It’s been three weeks since the launch of interest rate futures trading on the National Stock Exchange (NSE). The initial response has been far less encouraging than the launch of currency futures about a year ago. Average volumes in the interest rate futures contracts stand at Rs80 crore, while contracts worth Rs300 crore had traded in the currency futures segment three weeks after launch.
True, the initial volumes in the currency futures segment are, in hindsight, a mere fraction of the current daily average of Rs11,000 crore on the NSE and MCX Stock Exchange together. In that sense, the interest rate futures segment could also be far bigger a year from now. It’s too early to judge the markets’ response to the new product. But it looks like the growth of the segment won’t track the pace of growth of the currency futures segment. Futures on the US dollar, Indian rupee pair was straightforward in product design. Settlement was in cash, making it easy for market participants to take positions.
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With interest rate futures, the regulator has mandated physical settlement of government securities. The deliverable grade of securities include any government security with a maturity between seven-and-a-half years and 15 years and with an outstanding stock of Rs10,000 crore. Within this classification, there are a number of extremely illiquid securities which no buyer in the interest rate futures market would like to end up with. Many market participants are in a wait-and-watch mode, observing how the settlement mechanism works. For others, it’s a matter of getting the infrastructure in place in order to trade the product on the exchange.
Also, unlike currency futures, there aren’t enough market participants with divergent views on interest rates. While banks are expected to take the lead in the new product, most of them are on one side of the market given their large government security portfolios and the view that interest rates are headed north in the next few months. For volumes to pick up, it’s essential that non-bank participants start trading in significant amounts. Mutual funds and insurance companies are still staying away, but securities firms and large traders in the equities and currency futures markets could contribute meaningfully over time.
What’s the role of the regulator in all this? This column has always rued the fact that the regulator gets involved in product design. In developed markets, this is left to exchanges, which launch a host of products, some of which do well and some which fail. Exchanges in developed markets launch new products based on feedback from market participants and quickly fine-tune products to suit the evolving needs of the market. Of course, regulators in such markets give oversight to ensure that market integrity is maintained.
But in India, every financial product is designed by a committee set up a regulator. In this case, there are two regulators, Securities and Exchange Board of India and the Reserve Bank of India. If there are any changes required in the product, there will most likely be another committee. In this process, precious time is lost. Besides, the markets would like to have interest rate futures with different tenures and changes in the definition of what qualifies as a deliverable security. If these decisions were left to exchanges, they would have been made by now. Securities lending and borrowing of equities was launched in April 2008 but there are no trades in the segment 18 months hence because changes that are required are still being deliberated in committees.
Thankfully, in the case of currency futures, things fell in place and no changes were required to foster growth. But even there, it’s time new currency pairs such as euro and rupee are launched. This would have been done long back if it wasn’t controlled by regulators. The growth of the interest rate futures segment will depend on how fast changes are made and how soon new products and variations are introduced. The best way forward is for the regulator to step back and let exchanges have their say in these matters.
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