Mumbai: India will allow stock exchanges to introduce cash-settled interest rate futures (IRF) on 10-year government securities, in a bid to develop local debt markets, said market regulator Securities and Exchange Board of India (Sebi) on Thursday. The introduction will be on pilot basis.

An IRF is a contract between the buyer and seller agreeing to the future delivery of any interest-bearing asset. The product allows the buyer and seller to lock in the price of the interest-bearing asset for a future date.

Sebi has permitted two different designs for cash-settled futures on 10-year government bonds—coupon-bearing government security as underlying and coupon-bearing notional 10-year government of India security with settlement price based on basket of securities as the underlying.

Exchanges can allow trading of contracts on either one or both of these options, said Sebi, adding the product features would be reviewed with the experience gained after the trial period.

The Reserve Bank of India (RBI) too issued a separate notification on the instrument. In its second quarter monetary policy review, the RBI had said that cash-settled IRF will be issued to develop the money and government securities markets. Detailing the guidelines, RBI had said Indian residents and foreign institutional investors (FIIs) registered with Sebi can purchase such instruments for hedging an exposure to interest rate risk.

Detailing the guidelines, Sebi said foreign institutional investors will not be able to take positions that exceed 10% of open interest or 600 crore, whichever is higher.

Further, the total gross short (sold) position of each FII in IRF shall not exceed its long position in the government securities and in IRFs at any point in time, said the regulator.

“The total gross long (bought) position in cash and IRF markets taken together for all FIIs shall not exceed the aggregate permissible limit for investment in government securities for FIIs," said Sebi.