The Hindu Business Line : Rate hike fears push up volumes in derivatives

INTEREST rate uncertainty is leading to more action in the debt derivatives market as players want to hedge themselves against interest rate hardening. Volumes in the derivative market have more than tripled vis-à-vis a few months ago to daily averages of Rs 3,500 crore, equivalent to the traded volumes in the Government securities market. But how far will banks and bond houses be able to negate the adverse impact of rise in interest rates?

"Activity is picking up in the Overnight Index Swaps (OIS) and the Mumbai Inter-bank Forward Offered Rate (MIFOR) markets with several banks and bond houses finding it necessary to de-risk their portfolios. This nascent market is all set to take off,'' said the treasury head of a nationalised bank.

Large banks such as State Bank of India, Bank of Baroda, Bank of India, Canara Bank and Punjab National Bank are beginning to play this market in addition to the more active private and foreign banks and a handful of primary dealers.

Public sector banks were previously slow starters in this market due to lack of clarity on taxation, accounting and legal status of OIS and MIFOR markets.

"Volumes have been averaging at over Rs 3,500 crore for over a week now; it is comparable to the volumes in the Government securities market,'' said Mr S. Gopikrishnan, Senior Vice-President, IDBI Caps, an active player in the derivatives market. In January, the volumes in the market were around Rs 1,000 crore.

OIS is an over-the-counter derivative product in which one party agrees to pay a fixed rate of interest to another in exchange for a floating rate.

The agreement can be entered into for a variety of underlying assets such as tier-II bonds, call money rates or a clutch of investments in G-secs to protect against unfavourable interest rate movement. MIFOR too is an over-the-counter derivative product typically used for hedging of foreign currency exposures.

So can banks and bond houses fully nullify the adverse impact of interest rate hardening and plummeting of prices?

According to Mr Arvind Sampath, Vice President-derivatives, I-Sec, although it is technically possible to hedge the entire risk of portfolios, in India, the depth of the derivatives market is not sufficient to make that possible.

About 25-30 per cent of players' portfolios can be hedged considering that there are only 8-10 active players in the OIS market while there are over 100 players in the Government securities market.

Another dampener is that the OIS market is active only up to five years while active G-sec securities are of over 10 years maturity.

The swap spread i.e., the difference between the yield on the Government security and the OIS of comparable maturity has also increased to about 0.82 per cent with the five-year G-sec going at 5.48 per cent and the five-year OIS at 6.30 per cent from a spread of 0.20 per cent in January.

The increase in the spread indicates the increase in demand for the OIS product and the bearish sentiment in the market, explained a debt market analyst.

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