Interest rate futures may get second lease of life

Interest rate futures may get second lease of life

Mumbai: India’s second innings in interest rate futures, which ran into a road block due to lack of participation, may limp back with the recent changes announced by the National Stock Exchange (NSE).

Interest rate futures ware reintroduced in August 2008 to provide investors with a hedging tool against interest rate fluctuations, after a first attempt in 2003 failed.

But despite various changes to the original product, volumes remained muted, as traders said the new rules in 2009 were also biased towards the seller of the contract as the buyer could end up getting delivery of any eligible illiquid security.

“Buying is not happening as market players are afraid they may land up with some really illiquid securities, so these steps should definitely help," said Bekxy Kuriakose, head of fixed income, at DBS Cholamandalam Asset Management.

The new steps include narrowing the basket of deliverable securities to exclude the more illiquid ones and delaying the settlement date to the last business day of the month, so that participants have more trading days than previously.

“It gives the buyer a clearer idea of the interest accrual. Earlier there was uncertainty as to which day he will get the delivery... now that uncertainty has been done away with," Kuriakose said.

Moreover, the exchange has also roped in Life Insurance Corporation of India (LIC) and Central bank of India to act as indirect counterparties and reassure traders who are worried about being stuck with illiquid papers.

LIC and Central bank will buy these illiquid papers from banks at a small premium to the benchmark valuation rate, while Central Bank of India would also offer papers from its books to members to meet delivery obligations.

The basket of deliverable securities has been narrowed to 8-10.5 years from 7.5-15 years previously, thus reducing to some extent the uncertainty of being delivered an illiquid paper.

Currently of the seven securities eligible for delivery, only two papers are liquid and include the 6.35%, 2020 and 6.90%, 2019 papers. The list of eligible securities stood at 11 earlier.

Sreenivasa Raghavan, head of treasury at IDBI Gilts said the buyer and seller of a futures contract should be given the option to settle the contract physically or in cash terms.

Persisting concerns

But the twice-bitten market players now want to wait and see how the new changes will pan out before taking the plunge again.

Meanwhile, some argue that banks, the biggest group of holders of government debt, will have a limited need for hedging because of the portfolio allocation rules of the central bank.

Under the rules, banks can allocate a certain portion of their portfolio into a separate account called hold-to-maturity, or HTM, where the bonds are valued only at the time of transfer and stay at the same value till maturity.

“As long as the HTM concept is available.. interest rate futures will have only limited participation because HTM means you are already hedged," IDBI’s Raghavan said.

However, this is set to change as the International Financial Reporting Standards (IFRS) become mandatory from fiscal year starting April 2011, according to which, the entire portfolio holdings will have to be marked-to-market on a daily basis.

“Then there would be a pick up in interest rate futures trading," he added.