Context

The Reserve Bank of India proposed allowing foreign portfolio investors (FPIs) to undertake exchange-traded rupee interest rate derivatives transactions subject to an overall ceiling of Rs 5,000 crore.

About

What are Interest Rate Derivatives?

• Interest Rate Derivatives (IRD) are contracts whose value is derived from one or more interest rates, prices of interest-rate instruments, or interest rate indices.
• These may include interest rate futures, options, swaps, swaptions, and FRA's.
• Entities with interest rate risk can use these derivatives to hedge or minimize potential losses that may accompany a change in interest rates.
• The proposed Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2020 are aimed at-
  • encouraging higher non-resident participation
  • enhance the role of domestic market makers in the offshore market
  • improve transparency
  • achieve better regulatory oversight

Where FPIs will be allowed?

• FPIsmay transact in permitted exchange-traded IRDs subject to the conditions that, at any point in time "the net long position of FPIs, collectively, and across all exchanges, in exchange-traded IRDs shall not exceed Rs 5,000 crore".
• Also, the net short position of an FPI on exchange-traded IRDs should not exceed its long position in government securities and other rupee debt securities.

User classification:

• For the purpose of offering Rupee IRD contracts to a user, the market-maker (entities which provide bid and offer prices to users in order to provide liquidity to the market) should classify the user either as a retail user or as a non-retail user.
  • Non-retail users are entities regulated by RBI, SEBI, IRDAIor PFRDA; resident companies with a minimum net worth of Rs 500 crore; and non-residents, other than individuals.
  • Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.