Column: A bit too little, a bit too late

Jan 15 2013, 03:02 IST
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SummaryIn a bid to restart the credit default swap market, RBI last week allowed CDS on unlisted rated corporate bonds in addition to the listed ones.

RBI is to be blamed for infant mortality of CDS market. Unless CDS on loans are allowed, the market will remain non-starter

In a bid to restart the credit default swap (CDS) market, RBI last week allowed CDS on unlisted rated corporate bonds in addition to the listed ones. A CDS is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a bond default. The buyer of the CDS makes a series of payments called the CDS ‘fee’ or ‘spread’ to the seller and, in exchange, receives a payoff if the bond defaults. The initial guidelines issued by RBI allowed CDS on only listed corporate bonds and did not allow for unwinding of CDS bought positions. It also did not permit CDS on securities with original maturity up to one year like commercial papers, certificates of deposit and non-convertible debentures. All those restrictions have now been relaxed.

However, the change of regulation is a bit too little and a bit too late. It is like trying to press the ignition button of a vehicle that does not have any fuel in the first place. RBI was ultra-conservative when it kick-started the CDS market in India and now it has realised its mistake. RBI brought out the CDS guidelines after a long wait of four years on May 23, 2011. The operational guidelines were announced on November 30, 2011. Post this, in the nine-month period till August 2012, there had been only three CDS transactions for a total transaction volume of just R15 crore. A lot of the blame for the infant mortality of the CDS market should lie on the doorsteps of RBI. They stifled the growth of the market, even before it could start to develop.

The 2011 guidelines proved to be a non-starter for several reasons. First, RBI started with the premise that a self-sufficient market can exist with predominantly hedgers. Any market participant worth his experience will tell you that it takes both hedgers and speculators to make a market. Even for hedgers, RBI limited CDS only for bonds. Most international CDS contracts are referenced to loans or bonds, not merely to bonds. Even then, one can understand the rationale for the guidelines if the bond markets were highly developed. In India, we have a corporate bond market that is largely limited to AAA and AA ratings. Most hedgers don’t have

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