The Reserve Bank of India(RBI) has said FIIs may be allowed to take long position in the interest rate futures (IRF) market, subject to the condition that the total gross exposure in the cash and the IRF market does not exceed the extent maximum permissible cash market exposure limit, which is currently $4.7 billion.
In its final report on interest rate futures, the central bank said on Friday, FIIs could take short position in IRF, but only to hedge exposure in the cash market up to the maximum permitted limit of $4.7 billion. This may also apply, mutatis mutandis, to NRIs participation in IRF, the RBI said. The central bank also said banks will be allowed to trade in the interest rate futures market, subject to prudential regulations including capital requirements.
Until now, banks were allowed to only hedge their interest rate risk in the futures market. The RBI noted that for the success of IRF, it would be necessary to improve the liquidity and efficiency of the repo market. To begin with, the RBI said that one IRF contract based on a notional, coupon bearing, 10-year GOI security be introduced in the bond futures segment.
?Depending upon the market response and appetite, the exchanges concerned may consider introducing contracts based on 2-year, 5-year and 30-year GoI securities or those of any other maturities or coupons,? it said.
The existing contract on 91-day treasury bills futures may be retained but with settlement price based on the yield discovered at the weekly RBI auction. Besides, a contract based on an index of traded or actual call rates may also be considered.
The RBI also notified that the contract should be physically settled and whatever micro-structure changes are necessary including improvements in the liquidity of the underlying market to support such a contract may be carried out.
As for the money market futures the world-over in the short end, IRF on index is more popular like the euro-dollar futures (LIBOR based) command about 75% volume of IRF market. The RBI said that the introduction of this contract was considered desirable but side-stepped by the SEBI technical group in 2003 on doubts regarding its legal validity.
Interest rate futures were initially allowed in 2003, but they did not pick up as desired by regulators and the market because the norms barred banks from undertaking market-making activities. Only primary dealers were allowed to do jobbing. While IRF market will be used by corporates and individuals as well, RBI is not in favor of allowing corporates and individuals to short sell GOI securities in the cash market as the key purpose of risk management through short sales will in any case be more efficiently and transparently served through their participation in IRF.
