Alternative Investment

The Capital Quest | SEBI allows PE, VC funds to buy and sell credit default swaps

The Securities and Exchange Board of India has allowed private equity and venture capital funds to buy and sell credit default swaps.

SEBI said it has amended its Alternative Investment Funds Regulations to allow AIFs to participate in credit default swaps as protection buyers and sellers.

It said that Category I and Category II AIFs may buy CDS, a product that allows an investor to swap their credit risk with that of another investor, on underlying investment in debt securities, only for the purpose of hedging. Category III AIFs may buy CDS for the purpose of hedging or otherwise, within permissible leverage, it said.

Category I funds include VC funds, infrastructure funds and SME funds. Category II includes PE funds, real estate funds and stressed asset investment vehicles. Category III covers hedge funds and PIPE funds, or those that make private investments in public equities.

SEBI also said that Category III AIFs may sell CDS, subject to the condition that effective leverage undertaken is within the permissible limits. Category II and Category III AIFs may sell CDS by earmarking unencumbered government bonds and treasury bills equal to the amount of the CDS exposure. Such earmarked securities may also be used for maintaining applicable margin requirements for the CDS exposure, it said.

The regulator said that the total exposure to an investee company, including exposure through CDS, shall be within the limit of applicable concentration norm as specified in its AIF regulations.

PE and VC funds will have to report details of the CDS transaction to the custodian by the next working day and also report breaches, SEBI said. All CDS transactions will be on a platform regulated by SEBI or the Reserve Bank of India to enhance transparency and disclosure, it added.

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