Mumbai: Credit default swaps (CDS) may have to be mandatorily rated once they are introduced in India, a Reserve Bank of India (RBI) official said.
In the text of a speech presented in absentia on 28 February in Kenya, RBI deputy governor Shyamala Gopinath said that in India, where secondary market liquidity is dormant, ratings could be necessary, at least to start with, to provide participants information required for “considering entering, continuing (and) unwinding their CDS positions.”
A CDS is a derivative used to offset risks in debt markets. It allows creditors to insure themselves against the possibility that a borrower might default. Derivatives are financial instruments that reflect the value of an underlying instrument. In the case of CDS, the underlying instrument is a bond or a loan.
In the second half of 2008, CDS became controversial as firms with significant exposure to them such as US insurer American International Group Inc. needed to be bailed out by the government after this exposure exceeded their ability to honour contracts.
RBI had issued a draft guideline to introduce CDS in 2007 but shelved the launch following the global financial crisis triggered in 2008.
RBI is also planning to introduce a centralized reporting system when the CDS are introduced, according to a copy of the speech available on the RBI’s website. However, a centralized clearing and settlement system for such instruments could be challenging and RBI is examining international practices in this regard, it added.
The text did not specify a time frame for introducing CDS.