RBI’s Draft Revised Credit Derivatives Directions 2026: TRS, Credit Indices And New Risk Management Expectations

1. Why RBI Is Rewriting The Credit Derivatives Rulebook

The Reserve Bank of India (RBI) has released a Draft Revised Master Direction on Credit Derivatives in February 2026, inviting public comments before finalising the framework. The draft builds on the existing 2022 Credit Derivatives Directions but introduces a fuller architecture for credit index derivatives and total return swaps (TRS) on corporate bonds, in line with the policy push to deepen India’s corporate bond markets. For banks, large NBFCs and sophisticated investors, this marks a shift from a largely CDS centric framework to a broader credit risk transfer toolkit, with corresponding upgrades in governance and risk management expectations.

2. What Instruments And Markets Does The Draft Cover?

The 2026 draft widens the definition of “credit derivative” beyond single name credit default swaps to include instruments referencing an index of eligible debt instruments. It contemplates both over the counter and exchange traded products across three broad categories:

1. Single name CDS on corporate, infrastructure and certain other eligible debt instruments.
2. Credit index derivatives, where the underlying is a diversified index of corporate bonds or similar debt meeting specified criteria.
3. Total return swaps (TRS) that reference eligible corporate bonds and other permitted fixed income assets, transferring both income and price movements between counterparties.

RBI’s stated objective is to give market participants more flexible tools to hedge and manage credit risk, while preventing the build up of opaque or speculative exposures that could undermine financial stability.

3. Total Return Swaps On Corporate Bonds

What is a TRS in this context?

Under the draft, a total return swap is a bilateral contract in which the “total return payer” passes to the “total return receiver” all economic returns on a reference asset such as coupon interest, fees and price appreciation while receiving a periodic payment linked to a benchmark rate plus a spread; losses on the reference asset (defaults or price declines) flow in the opposite direction. In contrast to a CDS, which insures only against defined credit events, a TRS transfers the full economic performance of the underlying bond or portfolio.

Eligible market makers and users

The draft allows TRS trading only where at least one counterparty is an eligible market maker, which includes:

1. Scheduled commercial banks (excluding RRBs and local area banks).
2. All India financial institutions such as NABARD, EXIM Bank, NHB and SIDBI.
3. Systemically important NBFCs, including HFCs, meeting minimum net owned funds thresholds (for example, ₹500 crore).

The system divides users into two different categories which include non-retail users who include regulated entities and large corporates that meet specified net worth or turnover criteria (e.g., turnover of ₹1,000 crore or more), and who are permitted to use TRS for hedging or efficient portfolio management. Retail users include smaller entities and individuals who can only invest through standardised exchange traded products which have extra protective measures.

At least one market maker must be party to each TRS transaction, and retail participants cannot transact bespoke OTC TRS directly.

4. What can TRS reference?

The draft lists eligible reference assets broadly as:

1. Money market instruments and certain short term debt.
2. Rated INR denominated corporate bonds and debentures.
3. Unrated INR denominated bonds or debentures of SPVs set up by infrastructure companies, subject to conditions.
4. Bonds with embedded call or put options, provided the optionality is appropriately reflected in valuation and risk limits.

In the infrastructure and corporate spaces, the mix is made to allow a transfer of meaningful risk, without the need for resorting to those instruments which are very exotic or highly illiquid.

5. Credit Index Derivatives

The draft proposal establishes a framework which allows credit index derivatives to use an index that includes eligible debt instruments which comply with both diversification and concentration requirements. The design elements include these main components:

Index construction: The index construction process requires transparent rules to determine which assets will become index constituents and which sectors will have their limits and which issuers will face restrictions and which assets will undergo rebalancing. The index should maintain balance because no single issuer or group of issuers should control its entire composition.

Benchmarking: The floating rate legs in TRS or other derivatives must use published benchmarks which recognised benchmark administrators manage instead of using any internal or hidden rates which are not publicly available.

Governance: Index administrators require strong methods and transparent reporting systems to decrease their chances of index manipulation.

For investors, index products can provide more liquid and diversified hedging of portfolio level credit risk compared to single name CDS, but they also introduce basis risk and modelling complexity that risk teams must understand.

6. Eligibility, Risk Limits And Anti Arbitrage Safeguards

RBI’s draft is explicit that credit derivatives must not be used to circumvent underlying regulatory constraints. Among the key safeguards:

1. At least one counterparty in every credit derivative trade must be an eligible market maker, subject to RBI supervision and reporting.
2. Users are limited to exposures that are consistent with their underlying market risk profile and regulatory permissions; for instance, an entity barred from investing in certain categories of bonds cannot replicate that exposure synthetically through TRS.
3. Banks and NBFCs must treat TRS and CDS exposures as part of their overall credit and market risk limits, calibrating large exposure norms, sector caps and internal single name limits accordingly.
4. Existing prudential norms on derivatives such as mark to market, provisioning and capital charge requirements are extended or adapted to these products.

The measures which are being implemented will protect TRS and index derivatives from being used as methods to bypass regulations and achieve off balance sheet financial gains.

7. Documentation, Margining And Operational Expectations

The draft expects market makers to follow robust ISDA style documentation and collateral arrangements for OTC credit derivatives.

This includes:

1. Standardised master agreements, confirmations, credit event definitions and settlement procedures aligned with international practice, suitably adapted to Indian law.
2. Clear credit support annexes (CSAs) on margining, eligible collateral, haircuts and dispute resolution processes.
3. Daily mark to market valuations and margin calls for non-cleared trades, with counterparty exposure tracking and stress testing.
4. Timely trade reporting to recognised trade repositories or reporting platforms, enabling supervisory oversight of build ups in particular names or sectors.

Boards of market makers are expected to approve comprehensive credit derivatives policies, covering product approval, risk limits, independent model validation and back testing of pricing and risk models.

8. Practical Implications For Banks, NBFCs, Funds And Corporates

Banks and systemically important NBFCs

For banks and large NBFCs, the revised framework offers new tools to manage loan book and bond portfolio risk, but with higher expectations on governance and analytics. TRS on corporate bonds could help institutions hedge spread risk or free up capital linked to particular exposures, but only if integrated into capital, liquidity and large exposure frameworks.

Risk teams will need to:

1. Map TRS and index exposures to underlying obligors and sectors to avoid inadvertent concentration.
2. Align accounting (hedge accounting vs trading) with the economic purpose of transactions.
3. Coordinate closely between treasury, credit and risk functions to avoid “silos” in exposure measurement.

Mutual funds, insurers and other institutional investors

For mutual funds, insurers and pension funds, credit index derivatives and TRS could provide more targeted hedging of bond portfolios, subject to SEBI, IRDAI or PFRDA investment ceilings and derivative product approvals. These investors will need to ensure that their scheme documents, risk management policies and board approvals explicitly cover such instruments, and that valuation and risk models can handle the more complex payoff profiles.

Large corporates and sophisticated borrowers

Large corporates classified as non-retail users may be able to use TRS to hedge exposures to key counterparties or to manage the cost of their own borrowing programmes. However, they will need to weigh:

1. Accounting treatment and earnings volatility from fair value changes.
2. Disclosure and governance expectations under corporate law and securities law regimes.
3. Rating agency views on the use of derivatives for risk management versus speculation.

For many corporates, the immediate priority will be to understand the new products well enough to respond to bank proposals, even if they do not plan to be early adopters.

9. Key Open Issues And Comment Points For Market Participants

Commentary on the draft highlights several areas where industry feedback will be important.

Depth of underlying markets: India’s CDS market has remained shallow despite earlier frameworks; whether TRS and credit index products will achieve scale depends on corporate bond liquidity and counterparty appetite.

Eligibility thresholds: The proposed threshold for turnover and net worth requirements which applies to non-retail users will restrict access to mid-market companies. Some stakeholders will request precise adjustment of requirements which should include strict suitability standards.

Reference asset scope: The use of TRS on infrastructure SPV bonds and unlisted paper creates both valuation and liquidity problems. The organization requires better instructions which should include information about haircut procedures price sources and stress testing scenarios.

Regulatory coordination: clarity is required on how RBI’s framework intersects with SEBI’s rules for exchange traded derivatives, and with investment regulations for mutual funds, insurers and pension entities.

The comment window serves as a platform for market participants to request explanations and present recommended adjustments which will establish genuine hedging solutions that support market growth while eliminating undisclosed leveraged risks.

10. Takeaways For Compliance, Treasury And Legal Teams

The 2026 draft revised Credit Derivatives Directions signal RBI’s intent to move India’s credit risk transfer market closer to international practice, but on a tightly supervised, institution led model rather than a lightly regulated, dealer only market. Banks, NBFCs and large investors that intend to use TRS or credit index derivatives should begin work now on product governance frameworks, documentation standards, risk models and board level policies, so that they are ready when the final directions are issued. For corporates, the immediate task is to understand these products well enough to evaluate proposals and negotiate terms, recognising that these instruments can be powerful risk management tools but also carry modelling and governance risks if used without sufficient expertise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.