Insurance Regulatory and Development Authority (IRDA) has permitted the use of credit default swap (CDS), a derivative instrument that offers credit protection, for insurance companies to hedge their risk, reports PTI.

What is CDS

The CDS is a guarantee in which the buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product.

By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.

Guidelines of IRDA for Credit Default Swap

According to the guidelines, CDS are permitted as a hedge to manage the credit risk covering the credit event.

It will be allowed only on listed corporate bonds as reference obligations. Unlisted unrated bonds issued by SPVs of infrastructure companies are also eligible as reference obligation.

However, shift of exposure to protection seller (insurer) happens only in case the credit event is an investment in the infrastructure sector.

The regulator has also barred insurers from purchasing CDS if they belong to the promoter group or between the entities of the promoter group, on short-term instruments and on obligations such as asset-backed securities.