Interest derivatives soar as firms hedge against rate rise

Interest rate derivatives volume tripled to Rs 300 crore on Wednesday versus Rs 100 crore in January, as companies hedged against an interest rate hike.

Volume in interest rate derivatives is now on a par with that of government securities, said a joint survey of Fitch and Indian Banks' Association (IBA) released yesterday.

This is despite the fact that the market for interest rate derivatives is still at an embryonic stage, lacking in depth and sophistication.

The tenors of interest rate derivatives do not go beyond five years.

This is probably due to absence of counter-party lines for longer tenure, said Fitch as the market still lacks the tools to manage interest-rate exposure beyond five years.

The Indian bond market has a term structure of 30 years, with the 10-15 years bracket being the most active, as opposed to the five-year bracket in the overnight index swaps (OIS).

Majority of foreign and private sector banks revealed that 25 per cent of derivatives were traded for proprietary accounts, indicating a greater appetite for risks.

The report highlighted that foreign and private sector banks largely reported an average daily volumes of Rs 500 crore. This rapid growth in the volumes is mainly on account of increased uncertainty surrounding the interest rates as it is the only market, which permits participants to take a two-way view on the market, said the rating agency.

Large PSU banks cited covered intermediation as the primary motive for using derivatives. This they felt would help in the development of the market.

Further, Fitch believes that higher proportion of direct trades and robust counterparty credit profiles mitigate settlement risks.

This is because banks said that majority of derivatives counterparties are triple A-rated, and trades with brokers were limited to just 20 per cent.

Any disruptions in the market could have far reaching ramifications and "it is therefore important for policy makers to ensure that legal, accounting valuation and risk-reporting policies are continuously monitored and improved to ensure market stability," said Amit Tandon, managing director, Fitch Ratings.

Legal and documentation risks appeared the main concerns for market participants while illiquidity, accounting and tax treatment were seen as impediments, said the report.