Rupee Derivatives To Help Manage Risk
The Reserve Bank of India (RBI) has decided to introduce trading in rupee options to help banks and corporates better manage their risks.
The central bank has proposed to begin with less complex over-the-counter interest rate rupee options in the first phase.
These instruments are expected to help deepen the money market and enable market participants to manage and control interest-rate risk.
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Scheduled commercial banks, financial institutions and primary dealers will be allowed to buy and sell rupee options.
Corporates on the other hand, may sell options initially without being the net receiver of premium, the RBI stated in the credit policy.
The RBI intends to allow various OTC interest rate rupee options including vanilla caps, floors and collars, European swaptions, call and put options on fixed income instruments/ benchmark rates and unleveraged structured swaps based on overnight indexed swaps (OIS) and forward rate agreements (FRAs) where the risk profile of such structure is similar to that of the building blocks.
RBI had constituted a working group on rupee derivatives (chairman: Jaspal Bindra) with appropriate representations from Sebi, banks, PDs, mutual funds and RBI.
The scope of the group was later expanded to cover the issues relating to exchange-traded interest rate derivatives in addition to the issues on over-the-counter interest rate derivatives.
There is a huge appetite in the market for derivative products for better hedging of risks. The Indian market already permits currency and interest rate swaps, but options today are limited to the currencies of G-7 countries.
Bankers pointed out that while the holder of a forward contract must sell or buy the currency when the contract expires, the holder of an options contract has the right but not the obligation to buy or sell.
As such, an importer who books an options contract has the flexibility to ignore the contract should the market move in his favour. This helps reduce costs in terms of risk management.
Bankers expect a slow shift to the options market from the present forward market, especially since the RBI has also allowed corporates to sell (write) options. The rupee market being fairly liquid will facilitate in the pricing of options, said bankers.
As all market participants will be allowed to participate in rupee derivatives, this is expected to boost growth as evident from the lack of restrictions in the interest rate swaps market.
Further, with the liquidity in the market, the spread between bid and offer quotes on overnight rate swaps have also reduced from 25 basis points (bps) three years ago to three bps.