Ways2finance: Interest rate futures set for 2nd coming

FIIs May Be Kept Out Till Volumes Pick Up

INDIA'S financial regulators are set to launch exchange-traded interest rate futures again in the local market as part of a co-ordinated effort to broaden reforms in the financial sector. The move is aimed at helping firms manage the risks arising out of interest rate fluctuations.
    To start with, a futures contract based on a notional coupon or interest bearing 10-year government bond will be introduced. Foreign institutional investors (FII) may well be kept out of this segment of the market until volumes pick up and the market deepens, according to an official associated with the launch of the product.
    In an interest rate futures contract, the two parties to the agreement — a borrower and a lender — agree to fix the rate at which they will borrow or lend on a future date. For banks and even households, interest rate futures such as swaps can help protect them against major swings.
    The Reserve Bank of India and the Securities and Exchange Board of India have finalised the details for the launch, which is expected shortly. Interest rate derivatives or futures would help institutions such as banks, insurance companies and other financial sector players hedge their interest rate risk. Sharp fluctuations in interest rates impact institutions and companies, particularly banks that hold large stocks of government securities.
    By allowing banks to trade in these derivatives, the government and the regulators reckon that they would be able to cope better with interest rate differentials. The move is also expected to help bring about a more liquid and efficient debt market, besides providing depth. RBI to set policy guidelines, Sebi to fix settlement issues
INTEREST rate futures were launched in India over five years ago, but did not take off owing to deficiencies in product design and the fact that banks were not allowed to trade in these products.
    A major policy decision facing the regulators is whether or not to allow FIIs to participate. A committee constituted by the RBI had recommended that FIIs should be allowed to participate in the interest rate futures segment as they can add depth to the market besides providing liquidity. However, there is a view within the establishment that overseas investors could have an unfair advantage over their local counterparts given the restrictions on capital mobility for Indian firms. Foreign investors could cash in on regulatory arbitrage and therefore, it makes sense to first build the market and then allow entry to them, an official said. It is likely that this view would prevail.
    FIIs have so far not been allowed in the Indian currency futures segment also which was opened up last year but the volumes have nonetheless been impressive. The RBI will lay down the broad policy guidelines for interest rate derivatives while the settlement and other details will be in the domain of the capital markets regulator, Sebi.