RBI to allow cash-settled interest rate futures on 10-year government bonds

The Reserve Bank of India will soon introduce cash-settled interest rate futures on 10-year government bonds and has also permitted exchanges to launch these derivatives in other smaller tenor securities in the future, it said on Thursday.

The RBI has twice attempted to launch the interest rate futures (IRFs), in 2003 and 2009, but both attempts failed largely due to what participants called faulty product design.

Market participants were keen on cash-settled futures rather than a physical delivery, which requires financial firms to deliver an actual security to the investor, as was the case in 2009.

"This is a progressive and bold move by the RBI. They have given the market a wide variety of products across the yield curve spectrum," said Sandeep Bagla, executive vice-president at ICICI Securities Primary Dealership.

"There are multiple products here and there is some underlying demand so there is a good chance that at least one of these, if not all, will take off depending on market fancy and requirement."

The central bank has permitted exchanges to offer both physical and cash settled IRFs on the notional 10-year government securities. The physically settled 10-year IRF would have a semi-annual coupon rate of 7 percent, the RBI said.

The cash-settled 10-year derivative would be based on either a 10-year government bond with residual maturity between 9 and 10 years, or a basket of 10-year bonds that have residual maturity of between 9 to 11 years.

The central bank said all future IRF contracts based on the 91-day treasury bills, 2-year and 5-year coupon bearing government securities and other coupon bearing securities will be eligible to be cash-settled based on certain conditions.

Copyright: Thomson Reuters 2013