Few takers for interest rate futures

Average daily turnover has declined from Rs 267 crore at launch to Rs 13 crore.

There has been a tepid response to interest rate futures (IRF), which made a comeback in August, six years after an attempt to allow companies to hedge their risks failed.

IRF volumes on the National Stock Exchange (NSE), the only exchange that hosts trading, have recorded a significant fall since the launch on August 31.

The average daily turnover has declined from over Rs 267 crore on August 31 to Rs 13 crore today. The number of contracts fell from over 14,500 to 327.

Market players said this could be attributed to poor response from foreign banks and insurance companies.

“Foreign banks prefer over-the-counter markets (OTC) as rates there are based on overnight borrowings, or Mibor, and it is more liquid. The Insurance Regulatory and Development Authority Act’s rules to allow insurance companies to trade in IRFs are still to be changed,” said a Mumbai-based dealer with a state run bank.

Dealers said the OTC market for IRFs generated over Rs 1,000 crore volume daily. They said they were unable to take positions on NSE as rates on many securities were not known due to absence of trading. The Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) have stipulated that only bonds with maturities of seven-and-a-half years to 15 years can be used as underlying assets. At present, 19 government securities fit the bill. The delivery, too, is a constraint given the liquidity level of these papers.

Moreover, the minimum lot size of Rs 2 lakh set by NSE is seen as being too small. “The minimum value per contract of underlying securities in the cash segment is Rs 5 crore. So, for every one transaction in the cash market, 250 contracts have to be purchased on NSE and there is not much depth. In the OTC market for IRFs, the minimum value of each contract is Rs 25 crore,” said a dealer.

While NSE kept the lot size low to enable even individuals to hedge their interest rate risks, market participants said there was no relation between interest rates on retail loans and the price of the underlying government securities. The value of underlying government bonds was normally very high, which made it difficult for individuals to hedge their near-term risks, they said.

Globally, interest rate futures account for 25-30 per cent of derivatives transactions. Unlike the OTC interest rate swap market (OIS), which is an inter-bank market, exchange-traded IRFs are seen as more transparent and result in better price discovery.

Unlike in 2003, when IRFs were first launched, banks can now take positions for themselves. Non-resident Indians, companies, primary dealers and foreigners can also trade. Foreign investors can trade if they have the underlying security, but not for speculative purposes.

Market players said there was a need to educate investors, especially individuals. “NSE took various steps to boost trading in currency futures, where there is competition from other exchanges. As a result, the average daily turnover in currency futures has crossed the Rs 2,000-crore level,” said an executive with a financial services firm.

The Bombay Stock Exchange gas also announced a plan to launch IRF trading. However, the plan seems to be on the backburner as the exchange is fighting hard to maintain its market share in the equities segment.