FINANCIAL MARKETS

Well-functioning, liquid and resilient financial markets help monetary policy transmission as well as in allocation and absorption of risks entailed in financing India’s growth.

Overview

The Reserve Bank has a legislative mandate to regulate the interest rate and foreign exchange markets which are critical for the resilient functioning of the financial system and the broader economy, and for ensuring financial stability. As part of this mandate, the Reserve Bank is tasked with the regulation, development and oversight of the interest rate markets, including the Government Securities market; money markets including the market for repo in Government securities and corporate bonds; foreign exchange markets; derivatives on interest rates/prices, foreign exchange rates and credit. The Reserve Bank is also responsible for the regulation of financial market infrastructure, including financial market benchmarks, for these markets. The Reserve Bank regulates financial markets within the overarching statutory framework of the Reserve Bank of India Act, 1934, the Government Securities Act, 2006, Foreign Exchange Management Act, 1999, the Bilateral Netting of Qualified Financial Contracts Act, 2020 and the Payment and Settlement Systems Act, 2007.
The Reserve Bank authorises Electronic Trading Platforms (ETPs) under the Electronic Trading Platforms (Reserve Bank) Directions, 2018. ETPs are any electronic system, other than a recognised stock exchange, on which transactions in eligible instruments like securities, money market instruments, foreign exchange instruments, derivatives, etc. are contracted. No entity shall operate an ETP without obtaining prior authorisation of RBI. The list of ETPs authorised by the RBI is available here.
The robustness and reliability of financial benchmarks are critical for efficient pricing and valuation of financial instruments. To improve the governance of the benchmark processes in markets regulated by the RBI, the Financial Benchmark Administrators (Reserve Bank) Directions, 2019, were issued in June 2019. The Financial Benchmarks India Private Limited is authorised under these Directions to act as an administrator for significant benchmarks notified by RBI. The list of benchmarks notified as significant is available here.
To promote a robust, fair, liquid, open and appropriately transparent markets, underpinned by high ethical standards and to prevent abuse in markets regulated by the Reserve Bank, the Reserve Bank of India (Prevention of Market Abuse) Directions, 2019 have been put in place, in line with the best global practices.
To promote the highest standards of governance and conduct in Over-The-Counter (OTC) interest rate, foreign exchange and credit derivatives markets, the Master Direction – Reserve Bank of India (Market-makers in OTC Derivatives) Directions, 2021 set out the regulatory framework for product suitability and user appropriateness, governance arrangements and risk management for OTC derivative transactions.

Broad Regulatory Framework and Instruments

The prudential guidelines / directions issued by the Reserve Bank under its statutory powers to eligible market participants form the broad regulatory framework for the interest rate markets, including the Government Securities market; money markets, including the market for repo in Government securities and corporate bonds; foreign exchange markets; derivatives on interest rates/prices, foreign exchange rates and credit.
Government securities market: The Government securities market, which trades securities issued by Central and State Governments, has seen significant growth in the last two decades. It has a sizeable primary and an active secondary segment. Trading predominantly takes place on the Negotiated Dealing System-Order Matching (NDS-OM), an anonymous order-matching trading platform. All the secondary market transactions in Government Securities are settled through a central counterparty mechanism under Delivery Versus Payment (DVP-III) mode operated by the Clearing Corporation of India Limited (CCIL). Multilateral netting is achieved with a single funds settlement obligation for each member for a particular settlement date. The settlement is achieved in the RTGS (Real Time Gross Settlement) Settlement/Current Account maintained by the member in the Reserve Bank.

Individuals can access the Government securities market through the RBI Retail Direct in addition to through stock exchanges or through gilt accounts with commercial banks.

A primer on the Government securities market is available here. The outstanding stock of government securities is available here.
Money Markets: The money markets include:

(i) the uncollaterised segment (call, notice and term money market) which can be accessed by banks and primary dealers, subject to prudential limits;

(ii) the collateralised segment (triparty repo, market repo and repo in corporate bonds) which are accessed by banks, primary dealers, mutual funds, insurance companies and corporates;

(iii) Commercial Paper (CP) and Non-Convertible Debenture (original maturity upto one year) – instruments with original maturity up to one year which can be issued by companies, including Non-Banking Finance Companies (NBFCs) and financial institutions; and

(iv) Certificate of Deposit (CD) – a negotiable, unsecured money market instrument with original maturity up to one year which are issued by banks.

Regulatory guidelines on each segment of the money market are available under the section Notifications on this website: Call money; repo; commercial paper and certificate of deposit.
Foreign exchange market: The Foreign Exchange Management Act, 1999 (Act 42 of 1999), better known as FEMA, 1999, provides the statutory framework for the regulation of Foreign Exchange derivative contracts. Persons resident in India and persons resident outside India can hedge their valid foreign exchange exposures, including anticipated exposures, through OTC and exchange traded currency derivatives. Persons resident in India are also permitted to hedge their commodity price risk and freight risk in overseas markets (except gold, gems and precious stones).

To enable the integration of offshore and onshore foreign exchange markets, banks in India having IFSC Business Unit (IBU) are permitted to participate in the offshore rupee non-deliverable derivative markets. Non-residents can also access onshore prices and liquidity through an alternate mechanism wherein they can deal with their overseas banker which in turn can take price from and cover with an onshore bank.
Interest Rate Derivatives: Retail users are permitted to participate in the IRD market for the purposes of hedging. Non-retail users can take part in the IRD market for the purposes of hedging or otherwise Iinterest rate swaps (IRS), forward rate agreements (FRA) and European Interest Rate Options are permitted on various benchmarks for all users /clients. Market-makers are also permitted to offer structured derivatives and swaptions to non-retail users / clients (i.e. entities with a net-worth of Rs.500 crore and above). Market-participants can also undertake transactions in exchange traded IRD products such as interest rate futures (IRF).

Non-residents can utilise Rupee IRD products for the purpose of hedging and can also access the Rupee Overnight Indexed Swap (OIS) market for the purpose of hedging and otherwise. Banks having Authorised Dealer Category-I (AD Cat-I) license under FEMA, 1999 and Stand-alone Primary Dealers (SPDs), authorized under section 10(1) of FEMA, 1999 can undertake transactions in the Foreign Currency Settled OIS (FCS-OIS) market with non-residents and other such market-makers. FPIs can also undertake transactions in IRF, subject to position limits.
Credit derivatives: Market participants are permitted to utilise single-name Credit Default Swap (CDS) contracts in the OTC segment and the stock exchanges. In the OTC markets, retail users are permitted to buy protection only for the purpose of hedging while non-retail users are permitted to buy protection for hedging or otherwise. Non-retail users such as regulated financial entities and FPIs are also permitted to sell protection.
Non-resident Investment in Debt: The investment regime for non-residents in debt has evolved to facilitate foreign investment with calibrated macro-prudential controls. Foreign Portfolio Investors (FPIs) have three routes to invest in debt:

(a) Medium Term Framework (MTF) - Introduced in October 2015, this route enables FPIs to invest in all government securities, including treasury bills, and corporate bonds within an overall limit, fixed as a percentage of the total outstanding stock of government securities and corporate bonds. Investments under this route are subject to certain macroprudential limits.

(b) Voluntary Retention Route (VRR): Introduced in March 2019, the VRR offers a combined investment limit to FPIs through which they can either invest in government or corporate debt. Investments under VRR are broadly free of macro-prudential controls but are subject to a minimum retention period of three years.

(c) Fully Accessible Route (FAR): Introduced in April 2020, this route enables non-residents to invest in certain specified government securities without any limit or macro-prudential control. The list of specified securities under the Route are available here.

The current limits for investment by non-residents in debt and their utilization are available here (government securities) and here (corporate bonds).

Market Infrastructure

Market Infrastructure: A well-designed and reliable market infrastructure contributes to both financial stability and operational efficiency in the system. It is also important for the expansion of the market, both in terms of size and depth. RBI has taken several steps to put in place an effective and efficient market infrastructure.
Electronic Trading Platforms: Electronic Trading Platforms (ETPs) are available for trading in instruments like securities, money market instruments, foreign exchange instruments, OTC derivatives in RBI regulated markets. ETPs are any electronic system, other than a recognised stock exchange, on which transactions in eligible instruments are contracted. Entities desirable of offering ETPs can seek authorisation under the Electronic Trading Platforms (Reserve Bank) Directions, 2018 dated October 05, 2018. No entity shall operate an ETP without obtaining prior authorisation of RBI under. The list of ETPs authorised by the RBI and the instruments for which they have been authorised is available here.
NDS-OM: Negotiated Dealing System – Order Matching (NDS-OM) is an anonymous screen-based order matching electronic system which facilitates participants to trade anonymously in Government securities. NDS-OM is operated by the CCIL on behalf of the RBI and is authorised as an ETP under the Electronic Trading Platforms (Reserve Bank) Directions, 2018. Select financial institutions such as banks, primary dealers, NBFCs, mutual funds and insurance companies have direct access to NDS-OM while other participants can access this system through their custodians (with whom they maintain gilt accounts). Direct participation of gilt account holders is enabled through NDS-OM web (a web-based interface which provides access to NDS-OM).

NDS-OM has facilitated price transparency and more effective price discovery in the Government securities market. Over 90% of transactions in the Government securities market are contracted over NDS-OM.
Legal Entity Identifier: The Legal Entity Identifier (LEI) code is conceived as a key measure to improve the quality and accuracy of financial data systems for better risk management post the Global Financial Crisis. LEI is a 20-digit unique code to identify parties to financial transactions worldwide. LEI system has been implemented in OTC markets for Rupee Interest Rate derivatives, foreign currency derivatives and credit derivatives in India, in a phased manner. Globally, the use of LEI has expanded beyond derivative reporting and it is being used in areas relating to banking, securities market, credit rating, market supervision, etc. In line with the global trend, the Reserve Bank has mandated implementation of the LEI system for non-derivative financial markets regulated by the Bank as well.
Trade Repositories: Trade repositories (TR) are one of the most important market infrastructure on account of their ability to make the opaque OTC derivative market transparent. RBI in its Annual Policy Statement of 2010-11, announced the setting up of Working Group to work out the modalities for an efficient, single point reporting mechanism for OTC derivatives. Based on the recommendations of the Working Group, the Clearing Corporation of India (CCIL) was designated as a Trade repository for interest rate and forex derivative transactions. In 2016, CCIL TR was given recognition under the PSS Act 2007. Currently, all OTC Derivative transactions are required to be reported to the CCIL TR.
Financial Benchmark Administrators: The robustness and reliability of financial benchmarks are critical for efficient pricing and valuation of financial instruments. In recognition of the key role played by financial benchmarks in the financial system, a Committee on Financial Benchmarks (Chairman: Shri P Vijay Bhaskar, ED, RBI) was constituted in June 2013 by the Reserve Bank of India with a mandate to study the various issues relating to financial benchmarks in India. The Committee had recommended, among other things, regulatory oversight of benchmark administrators. The International Organization of Securities Commissions (IOSCO) has also issued Principles for Financial Benchmarks in July 2013 to create an overarching framework of principles for benchmarks used in financial markets. Accordingly, to improve the governance of the benchmark processes, Financial Benchmark Administrators (Reserve Bank) Directions, 2019, were issued in June 2019. The Directions are based on the practices recommended by IOSCO in their report on Principles for Financial Benchmarks as well as in the Report of the Committee on Financial Benchmarks set up by the Reserve Bank.

Looking Ahead

Legal Framework

Financial markets play an important role in the growth and development of an economy by facilitating efficient allocation of resources and sharing of risks. Given its significance, the development of financial markets has always remained one of the key priorities of the Reserve Bank. Accordingly, the Reserve Bank has been undertaking policy reforms and regulatory policies in active coordination with Government and other stakeholders to develop safe and stable financial markets which facilitate efficient price discovery through increasing the depth and width of financial markets and provide appropriate products for trading and risk management. As part of this approach, it seeks to broad base markets by easing access, enhancing participation, facilitating innovation, protecting users and promoting fair conduct.