It is two
months since the operational guidelines for ETIRF were issued by an RBI-SEBI
Committee. Now, National Stock Exchange is re-launching trading in ‘Exchange-Traded
Interest Rate Futures’ (ETIRF) from August 31, 2009. The operational guidelines for the interest
rate futures (IRFs) in India
were issued on June 17, 2009, by a committee jointly set up by RBI and SEBI.
Institutions like, banks, insurance companies, primary dealers, pension funds,
mutual funds, financial institutions, companies and provident funds are exposed
to interest rate risk on account of their huge exposure to government
securities and other fixed income securities. To mitigate the interest rate
risk, RBI along with SEBI, has introduced interest rate futures in India . This is
a measure that helps in deepening the debt market in India . (IRFs were first launched in
2003 by National Stock Exchange, but did not find favour with market players).
Exchange-Traded
Interest Rate Futures (ETIRF):
An IRF is a contract between two parties – a borrower and a lender – who agree to fix the rate at which they will borrow/lend on a future date. To put simply:
An IRF is a contract between two parties – a borrower and a lender – who agree to fix the rate at which they will borrow/lend on a future date. To put simply:
- It is a hedging mechanism used
by economic agents affected by interest rate movements
- Alternatively put, it is a tool
to manage interest rate risk
- It is a derivative contract –
providing standardization and transparency
- It may be used by banks,
insurers, primary dealers, provident funds, etc
- Even FIIs and NRIs are allowed
to take trading positions subject to norms
- It will be traded on a stock
exchange which bears the counterparty risk
Who are permitted:
- Members registered by SEBI for
trading in currency/equity derivatives are eligible to trade in IRF
- Even individuals who have got
interest rate exposures inherent in their fixed deposits, housing and car
loans can hedge their positions with the help of an IRF
- The minimum net worth of a
trading member should be Rs one crore
- The minimum net worth of a
clearing member should be Rs 10 crore
The Exchange-Traded IRF
product:
- The IRF is based on
yield-to-maturity curve
- The notional coupon on the
underlying 10-year Government Security would be seven per cent with
semi-annual compounding
- The size of the IRF contract
would be Rs two lakh
- Maximum maturity of the
contract will be 12 months
- The contract will be settled by
the physical delivery of securities
- The contract cycle will be at
the end of March, June, September and December quarters
Gross Open Position:
- The
gross open position of a trading member across all contracts should not
exceed 15 per cent of the total open interest or Rs 1,000 crore, whichever
is higher
- At
the client level, the gross open position should not exceed six per cent
of the total open interest or Rs 300 crore, whichever is higher
- FIIs and NRIs, the gross long position in
the debt market and the IRF contract should not exceed their maximum
permissible debt market limit prescribed from time to time.
What is not permitted as
of now:
- IRF
based on overnight rate (based on money market rates) is not permitted
- IRF
based on 91-day Treasury bill is not permitted now, but may be considered
later
The salient features of NSE’s new product are:
NSE Contract Specifications
|
|
Trading unit
|
One lot – equal to notional bonds of FV of Rs 2 lakhs
|
Underlying
|
10 Year Notional Coupon bearing Government of India (GOI)
security (Notional Coupon 7% with semi annual compounding)
|
Tick size
|
Rs.0.0025 paise
|
Trading hours
|
Monday to Friday
9:00 a.m. to 5:00 p.m. |
Contract trading cycle
|
Four fixed quarterly contracts for entire year ending March,
June, September and December
|
Last trading day
|
Seventh business day preceding the last business day of the
delivery month
|
Quantity Freeze
|
501 lots or greater
|
Settlement
|
Daily settlement MTM: T + 1 in cash
Delivery settlement : In the delivery month i.e. the contract expiry month |
Mode of settlement
|
Daily Settlement in Cash
|
Deliverable Grade Securities
|
Till now, the only interest rate derivative available for trading is Overnight Indexed Swap (OIS) which is a type of Interest Rate Swap (IRS). Interest rate swaps are agreements where one side pays the other a particular interest rate (fixed or floating) and the other side pays the other a different interest rate (fixed or floating). However, OIS is traded in the OTC market. The new IRF is the first interest rate derivative that is being traded on an Exchange.
IRF will be the first derivative product which will be settled by
delivery whereas other exchange-traded derivatives (for example, stock futures,
index futures, index options, etc) are settled by cash. Physical delivery will
be in the demat form through the depositories NSDL, CDSL and Public Debt Office
(PDO) of the Reserve Bank of India .
Other Exchanges:
While NSE
introduces ETIRF from 31.8.09, BSE it appears would introduce the product
through United Stock Exchange in which BSE took a 15 per cent stake recently.
Interest Rate Scenario:
The huge borrowing programme of the Indian
Government has muddied the interest rate scenario. What has been exacerbating
the interest rate situation is the food inflation (based on Consumer Price
Index or CPI) which has been rising to alarming levels of more than 10 per cent
for several months. Any pick up in credit disbursement during the oncoming
festive season and credit off-take from corporate sector during the second-half
of the fiscal year will put further pressure on the interest rates. With the
benchmark 10-year Government Security yield hovering around 7.30 per cent, an
increase of more than 30/35 basis points in the past one month; the bond market
is jittery about further hardening of bond yields. The bond market has
completely lost the appetite for new government paper with Banks’ SLR (statutory
liquidity ratio) holdings higher by more than 300 basis points over and above
the statutory levels.
The 10-year benchmark yield is expected to touch
7.50 per cent in the next few months due to higher inflationary expectations,
huge government borrowing programme, loss of agricultural output of around 20
per cent during the Kharif Season on account of monsoon failure across several
states in India, rising international crude oil prices and anticipated credit
demand in the second half of the fiscal. However, any revival in the
manufacturing sector and consequent rise in tax collections; usage of
disinvestment proceeds that are kept in National Investment Fund (NIF) for
reducing fiscal deficit; and huge resources of around Rs 35,000 crore that are expected
to accrue to the Government’s exchequer from 3G spectrum auction to the Telecom
Sector are likely to mitigate the crunch situation in the interest rate cycle
in India.
The launch by NSE is ushering in a product that
seems to have been timed well in the current rising interest rate scenario so
that market participants can hedge their positions.
Note: Interest
rate risk: If interest rates rise, the bond prices will fall. Similarly, if
interest rates fall, the bond prices will go up. As such, the movement of
interest rates will have a big impact on the bondholders; be it, banks,
insurance companies, mutual funds or such others, including individuals. The
risk that the interest rate fluctuations will affect the prices of bonds or
fixed-income investments is interest rate risk.
References:
RBI Report on IRF dt. Aug.8, 2008; RBI-SEBI Report on IRF dt. Jun.17, 2009; and
NSE.
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