India’s bond forwards may see strong demand from insurers, investors say

By Dharamraj Dhutia and Siddhi Nayak

MUMBAI, Feb 25 (Reuters) –

India’s soon-to-be-launched bond forwards could see strong demand from insurers as these instruments offer the option of taking delivery of underlying securities at the end of a contract, bankers and investors said on Tuesday.

Bond forwards allow investors to buy government securities at an agreed price on a future date. The central bank announced guidelines for these contracts last Friday, with the rules set to kick in from May 2.

Insurers currently use forward rate agreements (FRA), a derivative instrument used to hedge interest rate fluctuations. At the end of a contract, no securities are delivered and only the price differential is settled.

“Bond forwards would be very active and insurance companies will most likely prefer bond forwards over forward rate agreements,” said Churchil Bhatt, executive vice president at Kotak Mahindra Life Insurance.

Banks and primary dealers will be allowed to act as market makers for these transactions.

Bond forwards are also attractive as investors can align their cash flow with asset purchases and opt for either cash settlement or actual bond delivery.

“Cash settlement will be more popular with traders, especially those who want to take advantage of their call or are looking at a change in interest rates for a specific timeline. The deliverable part will help long-term investors like insurance companies,” said Alok Singh, group head of treasury at CSB Bank.

Traders expect domestic banks to participate in this market, which will ensure sufficient liquidity.

“Any instrument that allows investors to hedge or trade on both sides curbs volatility,” CSB Bank’s Singh said.

The launch of bond forwards could also improve demand for ultra-long bonds as more insurance companies would be willing be engage in instruments that are regulated by the Reserve Bank of India, investors have said.

The majority of debt supply from New Delhi has been focused on ultra-long papers in recent years.

“The bond forward guidelines will offer operational comfort to insurance companies. We do not expect it to impact the 10-year yield much, but it may lead to some softening in the ultra-long-end part of the curve,” said Ritesh Bhusari, joint general manager for treasury at South Indian Bank.

Investors anticipate bond forwards to reduce volatility at maturity.

By providing the option of bond delivery instead of only cash settlement, these instruments are expected to help insurers avoid speculation, South Indian Bank’s Bhusari said.

“That will prevent these companies from scrambling for bonds in the secondary market and, in turn, curb volatility.” (Reporting by Dharamraj Dhutia and Siddhi Nayak; additional reporting by Khushi Malhotra; Editing by Sonia Cheema)