Wants banks to perform the role of market makers to boost investor participation.
The Securities and Exchange Board of India (Sebi) will soon unveil amendments in guidelines governing interest rate futures (IRF), which have seen close to nil volume. According to people familiar with the development, the regulator wants banks to perform the role of market makers to enhance liquidity and investor participation.
Interest rate futures is an exchange-traded derivative instrument for hedging against interest rate risk. Only the National Stock Exchange (NSE) offers trading in IRFs, launched for the first time in 2003. IRFs are based on a notional 10-year government (GOI) bond, bearing a notional seven per cent interest rate coupon, payable half-yearly.
“The regulator wants banks to act as market makers, as they are the biggest players in the IRF space,” said a person familiar with the development. “Market making is a tried and tested method and is likely to boost IRF volumes. It will, however, be a part of a regulatory overhaul, as the current mechanism has certainly not worked,” he said, on condition of anonymity.
A committee is framing the new IRF guidelines and contract specifications. It has representation from Sebi and the Reserve Bank of India. It is believed the new guidelines will be announced after the new chairman takes over in February.
The IRF market has proved a tough nut to crack for regulators. It was launched for the second time in September 2009, but volumes are still the biggest concern. On most days in the recent past, only a single token trade has been executed on NSE.
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Market players feel market making isn’t enough and many issues will have to be revisited. A large section has been demanding cash settlement.
“Market making works in a ‘driven’ market and is not order-driven,” says Jayesh Mehta, MD & country treasurer, global markets group, Bank of America. “Today the underlying bonds itself are not trading enough and in a basket of deliverables, where the price is determined by formula, it is fine when all bonds are trading. Today, the buyer does not know what will get delivered and since these bonds don’t trade, theoretical pricing would be way different from the actual price. The solution is to move to single securities contract.”
It is widely believed the uncertainty over liquidity of the underlying bond is holding back players. There are concerns that one can just dump the illiquid bonds at the time of settlement.
The current regulatory framework allows participants to settle the contracts with delivery of GOI securities with a 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 of the segment.