Indian insurers tweak trading strategy as bond-swap spread widens

Demand for stripped-down Indian government bonds among domestic insurers has risen as the widening spread between their yields and overnight index swaps (OIS) rates has turned forward rate agreement (FRA) derivative trades unattractive.

The one-year and five-year swap rates have risen by more than 20 basis points (bps), while the bond yields have risen by less than 10 bps, "rendering FRAs less appealing," said Rahul Bhuskute, chief investment officer at Bharti AXA Life Insurance.
 

FRAs are agreements that insurers enter into with banks to lock in rates on long-dated bonds, helping them offer guaranteed returns to policyholders. Banks charge a margin to hold these bonds on their balance sheets until maturity.
 

 

However, FRAs only stay attractive as long as the OIS rates remain on the lower side, especially due to their complicated nature.

The widening spread has insurers "favouring alternative long-duration instruments like STRIPS," added Bhuskute.
 

Separate Trading of Registered Interest and Principal of Securities (STRIPS) are bond instruments that dealers break apart, or "strip", to sell the principal payment and coupon rates separately.
 

Those buying the principal get paid the principal amount on maturity, while those buying the coupons get paid the interest.

Investors can choose to buy only the required long-term duration for a more efficient asset-liability matching, said Badrish Kulhalli, head of fixed income at HDFC Life Insurance, leading to strong demand for these instruments generally.
 

Foreign and private banks which used to typically undertake FRAs have reduced this activity.
 

"There was regular demand from some banks at auctions for FRAs, which has now come down, but at the same time primary dealers that sell STRIPS to insurers have become more active," a senior treasury official with a foreign bank said requesting anonymity.
 

Investors from the 'others' category, which includes insurers, have bought bonds worth 214 billion rupees ($2.95 billion) on a net basis in the last five weeks, while primary dealers have sold bonds worth 578 billion rupees on a net basis during this period, data showed.