The secondary market risk management group of the Securities and Exchange Board of India on Friday recommended the introduction of interest rate derivatives from April 21.
Trading will take place through the anonymous order-driven, screen-based trading system of the stock exchanges.
The Sebi group has given advance notice of one month for regulatory review and two months for software changes. The group has promised to introduce improved products and more fine tuned margining systems within a period of six months.
According to Sebi, there is a need for exchange-traded IRDs as debt market volumes, particularly in interest rate swaps, have been growing rapidly and such exchange-traded products would reduce the risk substantially through a clearing corporation, notation, multilateral netting, centralised settlement and risk management.
Futures, options, swaps--both plain vanilla swaps as well as swaps with embedded options like caps/floors/collars--as well as standardised repos may be allowed to be traded on the stock exchanges, Sebi said in a consultative paper.
"Interest rate risk is one of the most pervasive risks in the economy that affects not only the financial sector, but also the corporate and household sectors," the paper said.
"The large stock of household financial savings on the asset side and the increasing amount of housing loans on the liabilities side makes interest rate risk increasingly important for the household sector. It is in fact likely that for many households interest rate risk is vastly more important than equity market risk," the paper pointed out.
The primary implication of early launch is a significant degree of over-margining in the initial six month period until more refined models are implemented, the group has pointed out.
"Since there can be no compromise on the issue of market safety, a Sebi working group is compensating for model risk by aggressive over-margining."
Yet another reason for the early launch is the software since it would be possible to allow only two decimal places in the price quotes at the time of launch. Exchanges will have to modify their software to allow four decimal places as soon as possible. The National Stock Exchange has indicated that this could be accomplished by mid-May.
Regarding maturity of the futures contracts, it was decided that exchanges would be free to introduce contracts up to a maximum maturity of one year.
Exchanges would be free to decide whether to have quarterly contracts beyond the first three months and whether the quarters should be fixed months of the year or rolling quarterly horizons from the contract introduction date.
The Group also decided that the exchanges should have the freedom to offer either or both of these products and also to choose the coupon rate in case of the coupon bond. Exchanges have indicated that the coupon rates could be in the range of 6-8 per cent.
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