Boost for interest rate futures, with 91-day contracts

Ashish Rukhaiyar
Mumbai, 4 July 2011

The interest rate futures (IRFs) segment, operational for nearly two years, could finally see some volume pouring in. Futures on the 91-day treasury bill (t-bill) are to be launched tomorrow and, more importantly, would be settled in cash. Industry players feel banks, mutual funds and even corporate houses could develop a liking for the product, to hedge against interest rate fluctuations.

Interest rate futures, as the name suggests, are derivative contracts, with government bonds the underlying product. Depending on one’s view on interest rate movements, an entity can go short or long to hedge against volatility in these. The instrument will be available for trading on the National Stock Exchange (NSE).

Market players say the 91-day t-bill contracts would offer a lot of advantages, with a high probability of gaining wide acceptance. The biggest advantage is that the contract will be settled in cash, an industry demand for the whole IRF segment, said a dealer in debt instruments.

The other advantages are an absence of Securities Transaction Tax and lower margins compared to other asset classes. And, since the contracts are cash-settled, there are no concerns among market participants related to dumping of illiquid bonds, he explained.

Corporate houses dealing in floating rate bonds are expected to use this instrument to hedge against interest rate volatility. So could the mutual fund industry, which has a lot of debt funds. Banks, though, are expected to be the biggest user, since they invest significantly in t-bills as part of their treasury operations. Banks can go short on the contracts if they feel rates would move northwards.

In the case of 91-day t-bills, there would be three serial monthly contracts, followed by three quarterly contracts. Each contract will have a face value of Rs 2 lakh. It will be cash-settled, based on the weighted average discount price, obtained from the Reserve Bank’s weekly auction of the 91-day t-bill.

The IRF segment was launched in 2009 with futures on 10-year government bonds. The contracts were allowed to be settled with delivery of government securities, the tenor between nine and 12 years. The tenor of deliverable grade securities was fixed between 7.5 years and 15 years at the time of the launch.

The segment, however, failed to enthuse market participants with the biggest fear being that of dumping of illiquid bonds.

Data available on the NSE website clearly shows the segment has not been registering any volumes in the recent past. Market players want the entire segment to be moved to a cash-settlement basis, a demand the Securities and Exchange Board of India is looking into.