Indian insurers are seeking regulatory modifications from the Insurance Regulatory and Development Authority of India (IRDAI) to facilitate their participation in the recently launched bond forwards market. This move aims to strengthen their investment strategies and align long-term asset-liability management practices. The insurers have formally communicated their requests to the IRDAI, seeking adjustments in the treatment of accounting standards and counterparty exposure.
The bond forwards market, which launched last week, is yet to see its first trade. Market participants suggest that many insurers are awaiting board-level authorization before entering the market. These financial instruments, which establish a fixed future price for the purchase of government securities, are seen as potential tools for managing interest rate risk and meeting insurers' long-term payout obligations. The Reserve Bank of India (RBI) has already approved the use of these instruments by banks.
Insurers are proposing easing the current “day-zero” accounting rule, which requires recognizing potential losses from the start of a trade. They are also seeking a change in how counterparty credit risk is calculated, suggesting using residual maturity to determine exposures, which could reduce compliance pressures. Additionally, insurers are requesting regulatory clearance to implement netting arrangements when settling trades with counterparties, a practice that consolidates multiple obligations into a single position and may reduce operational risk.
Bond forwards offer a different structure compared to forward rate agreements (FRAs), through the physical delivery of securities. This aspect is viewed as beneficial for long-term investors in aligning assets with their liability timelines. It is estimated that insurers are planning to shift up to ₹3.5 trillion (approximately US$41 billion) in derivative exposure from FRAs to bond forwards. The transition is expected to occur gradually, with companies collaborating with the RBI and IRDAI to resolve regulatory and procedural matters.
The current regulations calculate counterparty exposure based on the notional amount without considering the contract's tenure. Insurers are requesting that the regulator "water down" the counterparty exposure based on the maturity of the bond forwards. An executive at a large insurance firm noted that under the current rules, a 10-year forwards contract's limits are calculated on the notional amount, without weighting the tenure.
The introduction of bond forwards is expected to support institutional demand for long-term government securities, especially among insurers managing growing portfolios amidst rising financial market participation. These instruments can help insurers manage interest rate movements and secure long-term holdings. By using bond forwards to lock in future bond prices or yields, insurers can protect themselves against adverse interest rate movements that could erode the value of their holdings.
The IRDAI had previously permitted insurers to use equity derivatives starting in April 2024. The expansion of permissible instruments to include bond forwards reflects a continued effort to provide insurers with the tools they need to manage risk effectively and optimize their investment strategies.
While the bond forwards market holds promise, its success hinges on the final rules being trader-friendly, permitting physical delivery, and ensuring transparency in the funding spread between short- and long-term derivative products. Ideally, market participants would like these products to be traded on exchange platforms, similar to futures and options, to reduce counterparty and settlement risk and further deepen the forward bond market.
