Indian Debt & Derivatives Markets - Issues


This note is based on presentation by Sh Harun R Khan, DG, RBI. I am just attempting to understand his speech. I don't claim to be an expert on finances, students are advised (I was typing adviced - read the difference here) - you are advised to add if I miss something.

Regulation of Financial Markets
Financial market participants are 'glass half full' people, and regulators as their 'glass half empty' counterparts. Market participants- see opportunity for reward, regulators see exposure to risk.

Recent financial crisis has demonstrated the need for effective regulation, inadequacy of “free market paradigm”. From ‘light touch’ to ‘comprehensive regulation & efficient supervisory framework’


Global initiatives for regulating financial markets besides fiscal and monetary measures are:

Dodd-Frank Act: the largest financial regulation overhaul in US since the 1930s, to prevent repeat of 2008 financial crisis. Sweeping new rules for banks, hedge funds and complex financial transactions called derivatives.

Volcker Rule (part of Dodd-Frank): aims to limit risky behavior within banks. Banks that take retail deposits would not be allowed to engage in proprietary trading that is not directly related to the market making and trading they do for customers. These banks would also be prohibited from owning or sponsoring hedge funds or private equity funds.

Vicker’s commission in UK - biggest reforms to the banking sector.

EMIR (European Market Infrastructure Regulation): purpose - to improve transparency and reduce the risks associated with the derivatives market.



RBI’s approach: three broad principles

1) wider menu of financial products to enable economic agents (producers, consumers) to hedge emergent risks & meet funding requirements
2) introduction of new products should follow a graduated process (think Interest rate derivatives)
3) improved robustness of the market infrastructure for trading, settlement and reporting (think NSEL crises)


-> RBI prefer stability and safety over short term market activity, two main focus – building resilience and increasing liquidity.


Building Resilience of Debt & Derivatives Markets

1) Requirements for registration and reporting: To ensure that safe & financially strong entities have access to the financial system [e.g.  Primary Dealer authorisation; criteria to enter CDS market]. CDS (Credit default swap) is an agreement where the seller of the CDS will compensate the buyer in the event of a loan default or other credit event.

2) To promote transparency [e.g. reporting requirements for G-Sec trades, OTC derivatives].


Requirements for capital and collateral
3) To ensure that strong financial firms are doing business in financial sector- like Basel 3 guidelines for banks.
4) Ensure credit risk in transactions is managed through appropriate collateral – margins for derivatives.


Orderly market rules
5) To protect the integrity of market prices for encouraging wider market participation & providing credible price information for the economic agents (think benchmarks/ gold price rigging). Prices of products needs to be rational - CDS needs to be linked to underlying exposure its taking (CDS agreement should be followed in letter & spirit)

6) FIMMDA code of conduct for Dispute Resolution Mechanism.

7) Limits on IRF positions (interest rate futures)

8) “Suitability and appropriateness requirements for derivatives”


Enhancing Liquidity in Debt & Derivatives Markets

1) Liquidity in government securities market remains low despite regular issuance across yield curve and state-of-the-art infrastructure in place.

2) Actions have been initiated/completed in nearly 70% of the recommendations of the Gandhi Committee (RBI's Working Group on Enhancing Liquidity in the Government Securities and Interest Rate Derivatives Markets).

3) Market Making
Allocate specific securities to each PD (Primary dealer) for market making in them and if required, rotate it (recommendation of Gandhi Committee). It may be operationalised by next fiscal.

4) Short selling (basically means sell first, buy later)
RBI increased the short sell limits in a sequential manner; and would take appropriate action keeping in view the needs of market participants and imperatives of financial stability.


In the presentation Sh Harun Khan pointed out recent measures and issues of RBI which I think needs more elaboration, which I'll prepare and post here. The topics are:

Interest Rate Futures
CD/CP
Repo in Corporate Debt
Enhancing Foreign Investment Limits in G-Sec and Corporate Bonds
maintaing credibility of Financial Benchmarks
OTC Derivatives Market Reforms


So we've a lot of work to do.