RBI to introduce forward contracts in govt securities: Governor Malhotra

As part of the initiative to expand the range of interest rate derivative products available to market participants for managing interest rate risks, forward contracts in government securities will be introduced. This move aims to help long-term investors, such as insurance funds, manage interest rate risk across different cycles while also enhancing the efficient pricing of derivatives linked to government securities, said Reserve Bank of India (RBI) Governor Sanjay Malhotra in his monetary policy statement on Friday.

 

  “Over the past few years, we have expanded the suite of interest rate derivative products available to market participants to manage their interest rate risks. We shall now include forward contracts in government securities in this suite. This will facilitate long-term investors such as insurance funds to manage their interest rate risk across interest rate cycles. It will also enable efficient pricing of derivatives that use government securities as underlying instruments,” he said.

 

 

Bond market participants said that in bond forwards, there will be actual delivery of bonds, unlike forward rate agreements (FRAs), which involve no physical delivery. This mechanism functions similarly to how the non-deliverable forward (NDF) and actual forward markets operate.

 

For instance, an insurance company using bond forwards for hedging purposes can take direct delivery of the bonds. Previously, settlements were netted by cancelling benchmark rates, but now, while full details are yet to emerge, the new framework is expected to allow direct settlement with actual bond delivery. This is particularly beneficial for insurance companies and other investors looking to hold the bonds in their portfolios rather than settling positions through net transactions.

 

"It's similar to how the NDF and the actual forward market operate. An insurance company, for instance, can use it to take delivery of bonds. Previously, settlements were netted by cancelling benchmark rates. Now, while the full details are yet to be revealed, the idea is that direct settlement will be possible, allowing actual delivery of the bonds rather than a net settlement. This is beneficial for insurance companies and other participants who want to hold these bonds in their books. Ultimately, the bonds will physically come to them,” said the treasury head at a private bank.

 

Experts said that the regulatory announcement on forward contracts will improve price discovery and expand market participation.