SEBI circular on Participation of AIFs in Credit Default Swaps – January 12, 2023

SEBI, vide its circular dated January 12, 2023 allowed alternative investment funds (AIFs) to participate in the Credit Default Swaps (CDS) market as protection buyers and sellers.

It is to be noted that Regulations 16(1)(aa), 17(da), 18(ab) and 20(11) of AIF Regulations enable AIFs to participate in CDS in terms of the conditions as may be specified by SEBI from time to time. In this regard, the following is specified:

Conditions applicable Category I, II and III AIFs for buying CDS: 2.1. Category I AIFs and Category II AIFs may buy CDS on underlying investment in debt securities, only for the purpose of hedging. 2.2. Category III AIFs may buy CDS for the purpose of hedging or otherwise, within ­permissible leverage as specified in SEBI circular no. CIR/IMD/DF/10/2013 dated July 29, 2013.

Conditions applicable Category II and III AIFs for selling CDS: 2.3. Category III AIFs may sell CDS, subject to the condition that effective leverage undertaken is within the permissible limits as specified in SEBI circular no. CIR/IMD/DF/10/2013 dated July 29, 2013. 2.4. Further, Category II AIFs and Category III AIFs may sell CDS, by earmarking unencumbered Government bonds/Treasury bills equal to the amount of the said CDS exposure. Such earmarked securities may also be used for maintaining applicable margin requirements for the said CDS exposure. Exposure to CDS undertaken in the aforesaid manner shall not tantamount to leverage. 2.5.Total exposure to an investee company, including exposure through CDS, shall be within the limit of applicable concentration norm as specified in AIF Regulations.

Other conditions applicable for transacting in CDS: 2.6. AIFs shall report details of CDS transaction to the custodian, by the next working day, in the manner as specified by the custodian. 2.7. Custodian, shall put in place a mechanism to collect necessary details from AIFs transacting in CDS, to monitor the compliance with conditions specified at para 2A and para 2B above. 2.8. The obligation of manager/AIF and custodian in case of breach of leverage limits due to transactions in CDS by Category III AIFs, shall be as specified in para 3.4 of SEBI circular no. CIR/IMD/DF/10/2013 dated July 29, 2013 read with para 1 of SEBI circular no. CIR/IMD/DF/14/2014 dated June 19, 2014. 2.9. Further, for Category II AIFs and Category III AIFs which sell CDS by earmarking securities in the manner as mentioned at para 2.4 above, in case the amount of e