RBI wants PF money in rate swaps

Central bank keen to develop domestic interest rate derivatives market

The Reserve Bank of India (RBI) has sought the participation of the Employees' Provident Fund Organisation (EPFO) to help develop the fledgling interest rate swaps (IRS) market in the country. In a recent letter to EPFO, which manages the retirement savings of 85.5 million workers, the central bank had asked it to consider participating in the IRS market, said officials familiar with the development.

Interest rate swap is an instrument that allows swapping of interest rates to hedge an investment or loan against the risk of fluctuation in rates. RBI's interest in developing the domestic IRS market comes at a time when it is fighting a falling rupee, slowing growth and high inflation, amid rising liquidity concerns.

This year, RBI has written to EPFO on several occasions, citing the recommendations of a working group on enhancing liquidity in the government securities (G-Sec) and interest rate derivatives market. The working group, headed by RBI Executive Director R Gandhi, had recommended the participation of financially-sound entities in the IRS market to boost liquidity in this space. To improve the interest rate derivatives market, it had suggested several measures, including an electronic swap execution facility (electronic trading platform) for the IRS market, standardisation of IRS contracts, etc.

When asked about the investment of funds in IRS and the risks involved, Chief Provident Fund Commissioner K K Jalan said he wasn't aware of this. If there was such a proposal, a decision would be taken in consultation with the central board of trustees and the fund managers, Jalan said.

The working group had also said there was scope for more investments by provident funds (PFs) in the G-Sec market. "The share of G-Sec holding by PFs is only four per cent, while that of MFs (mutual funds) is a meagre 0.3 per cent....While the introduction of the NPS (National Pension System) will lead to the emergence of pension funds as potential investors for G-Sec in the medium to long term, there is a need to attract institutions such as pension funds, PFs (especially private PFs), MFs and trusts," said the report submitted in May 2012.

Given EPFO's corpus and its investments in long-term bonds, its hedging needs are limited, says K P Jeewan, head (fixed income), Karvy Stock Broking. "The market needs EPFO more than EPFO needs the swaps."

Interest rate swap in futures trading helps in hedging against the risk of a fall or a rise in interest rates, as the case may be. Since EPFO largely invests in long-term bonds, whether interest rates rise or fall in the interim may not be relevant to it, Jeewan says.

On whether investors would be at risk if the EPFO dabbled in futures trading or IRS, Jeewan says, "No, it won't. EPFO will not be speculating. If at all it gets into the futures market, it will be to hedge interest rate risk and, if done effectively, this will be good for its subscribers."

EPFO receives annual payments of about Rs 70,000 crore from its 85.5 million subscribers. Last year, it had an investment corpus of Rs 3,73,644 crore. It invests in central and state government securities, government guaranteed securities and public and private sector bonds. A part of its funds are invested in a special deposit scheme of the Centre.
KEY WORKING GROUP RECOMMENDATIONS

• It had recommended the participation of financially-sound entities in the IRS market to boost liquidity in this space
• The group had suggested an electronic swap execution facility for the IRS market, standardisation of IRS contracts, etc
• It said there was scope for more investments by provident funds in the G-Sec market
• It stressed the need to attract institutions such as pension funds, PFs (especially private PFs), MFs and trusts