The Reserve Bank of India (RBI) has released draft rules permitting market participants to take short positions in government securities, a move aimed at enhancing liquidity and price discovery. The draft, open for public feedback until July 17, also includes a framework for trading 'when-issued' securities, which are bonds announced but not yet issued by the government.
Short positions of 2% of the outstanding stock or ₹500 crore, whichever is higher, will be allowed for liquid government securities. Banks and standalone primary dealers (PD) can take both long and short positions up to 25% of the notified auction amount, while other eligible participants will have a 10% limit. For illiquid government bonds, the short position limit is set at 1% of the outstanding stock or ₹250 crore, whichever is higher.
The RBI has mandated that these short positions must be covered within three months through outright purchases in the secondary market, primary auctions, or the when-issued market. This regulatory clarity is expected to improve liquidity and price discovery by allowing traders and primary dealers to express views on interest rates more efficiently.
“This would establish a market-clearing price before the bond even enters circulation.”
A bond trader at a primary dealer
The draft directions also outline a detailed framework for trading in 'when-issued' securities. Typically, the RBI announces bonds on a Monday, with the auction held on a Friday.
"This would establish a market-clearing price before the bond even enters circulation," said a bond trader at a primary dealer. "More active when-issued trading could also reduce uncertainty around auction outcomes and improve secondary market liquidity once the bonds begin trading."
“More active when-issued trading could also reduce uncertainty around auction outcomes and improve secondary market liquidity once the bonds begin trading.”
A bond trader at a primary dealer
Background
The introduction of these draft rules marks a significant step in the evolution of India's bond market. Historically, the market has been characterized by limited liquidity and price discovery challenges, which the new rules aim to address.
As the RBI opens the draft for feedback, market participants will be keenly watching how these changes impact trading dynamics and liquidity in the government securities market.
