CHIEF GENERAL MANAGER
January 5, 2004
The Managing Director / Executive Directorof Derivative Segment of NSE & BSEand their Clearing House / Corporation.
Sub: Scheme for introduction of Exchange Traded Interest Rate Derivative Contracts on a basket of Government Securities
This circular is being issued in exercise of powers conferred by section 11 (1) of the Securities and Exchange Board of India Act, 1992, read with section 10 of the Securities Contracts(regulation) Act 1956, to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.
This circular is in continuation of SEBI Circular No. SEBI/SMDRP/DC/Cir-16/2003/04/17 dated April 17, 2003 on the scheme for introduction of Exchange Traded Interest Rate Derivative Contracts.
The SEBI Advisory Committee on Derivatives and Market Risk Management (RMG), in its meeting on October 28, 2003 and November 11, 2003 had recommended the introduction of exchange traded interest rate futures contract which would derive its value from a basket of dated Government Securities (hereinafter referred to as bond). Based on the recommendation of the RMG, SEBI has decided to permit interest rate futures contract on a “10 year coupon bearing notional bond” which shall be priced off a basket of bonds. The risk containment measures and the scheme for introduction of such futures contract shall be as follows:-
The interest rate derivative contract to be traded on the derivative exchange/segment and settled through the Clearing house/corporation of the Exchange (herein after collectively referred to as Exchange) shall have prior approval of SEBI. The Contract shall comply with the disclosure and other requirements, if any, specified by SEBI from time to time.
The minimum contract size of the interest rate derivative contract shall not be less than Rs. 2, 00,000/- at the time of its introduction in the market.
The interest rate futures contract on a 10 year coupon bearing notional bond shall be priced on the basis of the ‘Yield To Maturity’ (YTM) of a basket comprising bonds with maturity ranging from 9 to 11 years. The basket shall comprise atleast three bonds and the YTM of the basket shall be a simple average of the YTM’s of each bond comprising the basket. The Exchange shall prescribe the precise formula, including the day count and other convention, for arriving at the YTM’s of the bonds constituting the basket.
The interest rate futures contract shall be cash settled and shall be permitted upto maximum maturity of 12 months. The Exchange shall decide whether to have quarterly contracts beyond the first three months, and whether the quarters should be fixed months of the year or rolling quarterly horizon from the contract introduction date.
The features of the notional bond including, the coupon rate shall be disclosed to the market in advance and shall form a part of the contract specification.
The composition of the basket of bonds shall be disclosed to the market prior to the launch of the futures contract. Exchange shall specify the eligibility criteria for selecting the bonds constituting the basket. The Exchange shall also review the eligibility criteria and the basket at periodic intervals. The eligibility criteria shall be based on volume, turnover etc., and shall be disclosed to the market.
The price of the futures contract shall be quoted and traded as 100 minus the YTM of the basket.
For the purpose of computing the final settlement price, the Exchange shall disclose, in advance, the methodology for arriving at the YTMs of the bonds, comprising the basket, on the last trading day of the futures contract.
The final settlement price of the notional bond shall be obtained by discounting the cash flows of the notional bond at the YTM of the basket. The precise formulas for arriving at the settlement price, including, the day count and other conventions, shall be fully disclosed to the market.
The Exchange shall specify the parameters to determine whether a bond constituting the basket is illiquid. For this purpose an illiquid bond shall be one where, in the opinion of the Exchange, the volumes and/or turnover in a bond are not sufficient to reflect the fair price of the bond. In the event that bonds comprising the basket become illiquid during the life of the contract the following measures shall be adopted-
In case a bond is illiquid for 7 consecutive days excluding the shut period, reconstitution of the basket shall be attempted. In case reconstitution of the basket is not possible, the YTM of the basket shall be determined from the YTMs of the remaining bonds for arriving at the final settlement price and the daily closing price.Polled prices shall be used for determining the final settlement price and the daily closing price, when atleast 2 out of the 3 bonds comprising the basket become illiquid. Polling shall be carried out by the Exchange in a transparent manner and the prices of bond constituting the basket shall be regularly polled and published. The methodology of polling shall be disclosed to the market.
II) RISK CONTAINMENT MEASURES
The present portfolio based margining approach applicable to existing exchange traded equity and interest rate derivative contracts shall be extended to interest rate futures contract on a 10 year coupon bearing notional bond which shall be priced off a basket of bonds. The margins shall be computed taking an integrated view on the risk on a portfolio of an individual client comprising positions in all derivative contracts. The risk containment parameters for the contract shall be the same as specified for the “Long Bond Futures Contract” in Clause (II) of SEBI circular No. SEBI/SMDRP/DC/Cir-16/2003/04/17 dated April 17, 2003.
III) The Derivative Exchange/Segment shall submit their proposal for approval of the Contracts to SEBI which shall include:
the details of proposed derivative contract to be traded on the exchange which shall include:
Underlying – the definition of the underlying would include, the specification of the basket, the broad methodology for selecting the bonds comprising the basket and the features of the bonds
Last Trading Day
Margins, including procedure for intra-day or beginning of day margin calls, if any. Methodology for calculating closing price for mark to market settlement. Methodology for calculating closing price at time of expiryMethodology for computing (vi) & (vii) above if the futures contract and the bonds comprising the basket become illiquidThe criteria adopted by the Exchange to determine whether a bond comprising the basket is illiquid Details of the polling methodology adopted by the Exchange to determine YTM of bonds
b)the economic purpose it is intended to serve,
c)likely contribution to market development,
d)the safeguards and the risk protection mechanism adopted by the exchange to ensure market integrity, protection of investors and smooth and orderly trading,
e)the infrastructure of the exchange and the surveillance system to effectively monitor trading in Interest Rate Derivative Contracts,
f)details of settlement procedures & systems, and
g)details of back testing of the margin calculation for a period of one year.