RBI panel moots rate futures in 10-yr gilts

A Reserve Bank of India’s (RBI) panel today recommended introduction of interest rate futures on exchanges initially in the ten-year government bonds. It also added that the contracts should be settled through physical delivery.

RBI’s technical advisory committee said the contracts could later cover the two-, five- and 30-year government securities, depending on the market response and appetite.

Initially, only banks and primary dealers should be allowed to conduct delivery-based short-selling, the committee said.

Banks should also be allowed to contract interest rate futures for trading. This recommendation goes beyond the present rule, which limits them to take use futures only for hedging against interest rate risks inherent both on and off their balance sheets. At present, banks are allowed to hedge as well as take trading positions only in swaps and forward rate agreements.

The panel said RBI should be involved in designing the general framework of interest rate futures, including issues relating to the product and the market players. The nitty-gritty of the contracts should left be left to the exchanges, the panel said.

Seeking a review of norms prescribed for investment in securities, the RBI panel said, at present, banks classify their entire statutory liquidity ratio (SLR) portfolio as held-to-maturity, leaving them no incentive to hedge against the market risk.

A deep and liquid interest rate futures market will provide banks with a mechanism for hedging interest rate risks inherent in the SLR portfolio, it added. On the accounting regime for interest futures, it said the central bank must use its powers to mandate uniform accounting treatment for swaps and futures.

The futures contracts should also be exempt from the Securities Transaction Tax (STT), it added. Referring to the participation of foreign institutional investors (FIIs)/non-resident Indians (NRIs), it said FIIs may be allowed to take long positions in the interest rate futures market.

This is subject to the condition that the gross long position in the cash market and the futures market does not exceed the maximum permissible cash market limit, which is currently $4.7 billion.

FIIs could also take short positions in interest rate futures, but only to hedge the actual exposure in the cash market up to the maximum limit permitted. The rules prescribed to foreign investors will also apply to NRIs, it clarified.