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Draft Directions on Bond Forwards

Reserve Bank of India (RBI) has released draft directions on bond forwards.

What are Bond Forwards?

Bond forwards mean derivative contracts in which one counterparty (buyer) agrees to buy a specific debt instrument from another counterparty (seller) on a specified future date and at a price determined at the time of the contract.

Which transactions shall be covered under the directions?

The directions shall apply to transactions in bond forwards undertaken in Over-the-Counter (OTC) markets in India, including on Electronic Trading Platforms (ETPs).

What shall be the underlying debt instrument?

The transactions in bond forwards shall be undertaken on Central Government dated securities and State Government Securities.

Who are market participants?

The following persons shall be eligible to undertake transactions in bond forwards –

  • A resident
  • A non-resident who is eligible to invest in Government Securities

Who are market-makers?

Market-maker means an entity which provides prices to users and other market-makers.

The following entities shall be eligible to undertake transactions in bond forwards as market-makers –

  • Scheduled Commercial Banks (except Small Finance Banks, Payment Banks, Local Area Banks and Regional Rural Banks)
  • Standalone Primary Dealers (SPDs)

At least one of the parties to a transaction in bond forwards shall be a market-maker or a central counter party authorised by Reserve Bank of India (RBI).

Who are users?

User means a person that undertakes transactions in bond forwards other than as a market-maker.

The following entities shall be eligible to undertake transactions in bond forwards as users –

  • Small Finance Banks, Payment Banks, Regional Rural Banks.
  • Urban Cooperative Banks
  • Non-Banking Financial Companies (NBFCs), including Housing Finance Companies (HFCs)
  • Export Import Bank of India (EXIM), National Bank for Agriculture and Rural Development (NABARD), National Housing Bank (NHB), Small Industries Development Bank of India (SIDBI) and National Bank for Financing Infrastructure and Development (NaBFID)
  • Insurance Companies regulated by Insurance Regulatory and Development Authority of India (IRDAI)
  • Pension Funds regulated by Pension Fund Regulatory and Development Authority (PFRDA)
  • Mutual Funds and Alternative Investment Funds regulated by Securities and Exchange Board of India (SEBI)
  • Foreign Portfolio Investors (FPIs) registered with SEBI
  • Resident Companies (other than specified above) with net-worth of ₹500 crore or above as per the latest audited balance sheet.

What are Covered and Uncovered Short?

  • Covered Short means a position in bond forwards in which the seller of a bond forward holds an equivalent amount of the underlying debt instrument.
  • Uncovered Short means a short position in bond forwards other than a covered short position.

What are the directions for market-makers?

  • Market-makers may undertake long positions in bond forwards without any limit.
  • Market-makers may undertake covered short positions in bond forwards without any limit. Debt instruments underlying such positions in bond forwards may be used in a repo transaction subject to the condition that the maturity of the repo should not exceed the maturity of the bond forward.
  • Market-makers shall not undertake any uncovered short position in bond forwards.

What are directions for users?

  • Users, other than FPIs, may undertake long positions in bond forwards without any limit.
  • Users, except for resident companies, may undertake covered short positions. Debt instruments underlying such positions in bond forwards may be used in a repo transaction, if the user is otherwise eligible to undertake repo transactions, subject to the condition that the maturity of the repo should not exceed the maturity of the bond forward.
  • Resident companies shall not undertake any short position in bond forwards.
  • Users shall not undertake any uncovered short position in bond forwards. 
  • Users shall exit their short position in bond forwards within one week from the date they cease to hold the underlying debt instrument.

What is Cash and Physical settlement?

  • Cash settlement of bond forwards means a settlement process in which the cash settlement value of the bond forward as on the maturity / termination date is exchanged between the counterparties under the terms of the contract.
  • Physical settlement of bond forwards means a settlement process in which the seller transfers the underlying debt instrument to the buyer, against the receipt of the contracted price from the buyer.

What are the directions for settlement or unwinding?

  • Bond forwards can be physically settled or cash settled.
  • The settlement of physically settled bond forwards shall be through clearing agency approved by RBI.
  • Bond forwards which are cash settled, can be settled bilaterally or through clearing agency approved by RBI.
  • Market participants can exit their position in bond forwards by unwinding the position with the original counterparty or assigning the position to any other eligible market participant through novation.

What is novation?

Novation is the replacement of a contract between two counterparties to an OTC derivatives transaction (the transferor, who steps out of the existing contract, and the remaining party) with a new contract between the remaining party and a third party (the transferee). The transferee becomes the new counterparty to the remaining party.


References

Reserve Bank of India. (2023, December 28). 'RBI releases Draft Directions on Bond Forwards under Section 45W of the RBI Act, 1934'. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=57007

Reserve Bank of India. (2023, December 28). 'Reserve Bank of India (Bond Forwards) Directions, 2023 - Draft'. Retrieved from https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=4361


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