Overview : Credit Default Swaps (CDS)

The Reserve Bank of India (RBI) revised guidelines for credit default swaps (CDS which is effective from May 9, 2022.

CDS is a contract in which a counterparty (seller) commits to compensate the other counterparty (buyer) for the loss in the value of an underlying debt instrument.
As per RBI guidelines,CDS directions of Central Bank will apply to credit derivatives transactions undertaken in Over-the-Counter (OTC) markets and on recognised stock exchanges in India.
The CDS contract shall be denominated and settled in Indian Rupees;
CDS cannot be written on interest receivables;
CDS cannot be written on interest receivables;
CDS shall not be written on securities like CP (commercial paper), CD (certificate of deposit), and NCD (negotiable certificate of deposit) with an original maturity of up to one year.
CDS contract must represent a direct claim on the protection seller;
CDS contract must be irrevocable; there must be no clause in the contract that would allow the protection seller to unilaterally cancel the contract. However, if the protection buyer defaults under the terms of a contract, the protection seller can cancel/revoke the contract;
the protection seller shall have no recourse to the protection buyer for credit-event losses;

The above directions of Central Bank will apply to credit derivatives transactions undertaken in Over-the-Counter (OTC) markets and on recognised stock exchanges in India. Residents and non-residents who are eligible to invest in corporate bonds and debentures under the Foreign Exchange Management (Debt Instruments) Regulations 2019 will be eligible to participate in the credit derivatives market.Both retail and non-retail users can buy protection in the CDS market. Retail users can only buy protection for hedging, while non-retail users can buy protection for hedging and other purposes. Non-retail users include insurance companies, pension funds, mutual funds, alternate investment funds, and foreign portfolio investors.
Restrictions
Market Makers:
Market maker refers to a firm or an individual that engages in two-sided markets of a given security. It means that it provides bids and asks in tandem with the market size of each security. A market maker seeks to profit off of the difference in the bid-ask spread and provides liquidity to financial markets.Scheduled commercial banks, non-banking financial companies (NBFCs), housing finance companies (HFCs), and certain government financial institutions can be market-makers. They must meet certain quantitative thresholds and get approval from the RBI.