Domestic stock exchanges are about to launch trading in interest rate futures (IRF). Earlier, we have the experience of IRF being introduced and failing to take off. So how is the existing product different from the earlier one
Earlier when a product was launched, there were two main lacunae in that with one is it was based on zero coupon yield, which is popularly known as ZCYC. But the market was always looking for yield to maturity. So that has been rectified in the current one. Secondly, banks were not allowed to trade but only permitted to hedge. Under the new scheme the facility for the banks to trade in interest rate futures is allowed. These two factors which hampered trading in the interest rate futures earlier have been removed and that is why this time there is an expectation that the market would take of in the desired way.
You have been conducting road shows in different parts of the country to make the products familiarise with various financial market intermediaries. Which segment of the market is giving you maximum response
As our philosophy and interest of the exchange, we always believe in information dissemination and education of market participants. We have already completed our seminars in Mumbai, Chennai and New Delhi. We will be having one in Kolkata. The participation has been broad based with all those stakeholders in the economy who are having exposure to interest rates have shown active interest in our seminars. For instance, we had very good response from banks, insurance companies, mutual funds, NBFC's and brokerages in Mumbai, high net worth individuals in Chennai and corporate and brokerages in Delhi.
In the case of interest rate futures, settlement of contracts will be done through physical delivery of the underlying instrument, whereas in equity and currency futures segment, the final settlement is cash-based. So, how challenging will be the delivery-based settlement
If you look at the interest rate futures market globally, only 2% to 5% of the contracts are settled through physical delivery. Most of the contracts are cancelled, squared off or rolled over to the next series. Though the technical committee talks about the physical delivery, the delivery mechanism will be clearly spelt out by the exchanges. So I don't see this as a challenge, but on the other hand I foresee it as an opportunity for those who want to acquire the government of India security and those who want to spread their risk in this asset class will also be in a position to do this apart from banks, insurance companies and other financial institutions.
We had an example of commodity futures trading where the notional value of the outstanding contract was far higher than underlying commodity. And one section in the economy blamed excessive speculation in futures market for increase in spot prices. Do you think excessive trading in IRF will lead to high volatility in the underlying government of India security
Let me clarify one thing. Empirical evidence and data showed that there is no positive correlation between trading in futures market influencing the spot price. A futures market plays an important role of Price discovery (indicating a fair price) and is used by its participants for price risk management (hedging). As seen in the case of currency futures markets, these markets cannot influence the price but act as indicators of the price. Globally, if we look at, futures trading indicate the expectations of where the spot market will move, i.e., the expectations of the market participants like investors, hedgers among others. So I don't subscribe to the view that futures market would influence the spot prices.
So, do you think that the futures market in interest rate will be a useful tool for monetary authority for reading future sentiment while framing monetary policies
Monetary authorities will look at various parameters while framing policies. This will also be one of the indicators as it will reflect the sentiment of the financial market participants. So they might also look at this among multi other parameters for framing policies.
We have seen trading volume and turnover in exchange traded currency futures picking up with a dramatic pace. Do you see similar kind of response or will it take some time because of the complex nature of the product
When currency futures were introduced in India it was the apprehension if the product would take off or pick up volume. But the market has shown maturity and the volume zoomed. The turnover has increased from Rs 300 crore in the first day to Rs 3,100 crore a day and the highest was Rs 5,650 crore. That augurs well for the Indian market in the sense that the market is able to see the future potential. And there are lots of market participants interested in futures market. And if you look at from the parameters of the government of India debt outstanding and the person who are having the instrument and exposed to interest rate risk, the expected volume in the futures market is very high. We have done a back of envelope calculations where it shows that the volume in the futures market has the potential to generate a turnover of up to Rs 1 lakh crore a day or Rs 10,000 crore a day to start with.