IRF may take 2-3 quarters to see rise in trading volumes

With financial sector players, including banks and primary dealers, gradually warming up to trading in interest rate futures (IRF), the market will have to wait for a maximum of two-three quarters to see a rise in volumes, according to dealers. IRF is a tool to hedge risks related to interest rates.

The National Stock Exchange (NSE) had on the last day of August started trading in IRF with a bang by clocking a turnover of Rs 267.31 crore — the highest to date. According to NSE data, a total of 3,439 contracts were traded on Thursday with a combined value of Rs 63.28 crore.
 

LUKEWARM RESPONSE Interest rate futures
Date	Total contracts (volume)	Value In Rs crore	Open interest Position (in futures)
31-Aug	14,559	267.31	1,893
1-Sep	8,054	147.82	2,492
2-Sep	6,151	113.20	2,546
3-Sep	3,213	58.90	3,575
4-Sep	5,145	94.44	5,061
7-Sep	8,362	154.27	4,180
8-Sep	4,351	80.17	3,496
9-Sep	2,302	42.45	4,059
10-Sep	3,439	63.27	4,956
Source; National Stock Exchange

A dealer with a public sector bank said the number of contracts traded as well as their value dropped continuously throughout the first week. The trend in the second week was mixed, giving hope for stability, he said.

A few public sector banks such as State Bank of India, Bank of India and Bank of Baroda have been active in the IRF market. Among foreign banks, only Bank of America is reported to have shown some interest.

The future contracts are on the 10-year notional coupon bearing government bond. The notional coupon (interest rate) will be 7 per cent per annum with semi-annual compounding. IRF trading is available in futures contracts worth Rs 2 lakh each with a maximum maturity of 12 months.

The head of fixed income with a private mutual fund said, “The beginning has been made, but it won’t take off in a big way immediately. Market players have to get the hang of the trend, especially in the bond market where primary market issuances are huge. It will take two-three quarters before volumes rise.”

Many banks are in the process of getting the nod from their respective boards to enter the IRF space. Besides putting in place new systems, the banks’ treasury teams also have to decide on giving time for this segment, especially when volumes are small, according to a large public sector bank’s head of treasury.

Increased participation by banks is expected to infuse more liquidity this time than in 2003, when IRF was first launched in India. The expected participation by insurance companies and provident funds, which hold a sizeable chunk of government securities, will also add depth to the market.

Besides banks, brokers, non-resident Indians and Sebi-registered foreign institutional investors (FIIs) can also participate in IRF.

Suman Chowdhury, head of Crisil’s financial sector ratings, said trading in IRF should provide primary dealers with support to their earnings profiles over the medium term. In addition, the use of IRF would eliminate credit and settlement risks, cut transaction costs and enhance transparency in the debt market, Chowdhury said. The profitability of primary dealers has always been vulnerable to volatility in rates. Because of lack of adequate tools to hedge against increasing interest rates, they had had to reduce their portfolio sizes in recent years to contain losses.