Forward Rate Agreements (FRAs) are contracts between banks and sure Insurance companies that allow policyholders to lock in rates for a future date, thereby protecting them from volatility, can offer guaranteed returns to policyholders by entering into such agreements.
Central banks around the world and in India are set to cut rates in the coming months. Rising demand for debt across the board is derivatives For example, insurance company FRAs could cause yields to fall and help reduce borrowing costs for the government.
“We are already in talks with banks to start FRA operations in the near future,” Siddhartha Mohanty, CEO of Life Insurance Corporation, said at a press conference last week.
Widening spreads between government bond yields and overnight indexed swaps (OIS) are helping demand for such instruments, traders said. The five-year OIS rate has plunged 30 basis points since July 1, while bond yields maturing in 10 years or longer have fallen between 4 and 13 basis points on rising bets on a US rate cut. “At the current level, we should be seeing more interest in FRAs,” said Vikas Jain, head of India fixed income, currencies and commodities at Bank of America. Around 113 billion rupees ($1.35 billion) worth of FRA trades were done between July 1 and August 2, up nearly 20% from 87 billion rupees in June, clearinghouse data showed. Traders anticipate a further rise with LIC entering the market.
DEEPENING CURVE
Demand has also increased for “separate trading of registered interest and principal of securities (STRIPS),” traders said. These are bond instruments that dealers “strip” to sell the principal. pay and coupon rates separately.
“We have seen an uptick in STRIP trading recently as it is tied to the shape of the curve. If the curve is very flat, there is no interest in STRIP, but as the curve has become steeper, some interest is coming back,” said Bank of America’s Jain.
A bigger fall in short-duration bond yields than long-dated yields has led to a steepening, making “STRIPs more attractive than before as they now trade at par or at a slight premium to the spot rate,” said Rahul Bhuskute, CIO at Bharti AXA Life Insurance.
Given the steady growth in life insurers’ flows, demand for FRA and STRIP is expected to remain robust, especially given the seasonal recovery in insurance business in October-March, he added.
($1 = 83.9625 Indian Rupees)
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