“Such forward contracts will enable long-term investors such as insurance funds to manage their interest rate risk across interest rate cycles. They will also enable efficient pricing of derivatives that use bonds as underlying instruments,” said Sanjay Malhotra, governor, RBI
Mumbai: The Reserve Bank of India announced on Friday that it will be introducing forward contracts in Government securities for which the directions will be issued shortly.
The banking regulator has also finally approved the participations of insurers in dealing with derivative products such as Interest Rate Options, Interest Rate Futures, Interest Rate Swaptions, Forward Rate Agreements which are now only available for banks.
These interest rate derivative products help the market participants to manage their interest rate risks on a long term, said the central bank.
“Such forward contracts will enable long-term investors such as insurance funds to manage their interest rate risk across interest rate cycles. They will also enable efficient pricing of derivatives that use bonds as underlying instruments,” said Sanjay Malhotra, governor, RBI, while while announcing his first bi-monthly monetary policy for the current fiscal.
Over the past few years, the RBI has been expanding the suite of interest rate derivative products available to market participants to manage their interest rate risks. It has been receiving feedback about the need to allow forward contracts in Government securities to enable further market development, added Malhotra.
“RBI has announced the introduction of forward contracts in government securities. This is a welcome move from a life insurance perspective as it will allow us to more efficiently hedge interest rate risks,” said Prasun Gajri, chief investment officer, HDFC Life.
Balamurugan Shanmugam, chief investment officer, Aviva India, commented, the announcement by the RBI to introduce bond forwards in government securities is a welcome one. Insurance industry has been asking for this. It is expected that the sector regulator IRDAI will in due course issue guidelines for insurers to use the bond forwards for hedging their interest rate risk.”
Since insurance companies undertake long term liabilities, they are inherently exposed to interest rate risk. Currently, most of the players use forward rate agreements (FRAs) for mitigating this risk, where deemed necessary. The industry expects the bond forwards to be more efficient and something that will enhance the availability of sellers of such protection, explained Shanmugam.
Draft directions in this regard were issued in December 2023. The final directions, taking into account the public feedback, will be issued shortly, said the RBI.
Yashish Dahiya, chairman & Group CEO, PB Fintech, stated life Insurers have been using a limited suit of products to manage interest risk. This welcome move by RBI will enable insurer to hedge their interest and reinvestment risk efficificently and innovate further which in turn should provide more efficient products to customers.
Insurance regulations mandates insurers to invest 50 per cent of their investible corpus in the government securities.