Reserve Bank of India (RBI) has issued directions on credit derivatives.
What is Credit Derivative?
Credit derivative means a derivative contract whose value is derived from the credit risk of an underlying debt instrument or an index of underlying debt instruments.
What is Credit Default Swap (CDS) and Total Return Swap (TRS)?
- Credit Default Swap (CDS) means a credit derivative contract in which one counterparty (protection seller) commits to pay to the other counterparty (protection buyer) in the case of a credit event with respect to a reference entity and in return, the protection buyer makes periodic payments (premium) to the protection seller until the maturity of the contract or the credit event, whichever is earlier.
- Total Return Swap (TRS) means a credit derivative contract under which one counterparty (total return payer) commits to transfer the entire economic performance of a reference asset to the other counterparty (total return receiver), and, in return, receives a pre-determined fixed or floating rate linked to a benchmark.
What is credit event and what are the types of settlement?
- Credit event means a pre-defined event in a credit derivative contract, which triggers a settlement under the contract.
- Auction settlement of CDS means a settlement process in which the price of the reference / deliverable obligation at which the settlement will happen is determined through an auction mechanism.
- Cash settlement of CDS means a settlement process in which the protection seller pays to the protection buyer, the notional amount of the CDS contract less the expected recovery value of the reference obligation.
- Physical settlement of CDS means a settlement process in which the protection buyer delivers any of the eligible deliverable obligations to the protection seller against the receipt of notional amount of the CDS contract.
What is reference entity, reference obligation, reference asset and deliverable obligation?
- Reference entity means an entity against whose credit risk a credit derivative contract is entered into.
- Reference obligation means a debt instrument issued by the reference entity and specified in a CDS contract for the purpose of valuation of the contract and for determining the cash settlement value or the deliverable obligation in case of occurrence of a credit event.
- Reference asset means a debt instrument issued by a reference entity or an index of underlying debt instruments and specified in a TRS contract.
- Deliverable obligation means a debt instrument issued by the reference entity that the protection buyer can deliver to the protection seller in a physically settled CDS contract, in case of occurrence of a credit event.
Who can participate in credit derivatives market?
The following persons shall be eligible to participate in credit derivatives market –
- Residents
- Persons resident outside India
Which products are permitted in Over-the-Counter (OTC) market?
Market-makers and users may undertake transactions in CDS and TRS contracts.
Who can act as market makers in OTC market?
- Market-maker means an entity which provides prices to users and other market-makers.
- The following entities shall be eligible to act as market-makers in credit derivatives –
- Scheduled Commercial Banks (except Small Finance Banks, Payment Banks, Local Area Banks and Regional Rural Banks)
- Standalone Primary Dealers
- Non-Banking Financial Companies (NBFCs) – Upper Layer and NBFCs – Middle Layer (including Housing Finance Companies (HFCs))
- Export-Import Bank of India (EXIM Bank), National Bank for Agriculture and Rural Development (NABARD), National Housing Bank (NHB), Small Industries Development Bank of India (SIDBI) and National Bank for Financing Infrastructure and Development (NaBFID).
- At least one of the parties to a credit derivative transaction shall be a market-maker or a central counterparty.
- Central counterparty means an entity that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the performance of open contracts.
Who can act as users in OTC market?
- User means a person that undertakes derivative transactions other than as a market-maker.
- Users shall be classified by market-makers as retail or non-retail.
- The following users shall be eligible to be classified as non-retail users –
- NBFCs other than market-makers
- Insurance companies regulated by Insurance Regulatory and Development Authority of India (IRDAI)
- Pension funds regulated by Pension Fund Regulatory and Development Authority (PFRDA)
- Mutual funds regulated by Securities and Exchange Board of India (SEBI)
- Alternative Investment Funds regulated by SEBI
- Resident companies with (a) minimum net worth of ₹500 crore; or (b) minimum turnover of ₹1,000 crore, as per the latest audited financial statements
- Foreign Portfolio Investors (FPIs) registered with SEBI
- Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.
- Any user who is otherwise eligible to be classified as a non-retail user shall have the option to get classified as a retail user.
Who can act as protection buyers and protection sellers in CDS in OTC market?
- A resident retail user, other than an individual, shall be allowed to buy protection only for the purpose of hedging.
- Hedging means the activity of undertaking a credit derivative transaction to reduce credit risk of a particular debt instrument or a portfolio of debt instruments.
- A non-retail user shall be allowed to buy protection without any restriction in terms of purpose.
- The following non-retail users shall be eligible to act as protection sellers –
- Insurance company regulated by IRDAI
- Pension fund regulated by PFRDA
- Mutual fund regulated by SEBI
- Alternative Investment Fund regulated by SEBI
- FPI registered with SEBI
- The notional amount of CDS protection sold by all FPIs shall be subject to a limit of 5% of the outstanding stock of corporate bonds.
- A market-maker shall not offer CDS contracts to an individual.
Who can participate in TRS in OTC market?
- A market-maker may offer a TRS contract to a resident retail user, other than an individual, only for the purpose of hedging.
- A market-maker may offer a TRS contract to a resident non-retail user without any restriction in terms of purpose.
- A market-maker may offer a TRS contract to a person resident outside India, including an FPI, for the purpose of hedging.
- A market-maker shall not offer a TRS contract to an individual.
What are the directions on reference entities, obligations and assets in OTC market?
- The reference entity in a credit derivative contract shall be a resident entity who is eligible to issue any of the debt instruments mentioned below.
- The following debt instruments issued in India shall be eligible to be a reference obligation in a CDS contract or a reference asset in a TRS contract –
- Money market debt instruments (includes commercial papers and non-convertible debentures of original or initial maturity up to 1 year and certificates of deposit)
- Rated Indian Rupee (INR) corporate bonds and debentures
- Unrated INR corporate bonds and debentures issued by the Special Purpose Vehicles set up by infrastructure companies
- Bonds with call / put options shall be eligible to be reference obligations / reference assets.
- Asset-backed securities / mortgage-backed securities and structured obligations such as credit enhanced / guaranteed bonds, convertible bonds, etc. shall not be permitted as reference obligations / reference assets.
- The underlying reference obligation for a CDS or a reference asset for a TRS may be an index comprising solely of eligible debt instruments.
What are other directions for OTC market?
- A credit derivative contract undertaken with a non-resident by a market-maker, which is a bank having an Authorised Dealer Category-I license, can be settled in INR or in a foreign currency.
- Credit derivative contracts can be cash settled or physically settled. CDS contracts can also be settled through auction. TRS contracts undertaken by a person resident outside India, who is not an FPI, shall be cash settled.
- Users undertaking credit derivative transactions for the purpose of hedging shall exit their credit derivative position within 1 month from the date they cease to have the underlying exposure.
- The settlement basis and market conventions for credit derivative contracts shall be specified by the Fixed Income Money Market and Derivatives Association of India (FIMMDA).
What are the directions on novation? (Updated as on September 22, 2026)
- Novation means the replacement of a market maker with another market maker in an OTC derivative contract between two counterparties (transferor, who steps out of the existing deal, and remaining party) to an OTC derivative transaction with a new contract between remaining party and a third party (transferee). The transferee becomes the new counterparty to the remaining party.
- Remaining Party in novation means the user or a market maker or a central counterparty that continues to be counterparty in the new contract post novation.
- Market participants can exit their credit derivative contracts by unwinding the contract with the original counterparty. Market makers may also exit their credit derivative contracts by assigning the contract to any other eligible market makers through novation subject to the following –
- The novation shall be done at the prevailing market rates and with the prior consent of the remaining party, with the amount corresponding to the mark-to-market of the OTC derivative exchanged upfront between the transferor and the transferee.
- The parties to a novation shall enter into a tripartite agreement wherein the transferee steps in the contract to face the remaining party and the transferor steps out. The original contract shall stand extinguished and shall be replaced by a new contract with identical terms / parameters to the original contract, except for the change in counterparty for the remaining party.
- The transferor and the transferee may agree on the charge / fee between them for the transfer of the trade. The fees and their settlement terms may not form part of the novation agreement.
- These directions shall not apply to the novation of an OTC derivative contract undertaken –
- by a central counterparty, for the purpose of effecting settlement; or
- in terms of RBI circular on ‘Novation of an OTC contracts’ dated December 09, 2013.
What are the directions for exchange-traded credit derivatives?
- Exchanges may offer standardised single-name CDS contracts and CDS contracts on credit indices with guaranteed settlement.
- Single-name CDS means a CDS contract in which the underlying is a single reference entity.
- The credit index for an exchange-traded CDS contract shall be an index comprising solely of eligible debt instruments.
- Retail users shall undertake transactions in exchange-traded CDS only for hedging.
- FPIs may transact in exchange-traded CDS as protection sellers and / or protection buyers.
- Exchanges may offer futures contracts on credit indices with guaranteed settlement, provided that the credit index used as underlying for futures contracts shall be composed solely of eligible debt instruments.
- Future on credit indices means a standardised derivative contract, traded on a recognised stock exchange, to buy or sell an index of underlying debt instruments at a specified future date, at a price determined at the time of the contract.
References
Reserve Bank of India. (2026, June 25). 'Master Direction – Reserve Bank of India (Credit Derivatives) Directions, 2026'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=13552&Mode=0
Reserve Bank of India. (2026, September 22). Novation of OTC Derivative Contracts. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=13706&Mode=0
Reserve Bank of India. (2026, June 25). 'RBI issues Master Direction – Reserve Bank of India (Credit Derivatives) Directions, 2026. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=63028
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