Settlement issues hold up interest rate futures

Market participants and regulators seem to be divided in their views on the revival of the interest rate futures market.

According to market participants, while the Securities Exchange Board of India (Sebi) prefers a cash-based settlement of deals, the Reserve Bank of India (RBI) wants to push physical delivery of government bonds.

Interestingly, Sebi has found support in private and foreign banks, which prefer cash delivery so as not to burden themselves with government securities. Moreover, cash delivery offers an opportunity for arbitrage among other markets, said a banker.

Also Sebi will have to then initiate the practice of physical delivery in equity futures as well against the present cash settlement, added a participant.

The issue was discussed at a meeting of the RBI-appointed sub-committee on interest rate futures on Thursday. However, banking sources said, the RBI has in-principle decided to go for physical delivery of government bonds in settlement of interest rate futures trade, while Sebi has suggested deferring it for a while.

While RBI's views are important being the regulator for banks, securities market and authority for interest rate management, Sebi is the regulator for stock exchanges on whose platform the product is proposed to be traded.

Meanwhile, the RBI has clarified that banks will be allowed to act as market makers for the product and, as a result, they will act both as sellers and buyers.

Earlier when the product was launched in 2003, banks were only allowed to hedge their portfolio, which acted as a major hindrance. This is because there were no large-scale sellers of the product in wake of buoyant demand from banks.

To start with, banks have suggested the launch of interest rate futures on call rates, since it is the most liquid segment. Banks also want to clear and settle their own trades which, at present, is being done by brokers on any products traded on the exchanges.

Banks have urged the regulators to allow them to become members of exchanges for the limited purpose of clearing and settlement in interest rate futures without the involvement of brokers.