Interest rate derivatives may debut by Jan-end

Close on the heels of currency futures, exchange-traded interest rate derivatives may soon make their debut. A committee comprising the market and banking regulators is working on the final guidelines, which is expected to be unveiled by the end of January 2009.

“Interest rate futures are expected to come by January-end. It will give a further boost to the bond market,” said a senior official from the Securities and Exchange Board of India (Sebi). Interest rate futures were introduced in 2003, but failed to take off because of design flaws and the lack of a pricing benchmark.

An interest rate future is a standardised contract traded on an exchange to buy or sell an underlying asset (rupee interest rate in this case) at a certain date in future at a specified price on Thursday. The product is used to hedge volatility in the Indian interest rate.

Recently, the Reserve Bank of India (RBI) had come up with its report on currency futures trading. Sebi Chairman C B Bhave had earlier said in an interview that a joint committee of Sebi and RBI is working on operationalising the report. It had recommended to introduce interest rate futures contract based on a notional coupon bearing 10-year bond initially and settled by physical delivery.

It had also proposed to allow foreign institutional investors (FIIs) to take long positions. The total limit for FIIs however, was capped at $4.7 billion.

The RBI committee had suggested that since banks constitute the single most dominant segment of the country’s financial sector, they should also be allowed to contract interest rate futures. This would help not only to hedge interest rate risk in their financial statements, but also take trading positions subject to regulations.

It had also suggested that interest rate futures should be exempted from the securities transactions tax.