Introducing CDS in India

The Reserve Bank of India (RBI) recently put out a draft report on introducing credit default swaps as OTC derivatives product for corporate bonds in India. Two attempts to introduce the product were already made earlier in 2003 and 2007. The timing of the latest proposal indicates that perhaps the central bank was waiting for the financial crisis to subside and also buy that extra time to learn lessons from the crisis. However, RBI has not incorporated some key lessons from the crisis. The following are a few glaring shortcomings in the proposal – 1) At a time when the world is moving towards centralized clearing systems, issues such as opacity and counterparty risk associated with OTC markets seem to have been overlooked, at least for now. What is more worrisome is that the proposal is not even keen on establishing a trade reporting platform. While it envisages the establishment of a trade reporting platform in the future, the proposal gives a green signal to begin CDS trading without setting up a trade repository. 2) The proposal says that the market is essentially a dealers market. Users are only allowed to buy CDS from dealers alone. However, what is very surprising is that it does not allow CDS buyers to unwind the protection by entering into another offsetting contract. If buyers desire to unwind, they have to terminate the position with the original counterparty, thereby allowing excessive and unfair control to the sellers. 3) The trade reporting format provided in the proposal does not include price data, which makes it even more unfriendly to the buyers. Opacity in prices even on post-trade basis, along with transparency issues arising out of the OTC nature of the market loads the dice heavily against CDS buyers. One would just hope now that the CDS market does not suffer in the same manner in which interest rate futures market did, especially given that India certainly needs a mature CDS market to manage systemic risks prudentially.