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Forward Contracts in Government Securities

Reserve Bank of India (RBI) has released directions on forward contracts in government securities.

What is Bond Forward?

Bond forward means a rupee interest rate derivative contract in which one counterparty (buyer) agrees to buy a specific government security 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 forward contracts in government securities (referred to as bond forwards) undertaken in the Over-the-Counter (OTC) market in India.

Who are market participants?

The following persons shall be eligible to undertake bond forward transactions –

  • 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)

What are the directions for market-makers?

  • A market-maker may undertake long positions without any limit and covered short positions in bond forwards.
  • A market-maker, permitted to undertake short sales, shall also be eligible to undertake uncovered short positions subject to the underlying government security being eligible for short sale. Such uncovered short positions shall be reckoned in the security level limits on short sales and cannot remain uncovered for a period exceeding the maximum period specified for covering a short position in the Short Sale (Reserve Bank) Directions, 2018 dated July 25, 2018.
  • At least one of the parties to a bond forward transaction shall be a market-maker or a central counter party authorised by the RBI.

Who are users?

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

Any entity, eligible to be classified as a non-retail user in terms of the Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019, dated June 26, 2019, shall be eligible to undertake transactions in bond forwards as a user.

What are directions for users?

  • An eligible resident user may undertake long positions in bond forwards without any limit.
  • An eligible user (resident and non-resident) may undertake covered short positions in bond forwards only for the purpose of hedging.
  • A user with a covered short position in a bond forward shall exit its short position in case it ceases to hold the underlying government security.

What are Covered and Uncovered Short?

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

What is Cash and Physical settlement?

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

What are the directions for settlement or unwinding?

  • A bond forward transaction may be physically-settled or cash-settled.
  • A physically-settled bond forward transaction shall be settled through the Clearing Corporation of India Ltd. (CCIL).
  • A cash-settled bond forward transaction may be settled bilaterally or through any clearing arrangement approved by RBI.
  • A market participant may exit its position in a bond forward by unwinding the position with the original counterparty or assigning the position to any other eligible market participants through novation. 
  • The settlement basis and market conventions for bond forward transactions shall be specified by the Fixed Income Money Market and Derivatives Association of India (FIMMDA), in consultation with market participants. 

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.

What are other directions?

  • Government securities held to cover short positions in bond forwards may be used in a repo transactions or lent / placed as collateral under a Government Securities Lending (GSL) transactions subject to the condition that the holder of the short position is otherwise eligible to undertake a repo / GSL transaction.
  • Government securities held to cover short positions in bond forwards shall be eligible to be reckoned for Statutory Liquidity Ratio (SLR) by the entity covering the short position, provided that the security is otherwise eligible to be reckoned for SLR.
  • A bond forward transaction that is not centrally cleared shall be subject to requirements for exchange of variation and initial margin in terms of the provisions of the Master Direction – Reserve Bank of India (Margining for Non-Centrally Cleared OTC Derivatives) Directions, 2024 dated May 08, 2024.

From when will the directions be effective?

The directions shall come into force with effect from May 02, 2025.


References

Reserve Bank of India. (2025, February 21). 'Reserve Bank of India (Forward Contracts in Government Securities) Directions, 2025'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12784&Mode=0


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