Mumbai, April 19: Taking another step to broaden the derivatives market in the country, the Securities and Exchange Board of India (Sebi) today set the initial guidelines which will allow interest rate futures to be traded on the premier stock exchanges.
The capital market regulator has decided to begin with futures contracts on a Notional Government Security with a 10-year maturity and a Notional Treasury Bill with a maturity of 91 days or three months.
At a time when interest rates are decided more by market dynamics than by Reserve Bank guidelines, the decision is timely, say debt market circles. Interest rate futures are used for hedging by banks, financial institutions, pension funds and others whose assets or liabilities can be affected by changes in interest rates.
By picking interest rate futures used mainly by banks, pension funds and financial institutions to protect themselves from interest rate volatility as the first instrument to start with in the financial futures segment, Sebi has taken a cautious step towards broadening the derivatives markets.
The minimum contract size of the Interest Rate Derivative Contract shall not be less than Rs 2 lakh, at the time of its launch, Sebi said. Sebi has also capped client level position limits at Rs 100 Crore or 15 per cent of open interest whichever is higher.
In the interest rate futures markets, short hedgers are those seeking protection against rising interest rates while long hedgers are those seeking protection against falling interest rates.
The method of quotation is structured so that a short hedger sells futures and benefits from a fall in price (rise in interest rate) in his futures transaction while a long hedger buys futures and benefits from a rise in price (fall in interest rates) in his futures transaction.
Interest Rate Derivative Contracts will be traded on the derivative exchange/segment and settled through the clearing house/corporation of the exchange which shall have prior approval of Sebi, the guidelines said.
The exchange shall specify the coupon rate and disclose the same to the market prior to introduction of the contracts. The features of the notional bonds, including the coupon rate shall, however, be disclosed to the market in advance and form a part of the contract specification, Sebi said.
Sebi has deemed that long bond futures and notional T-bill futures shall initially be cash settled. It added that futures contract on the notional bonds will have a term of maturity of one year. However, Sebi gave the exchange the freedom to decide whether to have quarterly contracts beyond the first three months, and whether the quarters should be fixed months of the year or rolling quarterly horizon from the contract introduction date.