The Hindu Business Line : Banks, FIs can now deal in interest rate derivatives

SCHEDULED commercial banks, financial institutions and primary dealers may now transact in interest rate futures on notional bonds and T-Bills for the limited purpose of hedging the risk in their underlying investment portfolio.

In its guidelines for exchange traded interest rate derivatives, the RBI has said, such entities will be allowed to deal in interest rate derivatives (IRDs) in a phased manner. In the first phase, allowing transactions in a wider range of products, and market making will be considered in the next stage on the basis of the experience gained.

The Securities and Exchange Board of India will introduce `anonymous order driven system for trading in IRDs on the Bombay Stock Exchange and the National Stock Exchange.

According to RBI, while derivatives present immense opportunity for mitigating the market risks inherent in the balance sheet, it can also expose one to substantial losses on account of inadequate understanding of the product, absence of proper monitoring, poor risk control measures, etc.

Banks and financial institutions desirous of transacting in IRDs on the stock exchanges should take specific approval from their respective boards covering, the products that they may transact in, size, composition of the investment portfolio intended to be hedged, organisational set-up to monitor, rebalance, report, account and audit such transactions. Further, it is desirable that derivative desks are created within the treasury and the management level responsibility clearly assigned.

The apex bank has stated that certain norms will be applicable for transacting IRDs on the futures and options (F&O) segment of the stock exchanges, that include a membership of the F&O segment of the stock exchanges for the limited purpose of undertaking proprietary transactions for hedging interest rate risk. Entities that desire trading membership on the F&O segment of the stock exchanges should satisfy the membership criteria and also comply with the regulatory norms laid down by SEBI and the respective stock exchanges (BSE/NSE). Those not seeking membership of stock exchanges, can transact IRDs through approved F&O members of the exchanges.

As trading members of the F&O segment, banks and financial institutions should settle their derivative trades directly with the clearing corporation or clearing house.

Regulated entities participating through approved F&O members shall settle proprietary trades as a participant clearing member or through approved professional/custodial clearing members.

RBI has said, broker trading members of stock exchanges cannot be used for settlement of IRD transactions.

For the present, only the interest rate risk inherent in the Government securities classified under the Available for Sale and Held for Trading categories will be allowed to be hedged. For this purpose, the portion of the Available for Sale and Held for Trading portfolio intended to be hedged must be identified and carved out for monitoring purposes.

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