RBI introduces interest rate swaptions, allows NRIs to participate in swaps market

The move was largely welcomed by market participants, who concurred that it was a step in the right direction to deepen the domestic derivatives market..

The Reserve Bank of India on Thursday proposed introducing interest rate swaptions in rupees to improve timing flexibility for those looking to hedge against interest rate risks.

Swaptions are basically options that give the holder the right but not the obligation to enter into an underlying swap. A swap is nothing but a derivative contract through which two parties can exchange financial instruments.

The move was largely welcomed by market participants, who concurred that it was a step in the right direction to deepen the domestic derivatives market.

However, most experts Moneycontrol spoke to iterated that unless the RBI comes up with measures to significantly improve the liquidity in the domestic derivatives market, introducing swaptions will be but a baby step.

“Introducing swaptions is certainly a good thing because our derivatives market really needs deepening,” said R Sivakumar, Head – Fixed Income, Axis Mutual Fund. “But the biggest problem there is participation, which is currently restricted to banks primarily.”

Most banks have hedging needs that are quite similar to one another’s and therefore, will be interested in taking similar positions in the market, Sivakumar said. This he said leads to the market getting tilted to reflect one point of view.

Others agreed with Sivakumar's opinion and maintained that liquidity in the derivatives market is a cause for concern. However, some of them also said the RBI was doing what it is supposed to do, and that as a regulator, its responsibility is to try deploying different tools and see if they work out.

“It is a chicken and egg situation,” said Dwijendra Srivastava, Chief Investment Officer – Debt, Sundaram Asset Management Company. “As a regulator, RBI did what it is supposed to do by bringing in swaptions but yes, liquidity and participation are big issues.”

Srivastava added something needs to be done to encourage wider participation in the domestic derivatives market, even from banks.

“If you see, private banks and foreign banks are the biggest players in the derivatives market,” Srivastava said. “Public sector banks are not so big on derivative instruments and have zero participation in some.”

Apart from introducing interest rate swaptions, the RBI also allowed non-resident Indians to participate in the swap market, which was yet another step towards deepening the market.

“Allowing non-residents into swap markets and introduction of rupee swaptions would deepen the domestic derivative market, while also aiding product development to enable better risk management by domestic entities,” said Chanda Kochhar, Managing Director and Chief Executive Officer, ICICI Bank.

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