Mumbai/Hong Kong: India has opened the door to credit derivatives after years of debate, but the market could sputter if trading is restricted to bond derivatives alone.
Last month, the central bank said it would permit commercial banks and primary dealers to trade credit default swaps— insurance-like contracts that protect against default and restructuring—as a first step in introducing credit derivatives, the fastest growing financial tools in the world.
The Reserve Bank of India (RBI) says it wants the market for this essential risk-control tool to develop, but at the same time it stipulates that derivatives’ underlying assets must be rated, effectively ruling out loans, which are the primary assets bearing credit risk on Indian banks’ books.
“A substantial amount of debt in the market is loans and not bonds, there are virtually no pure corporate (non-financial institutional) issuers,” said Anindya Dutta, head of capital markets, India, for Calyon Corporate & Investment Bank. “It is necessary to have both bonds and loans as reference and deliverable obligations.”
The central bank has published guidelines for trading credit default swaps and has invited comments and feedback. Final guidelines are expected later this month.
Analysts expect initial trades to be dominated by highly rated banks on the protection-selling side, while protection buyers will be banks holding weaker, high-risk portfolios.
Global banks such as Standard Chartered, Citigroup, HSBC and JPMorgan could dominate the early phase, especially as protection sellers.
Privately owned local banks such as ICICI Bank Ltd and HDFC Bank Ltd and state-run banks such as Bank of Baroda and State Bank of India would be prominent participants.
However, interested parties such as the International Swaps and Derivatives Association (Isda) say the rules are too narrow, focusing on a single product, and that volume will be stunted unless these are widened. India currently allows few derivatives in the interest rate and currency markets, where products such as interest-rate futures and currency swaps suffer from thin volume.
Analysts blame restrictions such as those allowing certain products to be used for hedging only, as well as technical problems, including the absence of a single, common benchmark for certain products like interest rate swaps.
They are concerned that credit derivatives could meet a similar fate unless the guidelines are extended to loans, which are more popular than bonds among corporate borrowers.
Indian banks hold Rs17.9 trillion in all loans, according to the Centre for Monitoring Indian Economy. Outstanding Indian corporate debt is estimated at Rs53,500 crore, National Stock Exchange data showed.
RBI is keen to let the banking sector have access to more hedging tools.
“While banks have been provided the options of managing their interest-rate risk and foreign-currency risks through the use of derivatives, a similar option is not available for managing their credit risks,” RBI said. reuters