Bond forwards replace FRAs for insurers; SDLs become preferred choice

Insurers are increasingly shifting to bond forwards linked to state development loans, attracted by higher yields and the RBI's new framework for managing interest-rate risk

Attracted by higher returns and ample supply, insurance companies are increasingly shifting their activity to bond forwards, particularly in state development loans (SDLs), according to market participants. This follows the introduction of Reserve Bank of India's (RBI’s) bond forward framework, which has prompted insurers to move away from bond forward rate agreements (FRAs).

 

“Post the introduction of bond forward guidelines by RBI, we have started participating in bond forwards with underlying state government and government securities. Given the relatively higher returns and adequate supply in SDLs compared to government securities, most of our incremental bond forward activity has shifted towards SDLs,” said Arun Srinivasan, chief - fixed income at ICICI Prudential Life Insurance.

 

“We still have some legacy bond FRA positions. But after the bond forward guidelines were introduced, we moved completely to bond forwards… We are no longer active in bond FRAs, as bond forwards are a much simpler product from an execution and settlement standpoint," he added.

 

The RBI issued final directions on forward contracts in government securities in February 2025. The framework came into effect on May 2 the same year. It was aimed at enabling long-term investors, including insurance companies, for a more efficient management of interest rate risk and cash flows.

 

Under the framework, market participants can enter into forward contracts in government securities, including Central government bonds and SDLs, at a pre-agreed price for settlement on a future date. The RBI had first floated draft guidelines in December 2023 following feedback from market participants seeking a dedicated bond forward product.

 

Market participants had earlier said insurers were expected to migrate from FRAs to bond forwards as the latter involve physical delivery of the underlying security at maturity, unlike FRAs, which are cash-settled.

 

"We had been pushing for bond forwards as they are an important risk-management tool for insurers. Since the framework came into effect, most of our incremental activity has shifted to SDLs," said a market participant.

 

The Insurance Regulatory and Development Authority of India (Irdai) in March 2025 permitted insurers to undertake bond forward transactions for hedging interest rate risk. However, insurers can take only long positions in bond forwards and are required to report such transactions on a quarterly basis. Bond forwards are not permitted for unit-linked insurance plans (Ulips).

 

The bond forward market, estimated at ₹4 trillion to 4.5 trillion, remains dominated by foreign banks, which account for nearly 85-90 per cent of activity. Market participants said broader participation from private and public sector banks could increase if the market migrates to a centralised clearing and settlement framework.

 

Clearing Corporation of India Ltd (CCIL) is working on a dedicated platform for bond forward trades. Market participants expect the facility to be rolled out during the ongoing quarter.