TRADING in interest rate futures is fast diminishing, with barely Rs 13 crore worth of contracts changing hands in March so far, compared with Rs 1,473 crore in September last year when the instrument was just relaunched. Interest rate futures (IRF) are used by fixed income traders for protection against adverse movement in interest rates.
The failure of the product to take off in India comes in the backdrop of IRFs being one of the most popular derivative instruments globally. Experts are blaming this on the extra advantage that the current set of rules give to the seller of the instrument.
“The underlying bonds are illiquid and cash settlements are not allowed,” says Jagannadham Thunuguntla, equity head, SMC Capitals, adding, “It is biased towards the seller of the contract as the buyer could end up getting delivery of illiquid securities.”
The local version of IRFs involve the seller delivering actual bonds instead of the difference in the predetermined and market price — a practice called physical delivery. In the stock and currency futures segments, this is done through exchange of cash.
In December last year, in a bid to boost volumes, the National Stock Exchange (NSE) had restricted the universe of securities that could be delivered as part of the physical settlement. From close to 19 securities, the number was brought down to six bonds. But this too has failed in having the desired effect.
Only three bonds account for 70% of the total volumes in the GSec market. Other bonds are barely traded, dealers point out.
Mr Thunuguntla also pointed out that the level of awareness among market participants about the product is quite low, restricting participation in the segment.
Arvind Konar, head of fixed income, Almondz Global Securities, says big players like insurance companies and mutual funds are still shy away from dabbling into the IRF space because of poor volume and liquidity issues. “This has become a self-fulfilling prophecy since a substantial amount of volume was initially expected from these large players,” he explained.
Earlier in June 2003, NSE had introduced interest rate futures contracts. However, market participants were not comfortable with its design. Globally, the interest rate derivative market is much bigger compared to major asset classes such as equity and equity derivatives. In the US, it is more than 10 times bigger compared to other asset classes.
Mr Konar says the absence of short-term instruments as underlying is also responsible for illiquidity. The only futures available currently are those with a notional 10-year bond as underlying.
According to experts, banks can be indifferent to yields for a quarter of their G-Sec portfolio, as it is classified as held-to-maturity (HTM) and does not have to be marked-tomarket (MTM.) Once the International Financial Reporting Standards (IFRS) is introduced in April 2011, volumes may pick up as the entire G-Sec holdings will have to be MTM on a daily basis, Mr Konar said.
The other key reasons, players said, is the rule restricting short sales and the absence of a well-developed corporate repo market.