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Informist, Monday, May 5, 2025

 

By Aaryan Khanna

 

NEW DELHI – Bond investors did not make much use of the newest derivative instrument in their toolkit despite the long lead time in its introduction. There were likely less than a handful of bond forward trades struck on the day of the launch Friday, according to bond market participants.

 

The Reserve Bank of India had issued final bond forward guidelines in February, nearly 14 months after the draft norms. These came into effect Friday. A bond forward is an interest rate derivative contract in which one party agrees to buy a government bond from another party on a future date at a price agreed at the start of the trade. These products were not permissible in India until a legal amendment February gave the go-ahead to any instrument the central bank allows. 

 

"Not a single trade has been heard (of)," a treasury official at a bank said on Friday. "We are set up to do forwards, but we didn't hear much interest from insurers. Even foreign banks don't seem to have anything, unless someone did a muhurat trade."

 

Market participants expected interest in bond forwards largely between life insurers on the one hand and banks, the market makers, on the other. The long-term investors have staggered but recurring premium incomes. Bond forwards allow a frontloading of the investment and reduce reinvestment risk. Insurers pay banks a fee and a funding cost, typically the overnight indexed swap rate of a tenure matching the forward, to essentially "borrow" their balance sheet for a period of time. The new instrument allows physical settlement of bonds on maturity of the transaction.

 

However, participants from both the segments said that despite the lead time, it would likely take another two weeks to get the market started properly. Most banks which offer bond forward-rate agreements, a popular cash-settled interest-rate hedging tool, said they had not made the formal switch over to offering bond forwards. While some were still seeking board approval, others said the procedures to integrate the instruments with their internal treasury software had not been completed.

 

Two private life insurers said they had yet to receive board approval to go ahead for bond forwards. Functionally, there was little difference for a fund manager in conducting a trade through the new instruments, and bond forwards offered advantages such as physical settlement, which are attractive to money managers, IndiaFirst Life Insurance Co. Chief Investment Officer Poonam Tandon told Informist in a recent interview. Some insurers had also already locked in their cash flows at the end of April through bond-forward rate agreements ahead of the shift to bond forwards.

 

"Nobody has stuck their head out on day one and said, 'offer me a quote and let's do a deal'," an investment official at a life insurance firm said Friday. "I can tell you, at least from the industry side, we have not heard of any (bond forward) deals being finalised."

 

Users cited two operational hitches. One, market participants had expected the Clearing Corp. of India to develop a platform for bond forward trades between February and May, which has not been launched so far. The clearing house hosts the trading platform for overnight indexed swaps and the RBI's platform for trading government securities. Such a platform would potentially allow anonymised quotes for better price discovery, market participants said.

 

Two, the process note currently floated by the Fixed Income Money Market and Derivatives Association to potential users on bond forwards was vague and left several questions on accounting and other nitty-gritties answered poorly, market participants said. The industry body was expected to come out with a comprehensive process note well before the implementation of the bond forward norms, but it only issued the note on Apr. 30, which gave traders little time to absorb, understand, and implement these. This has also delayed the start of trading, market participants said.

 

Finally, market participants also said it would have been a quiet day for bond forwards even without the novelty. Long-term gilts are life insurers' favourite target to buy through forward-rate agreements, and the weekly gilt auction Friday lacked bonds maturing beyond 10 years. Still, bond forwards are expected to get going sooner rather than later, perhaps as early as the auction of INR 230 billion of state bonds Tuesday. State bonds are expected to gain the most from the introduction of bond forwards. Bond forward-rate agreements had no provision for state bonds, and investors may prefer the higher-yielding bonds given the choice.

 

Moreover, several bankers are starting to get jittery about offering bond forward-rate agreements, a regulatory grey area not too long ago, at a time when bond forwards have received the central bank's blessing. Insurers are less picky, but see the INR-3.5-trillion forward-rate agreement market subsumed by the new product and its advantages. And when the next batch of hedging demand come in from some of the largest financial institutions in the country, banks plan to meet it with bond forward contracts.  End

 

Edited by Akul Nishant Akhoury

 

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