparison).
The exposure shall form part of overall single issuer limits for the
reference entity or seller of CDS, whichever is applicable.
In case of same rating for reference entity and seller of CDS, the
exposure shall then be considered on reference entity and not on seller
of CDS.
12.28.4. MF schemes shall buy CDS only from such sellers that have instruments
with lowest long-term rating of investment grade and above.
12.28.5. Schemes may buy CDS for investment grade and existing below
investment grade debt securities in the portfolio, if any.
Mutual Fund Schemes as seller of CDS
12.28.6. MF Schemes may sell CDS only as part of investment in synthetic debt
securities, i.e., sell CDS on a reference obligation covered with Cash/G-
Sec/T-bills. Overnight and Liquid schemes shall not sell CDS contracts.
12.28.7. The following shall be ensured with respect to the cover:
12.28.7.1. Cash, G-Sec and T-bills can act as cover. Government securities with
maturity within +/- 6 months of the maturity of respective debt security
(reference obligation) shall act as cover and such cover may be used
for maintaining margin requirements on respective CDS.
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12.28.7.2. The required amount of cover shall be enough to ensure that notional
amount does not exceed the value of cover kept, which shall be
calculated as follows:
 Notional amount in CDS sell contract
(+)
 Buffer, for price fluctuations on government securities kept as
cover: The buffer shall be calculated to address interest rate risk
on government securities. The buffer shall be atleast equal to
three times the daily haircut applicable for the said G-sec
instrument in case of repo transactions on Clearing Corporation
of India Limited.
12.28.7.3. The value of cover kept shall be reviewed on a daily basis.
12.28.7.4. The cover shall be earmarked to CDS sell position and can be used
for maintaining margin requirements on respective CDS. However,
investment in aforesaid instruments as cover shall not be considered
as part of Liquidity Ratio – Redemption at Risk (LR-RaR) and
Liquidity Ratio - Conditional Redemption at Risk (LR-CRaR) eligible
instruments and shall not be sold or used for any other purpose till
CDS sell position is open.
12.28.8. The exposure of synthetic debt security (notional amount) shall be
considered in respective single issuer, group issuer and sectoral limits.
Such exposure to the issuer, group and sector of the issuer shall be
equal to the notional amount.
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12.28.9. For the purpose of computing gross exposure of scheme investing in
synthetic debt security, the exposure due to such investment shall be
computed as follows:
 Notional amount
(+)
 Buffer (i.e., cover kept over and above notional amount)
12.28.10. Schemes shall sell CDS only against securities rated investment grade
and above.
12.28.11. Credit risk rating of the synthetic debt security shall be same as of
reference obligation. For the purpose of Risk-o-meter, liquidity risk value
of the synthetic debt security shall be
 Liquidity Risk Value of reference obligation + 2
12.28.12. For Potential Risk Class (PRC) matrix, Credit Risk Value shall be same
as reference obligation.
12.28.13. Debt Index funds and ETFs: Such schemes may also take exposure
through synthetic debt securities and the same may be treated as
replication as required under clause 3.5.3 of the Master Circular.
Other conditions
12.28.14. Schemes shall comply with the directions issued by RBI from time to
time in this regard.
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12.28.15. Schemes shall participate in CDS only through standard contracts
prescribed by Fixed Income Money Market and Derivatives Association
of India (FIMMDA).
12.28.16. All CDS contracts shall be transacted either through Central
Counterparty, if any or Request For Quote (RFQ) Platform.
12.28.17. MFs shall ensure Two-way Credit Support Annex (CSA) as part of CDS
contracts.
12.28.18. The following disclosures shall be made by schemes in their periodic
scheme portfolio disclosures:
12.28.18.1. Credit Rating of CDS seller (lowest long term) where CDS is bought
by schemes
12.28.18.2. CDS transactions with associate or group companies of sponsor
12.28.19. CDS contract shall mature on or before winding up date of schemes,
wherever applicable.
12.28.20. Exposure through CDS (Notional amount of both CDS bought and sold)
shall not exceed 10% of AUM of scheme and shall be within the overall
limit of derivatives exposure as prescribed in Scheme Information
Documents.
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12.28.21. Valuation and Accounting: AMFI, in consultation with SEBI, shall issue
guidelines for valuation and accounting of CDS by MF schemes based
on a waterfall approach, that may be as follows:
 Level I: Actual Traded levels
 Level II: Corporate bond credit spreads
5. The relevant changes in the Scheme Information Documents, basis the
provisions of this circular, shall not be considered as a “Fundamental Attribute
Change” of the scheme in terms of regulation 18(15A) of SEBI (Mutual Funds)
Regulations, 1996.
6. The provisions of this circular shall come into force with immediate effect.
7. This circular is issued in exercise of powers conferred under Section 11 (1) of
the Securities and Exchange Board of India Act, 1992, read with the provisions
of regulation 43 (1) and regulation 77 of SEBI (Mutual Funds) Regulations, 1996,
to protect the interest of investors in securities and to promote the development
of, and to regulate the securities market.
8. This Circular is available at www.sebi.gov.in under the link “Legal > Circulars”.
Yours faithfully,
Lakshaya Chawla
Deputy General Manager
Tel no.: 022-26449369
Email: lakshayac@sebi.gov.in
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