By AltG Investment Research Lab
If you've watched The Big Short or read Michael Lewis' book, you're likely familiar with one of the most iconic trades in Wall Street history. The film chronicles how California-based hedge fund manager Michael Burry predicted the 2008 financial crisis and turned his foresight into $700 million in profits for his investors over two years.
Burry's strategy hinged on credit default swaps (CDS), a financial instrument that allows investors to "insure" themselves against the default of a debt. By purchasing a CDS, the buyer essentially bets that a bond or loan will default, while the seller takes the opposite stance. The cost of this "insurance"—the CDS premium—depends on the market's perceived risk of default.
SEBI & Credit Default Swaps: India’s Tryst With Destiny
SEBI’s decision to ease up regulations around the trading of CDS products is a fundamental step towards revolutionising the corporate bond market in India. Here’s why CDS products matter:
Better Pricing Of Credit - The pricing of credit risk allows for lenders to be able to gauge the credit quality of the borrower and differentiate between the good ones from the not so good.
Reduction In Jump To Default Risk - The risk of a bad credit sitting hidden in plain sight becomes lower with constant market pricing visibility. This is something we saw with the IL&FS case.
Structural Changes in Bank Balance Sheets - With banks struggling for deposits, a structural trend, corporate bond markets will pick up momentum as bank loans to corporates start becoming a smaller component of the pie. These are massive structural changes in the market and a deep and liquid CDS market will enable rapid development of a robust corporate bond market in India. There are structural shifts in the Asset-Liability Structures of the Banking Sector that need CDS products to enable better lending.
Disclaimer: In the article "Unleashing India's Credit Potential: The Power of CDS" above - Any views, comments or communication (above or in the past) should not be construed to be investment advice by Alternative Growth (hereafter referred to as “AltG”) in any form whatsoever. AltG does not make an offer to sell or solicit to buy any securities.
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