The underlying security offered for IRFs is the benchmark 10-year government security and the 91-day treasury bill. The 10-year security saw a sharp rally last month, amid easing inflation and hope of an interest rate cut by RBI. Last week, the central bank announced a 25-basis point cut in the key policy rate, which led to further gains in bond prices. So far this month, the daily average turnover for bond futures is at about Rs 2,500 crore.
“IRFs, introduced at the beginning of 2014, gathered momentum as market participation turned wider and unidirectional movement of the underlying enabled view-taking…the participation picked up significantly and, across investor categories. With a rally in government bonds, most days witnessed net-buy trades,” said Jagdeep Kannarath and Prithwiraj Dutta, analysts at Edelweiss.
In January 2014, IRFs were launched for a third time. Trading in the instrument had failed to take off in two previous attempts. The success of the instrument is considered vital to deepening India’s bond market.
Ashish Ghiya, managing director, Derivium Capital & Securities, said bond futures volumes could rise further if certain regulatory issues hindering the participation of large domestic investors were addressed. “There is high interest in bond futures. This is the time to remove certain irritants, as this will unleash the true potential of the instrument,” he said, highlighting the absence of “big-balance-sheet” players. “The participation of insurance companies is minuscule due to regulator ambiguity. MFs, sitting on huge bond portfolios, aren’t big participants. About 70 per cent of state-owned banks are barely active,” he added.
Experts say most insurers and mutual fund houses are unsure what extent of their exposure to IRFs can be hedged, as the measures prescribed by the Insurance Regulatory and Development Authority of India and the Securities and Exchange Board of India aren’t clear on the flexibility to trade in these. Differences in lot-sizes led to liquidity issues, they added.
A senior executive at a fund house said, “Certain players, such as mutual funds, are allowed to participate in the IRF market for hedging, the condition being they should hold the underlying security. Instead of the exact underlying security, the regulators should allow hedging for all similar-tenured securities.” The underlying securities offered in the IRF market should be expanded further, the executive added.
According to reports, Sebi plans to allow exchanges to launch IRFs, with three- and five-year bonds as underlying.