Are T-bill futures a good idea? Financial Express 11th July 2011

Futures on 91-days’ T-bill is an interesting development, considering that there is scepticism attached to money market derivatives, given the lacklustre response to the IRFs twice over. But, this one can be different because it does address, to a large extent, the concerns that thwarted the growth of the IRF market.

If we look at the structure of the market, the primary market has issues every week of, say, R8,000-10,000 crore depending on the RBI’s calendar. The buyers are banks, mutual funds, corporates and other institutions and some state governments. The secondary market does not inspire too much of trading and at best registers around R2,000 crore a day, which obviously has to change. This may be contrasted with, say, trading of around R20,000 crore a day in the cash segment of the stock market. Overall outstanding on such paper would be around R80,000-90,000 crore, though there is considerable churning of such bills as they expire every 91 days, which, in turn, are replaced by fresh issuances. This makes it an interesting underlying product as there is a virtual rollover of paper on a regular basis. How then will the derivative product on this underlying work?

For any market to work for a derivative product, we need to have large number of players—hedgers and speculators besides the arbitragers. The actual holders would be interested in such an instrument as hedgers. In FY12 so far there has been a movement of a little over 100 bps in the primary yield on 91-days T-bills, which means that the prices of these bills have been coming down. Intuitively, in such an environment of rising interest rates, this is a big risk that is being carried in the books of the holder and there is need to hedge it. This is where the investors or speculators could come in and take an opposing view on movement in interest rates. Hence, holders of such instruments would be shorting their futures, so as to buy back at a lower rate and provide cover for their loss on portfolio. At times, when the volatility in interest rate has been high and uncertain, given that one is still not too sure of RBI’s view on interest rates, this is a very useful option for interest rate hedging. As a corollary, it makes a sensible investment option.

T-bill futures have the potential to actually set benchmarks for short-term instruments such as commercial paper, certificates of deposits and other treasury bills. 91-days T-bills futures will hence help enable them to take positions based on their holdings of pother instruments. Corporates who are dealing with floating rate bonds would find this attractive as they are able to benchmark and hedge or trade based on interest rate perceptions. In fact, even within the T-bills market there have been major shifts in yields on other maturities which are above 50 bps for 14-days and around 75 bps for 182- and 362-days bills in the last three months. A major improvement over the IRFs is that there is no delivery and all transactions are cash settled, meaning thereby that one does not have to go running around for the right security to deliver. The absence of securities transactions tax will also help in further lowering costs along with lower margins, which provide greater leverage to investors.

In fact, this instrument should also attract attention from the retail end as one can actually take advantage of interest rate movements, especially in an era of rising interest rates. Deposit holders normally get into the instrument and have their interest rate locked for a fixed tenure. In an increasing rate environment, one can actually start playing on T-bill futures to derive the benefit of hedging or making a profit. The advantage for this derivative segment is that one can directly trade on the NSE platform just like one does for, say, shares.

A vibrant futures market in the IRF segment including T-bills has the potential to make the financial markets more buoyant. Futures typically trade a multiple times that in the physical or cash markets. In stock markets, for example, we have trades of around 6-7 times the cash segment, which, on its own, could mean comparable numbers for this segment. Commodity futures generate business volumes of around R60,000-70,000 crore a day while currency derivatives clock R30,000 crore a day. Quite clearly, the money market, which has a large underlying of GSec paper, corporate bonds, T-bills, CPs and CDs, should be able to match the same once they set acceptable benchmarks for other instruments, given that there is a large mass of GSecs which banks hold on to that always run the risk of MTM losses in a regime of rising interest rates. The IRFs were to address this issue, but the contract structures were a deterrent. Hopefully, we have gotten the product right this time as the initial trading volumes look more respectable than it were when the initial IRFs were launched.