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Informist, Friday, Feb. 21, 2025

 

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--RBI notified directions for Forward Contracts in Government Securities
--RBI: Bond forward directions will come into effect May 2
--RBI: Non-residents eligible to invest in govt bonds can enter bond fwds 
--RBI: Banks, standalone PDs eligible as market makers under bond fwd norms 
--RBI: Bond forward transactions can be physically-settled or cash-settled
--RBI: CCIL, other clearinghouses to settle physically-settled bond fwd deals 
--RBI: Cash-settled bond fwd deals can settled bilaterally 
--RBI:Cash-settled bond fwd deals can be settled via RBI-okayed arrangements
--RBI: Must follow prudential norms like capital adequacy for bond fwd deals 
--RBI: G-sec held to cover bond fwd short positions can be used in repo trade 
--RBI: G-sec held to cover bond fwd short positions will count towards SLR

 

NEW DELHI – The Reserve Bank of India Friday notified directions for forward contracts in government securities, nearly 14 months after issuing the draft guidelines. The final norms will come into effect on May 2, the notification said.

 

RBI Governor Sanjay Malhotra had on Feb. 7 announced the central bank would soon issue the final directions. For forward contracts, government securities would mean gilts and state bonds, but not Treasury bills, the directions said. As in the draft norms, residents are eligible to undertake bond forwards while only those non-residents are allowed who are already eligible to invest in government securities under the RBI's Foreign Exchange Management Regulations.

 

A bond forward is an interest rate derivative contract in which one party agrees to buy a government bond from another party on a specified date for a specified price determined when the contract is written. These products were not permissible in India until the RBI amended the norms last week to allow such instruments that the central bank permits.

 

All scheduled commercial banks, except small finance banks, payment banks, local area banks, and regional rural banks, are eligible to undertake these transactions as market makers, where they provide prices to users. Standalone primary dealers are also eligible to do the same, the RBI said. At least one of the parties to the bond forward shall be a 'market-maker' or a central counterparty authorised by the RBI as an approved central counterparty for such transactions, the notification said. Both these norms carried over from the draft norms.

 

"A market-maker may undertake long positions without any limit and covered short positions in bond forwards," the notification said. They may also undertake forward short sales without cover provided the underlying bond is eligible, and the forward short sale would count towards the security's short selling limit. The RBI's short sale norms would also impose a maximum period for the short sale, the notification said.

 

While the definition of market makers remains unchanged, the RBI has broadened it for bond forward users from the draft norms to extend eligibility to all non-retail entities eligible to participate in rupee-denominated interest rate derivatives. The final guidelines remove restrictions on foreign portfolio investors entering all bond forward trades, including long positions. Users can undertake long positions without a limit but can only undertake covered short positions to hedge their risk. The user must exit the short position if it no longer holds the underlying government security, the notification said. 

 

Bonds held to cover short sales may be used in a repo transaction or government securities lending contract, provided the short seller is eligible to trade in either contract. These bonds can also count toward calculating a bank's statutory liquidity ratio, which was not allowed under the prevalent bond forward-rate agreements in the market.

 

While these bond forward rate agreements were only cash-settled, the new guidelines allow physical settlement as well. A physically settled contract, which would include delivery of the bond, shall be settled through the Clearing Corp. of India Ltd. or other clearing agencies approved by the RBI, the guidelines said. Meanwhile, cash-settled transactions can be settled bilaterally or through any RBI-approved arrangement.

 

Bond forward contracts are eligible for novation – any of the counterparties can exit the contract by trading it to someone else. Alternatively, the user can unwind the contract directly with the counterparty, the central bank said.

 

"The settlement basis and market conventions for bond forward transactions shall be specified by the Fixed Income Money Market and Derivatives Association of India, in consultation with market participants," the notification said. The industry body may prescribe standard documentation, or users can follow an alternate standard master agreement, the RBI said.

 

Market makers must report all bond forward transactions to the Clearing Corp. of India's trade repository on the same day. Reporting shall include counterparties' details, the underlying bond, settlement type and whether the short position is covered or uncovered, among others, the notification said. The market maker must also report the unwinding of bond forward trades, novation, bilateral settlement and settlement default to the trade repository.

 

Clearing Corp.-settled trades involving users shall be reported to the trade repository as well, by either the user or the clearing member of the central clearinghouse. For other trades, there is no requirement for the user to report or confirm the transaction details to the trade repository. Instead, the market maker would be responsible for ensuring accuracy, the norms said. 

 

"Market participants shall follow the applicable prudential norms including those related to capital adequacy, exposure norms, related party transactions, etc., issued by their respective regulators for bond forward transactions," the RBI said. Market makers must also have methodologies in place for calculating the mark-to-market impact of bond forward trades. The central bank also said it can publish anonymised data related to bond forwards.

 

Moreover, the RBI can demand details of bond forward transactions from any of the entities involved in the market which the entity will be obliged to provide. Should an entity violate the directions, the RBI can disallow it from taking part in bond forward transactions for up to a month at a time, in addition to penal or regulatory action, the norms said.  End

 

Reported by Aaryan Khanna

Edited by Saji George Titus

 

 

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