The Insurance Regulatory and Development Authority (Irda) has modified its earlier proposals on guidelines for participation in credit default swaps (CDS). It proposes that CDS will only be allowed on listed corporate bonds.
CDS is a counter- party agreement, allowing the transfer of third-party credit risk from one party to the other. An insurance company acts as a counter-party, which agrees to insure the risk against payment of a premium. If the third party defaults on payment, the counter-party will have to purchase the defaulted asset from the insured party.
The draft said CDS would be permitted as a ‘hedge’ to manage the credit risk covering the credit event. “CDS will be allowed only on listed corporate bonds, as reference obligations. CDS can also be bought on unlisted but rated bonds of infrastructure companies,” said Irda in the draft. It also said unlisted/unrated bonds issued by special purpose vehicles set up by infrastructure companies are also eligible as reference obligations.
According to the guidelines, a CDS is permitted as a hedge to manage the credit risk covering the credit event. It will be allowed only on listed corporate bonds as reference obligations.
Unlisted unrated bonds issued by SPVs of infrastructure companies are also eligible as reference obligations. However, shift of exposure to the protection seller (insurer) happens only in case the credit event is an investment in the infrastructure sector.
The regulator has also barred insurers from purchasing CDS if they belong to a promoter group or between the entities of a promoter group, on short-term instruments and on obligations such as asset-backed securities.
Further, it said that all CDS transactions shall be reported to the investment committee and audit committee on a quarterly periodicity. Irda has asked the board of directors of insurers to amend their investment policy and put in place the necessary risk management framework covering aspects such as types of assets on which protection can be bought, counter-parties from which CDS can be bought and limits on the counter-parties, and valuation norms, among others.
Irda had prepared an exposure draft on these in August and invited comments from various stakeholders. Those draft guidelines have been modified after examining these comments.