Govt clears three new interest rate futures products

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New Delhi: Financial institutions such as insurance companies, banks, provident funds and primary dealers, who carry almost 88% interest rate risk, will have the option to hedge it on an exchange-traded platform within a month. The government and regulators have finalised three interest rate futures products for them: 91-day Treasury Bill futures, short-term interest rate futures based on an index of actual call money market rates, and a notional coupon bearing ten-year bond futures.

Sebi and RBI have informed the high-level coordination committee on financial markets, which met in the Capital on Monday, that these products would be unveiled by January, a senior official said. He added that the operational modalities have been worked out and that the standing technical committee of both regulators is now examining risk management systems before launch. The committee released its final report on exchange-traded interest rate futures, or IRFs, in August 2008.

Along with these futures, RBI is likely to effect another key change that would encourage banks to hedge their portfolio of SLR securities. Currently, banks can keep their entire SLR portfolio, which comprises government bonds, in the held-to-maturity category. This accounting treatment exempts banks from mark-to-market requirements and, hence, bears no interest rate risk, in effect, rendering the new futures products irrelevant.

“This would most likely change with the introduction of IRFs, as it will encourage banks to hedge their interest risk,” a finance ministry official pointed out. He said the actual interest rate risk on G-secs could be quite high. One percentage point change in the interest rate on the entire stock of government bonds is estimated at a massive Rs 1.15 lakh crore.

India already has over-the-counter interest rate derivatives such as interest rate swaps and forward rate agreements, but these are not marked to market and are less transparent. “The extent of losses and profits is not known until the maturity of OTC derivatives,” said Bonanza Capital director SK Goel. Exchange-traded derivatives are marked to market on a daily basis.

Market participants would be allowed to take both hedging and trading positions in these futures, subject to certain prudential norms. Deals are likely to be exempt from securities transaction tax and FIIs would be allowed only long positions up to a maximum of $4.7 billion, the committee said in its final report.