Short-term securities allowed in IRFs

The Reserve bank of India (RBI) has allowed trading in interest rate futures (IRFs) on securities with short-term maturities such as two-year and five-year securities and 91-day treasury bills.

The RBI-Sebi Standing Technical Committee will finalise the product design and operational modalities for introduction of these products on the exchanges. At present, only 10-year Government of India securities are available for trading under exchange-traded IRFs.

Golak Nath, senior vice-president, Clearing Corporation of India, said, “When interest rates are rising, people tend to trade at the shorter-end of the market. The introduction of these securities will surely fill the gap in the interest rate futures market."

“The interest rate futures contract on the 10-year notional coupon bearing Government of India securities was introduced on August 31, 2009. Based on the market feedback and the recommendations of the Technical Advisory Committee on Money, Foreign Exchange and Government Securities Markets, short maturity products are being introduced,” said RBI in the Annual Policy Statement.

Interest rates futures traded on exchanges are settled physically – the only segment where physical settlement takes place. The other two markets -- equity and currency -- follow cash settlement. Though RBI’s policy statement did not give any indication of the introduction of cash settlement in the new product, some market players felt this could be allowed for 91-day treasury bills. Sebi is yet to come out with guidelines on this.

Ashish Nigam, head - fixed income, Religare Mutual Fund, said, “More products will certainly deepen the interest rate derivative market and increase liquidity.” At present, the daily volume in IRFs is negligible. The majority of the action takes place in the over-the-counter (OTC) market and most of the volume happens in overnight swaps. The trading also takes place at only one exchange – the National Stock Exchange. Analysts said public sector banks were not very active in this market. Also, given the complexity of the product, even retail investors do not participate.

Regarding the operational framework, RBI is also expecting a final report from an internal working group for the introduction of plain-vanilla OTC single-name credit default swap for corporate bonds for resident entities, subject to appropriate safeguards. The apex bank plans to put the draft report of the internal working group on the RBI website by July.