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Sebi looks at cash settlement in interest rate futures
February, 18th 2011

Sebi-RBI committee looking at ways to boost dwindling volume.

As part of efforts to boost volumes in exchange-traded interest rate futures (IRF), the Securities and Exchange Board of India (Sebi) is evaluating the option of introducing cash settlement in the segment. If approved, it could come as a shot in the arm for the niche market that has been witnessing almost nil volumes for months.

IRF is an exchange-traded derivatives product for hedging interest rate risks. Only the National Stock Exchange (NSE) offers IRFs, which were launched for the first time in 2003.

According to people familiar with the development, the joint technical committee reviewing the guidelines and contract specifications for IRFs is looking at cash settlement as one of the ways to attract more market participants. The committee comprises representatives of Sebi and the Reserve Bank of India (RBI).

It is believed that the uncertainty over liquidity of the underlying bond is acting as the biggest deterrent for the growth of the IRF market, said a person privy to the developments. If cash settlement is allowed, concerns related to dumping of illiquid bonds can be addressed, he added.

He, however, clarified that nothing had been finalised yet and the technical committee could look at tweaking other features of the segment without switching to cash settlement.

At present, participants can settle contracts with delivery of government (GoI) securities with a tenor between nine and 12 years. The tenor of deliverable grade securities has been fixed between 7.5 years and 15 years.

IRFs are based on a notional 10-year GoI bond, bearing a notional seven per cent interest rate, payable half-yearly. They were launched for the second time in September 2009. But volumes are still negligible. On most days in the recent past, only a single token trade has been executed on NSE.

Incidentally, the regulator has been trying hard to make the IRF segment more market friendly. Another idea that is being discussed is the concept of banks performing the role of market makers to enhance liquidity. Banks are the biggest players in the IRF market and any initiative taken by them is expected to lead to an exponential rise in volumes. Globally, IRF is a huge market with volumes running into trillions of dollars.

With U K Sinha, the new chairman of Sebi assuming office from Friday (February 18), it is expected that the revised guidelines for IRFs will be unveiled soon.

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