On 21 February 2025, the Reserve Bank of India (“RBI”) issued directions to permit bond forwards in government securities by way of the Reserve Bank of India (Forward Contracts in Government Securities) Directions, 2025^[1] (“Bond Forward Directions”). The Bond Forward Directions will come into effect from 2 May 2025.

Background

Pursuant to a notification in 2010 (“2010 Notification”),^[2] the RBI had prohibited all forms of sale and purchase contracts in government securities other than (i) spot delivery contracts; and (ii) contracts traded on recognized stock exchanges.

Based on suggestions received from market participants to introduce bond forwards in government securities, the RBI had issued draft directions on bond forwards in December 2023^[3] and sought public feedback.

The RBI has now permitted bond forwards in government securities through the Bond Forward Directions, and has also modified the 2010 Notification to permit all forms of sale and purchase contracts in government securities that are approved by the RBI from time to time.

Snapshot of the Bond Forward Directions 

Bond Forward	A rupee interest rate derivative contract in which one counterparty (buyer) agrees to buy a specific government security from another counterparty (seller) on a specified future date and at a price determined at the time of the contract
Eligible Market Makers	Scheduled commercial banks (except small finance banks, payment banks, local area banks and regional rural banks) Standalone primary dealers
Eligible Users	Resident Users Entities regulated by the RBI Insurance companies Mutual funds, pensions funds and other collective investment vehicles All India Financial Institutions viz., Exim Bank, NABARD, NHB and Small Industries Development Bank of India Companies/entities with net-worth of ₹500 crore or above   Non-resident Users All non-residents (other than individuals) who are eligible to invest in government securities in India (which would include foreign portfolio investors)
Position and Limits	Market Makers Long positions without any limit Short positions (both covered[4] and uncovered[5]; uncovered short positions can only be undertaken by market makers that are permitted to do so under the Short Sale (Reserve Bank) Directions, 2018[6]) Users Resident Users (i) Long positions without any limit, and (ii) covered short positions only for the purpose of hedging   Non-resident Users Covered short positions only for the purpose of hedging   A user (either resident or non-resident) cannot undertake uncovered short positions. A user with a covered short position must exit the short position bond forward when it stops holding the underlying government security
Settlement and Unwinding	Can be physically settled or cash settled Physical settlement will be through Clearing Corporation of India Limited (“CCIL”) or any other agency or clearing arrangement approved by the RBI Cash settlement can be done on the basis of bilateral terms or any clearing arrangement approved by the RBI
Settlement Basis and Market Conventions	To be specified by the Fixed Income Money Market and Derivatives Association of India (“FIMMDA”) in consultation with market participants
Documentation	As prescribed by FIMMDA or a standard master agreement (i.e., ISDA Master Agreement)
Reporting	Market Makers Market makers must report all bond forward transactions undertaken during the day to CCIL Reporting to include details of counterparties, the underlying government security, settlement type (cash settled or physically settled) and whether a short position is a covered or an uncovered short position   Users Users (themselves, or through a market maker or CCIL clearing member) will be required to report bond forward trades to CCIL only when such trades are to be settled through CCIL
Margining	Mandatory exchange of initial margin and variation margin for non-centrally cleared bond forwards in accordance with the Master Direction – Reserve Bank of India (Margining for Non-Centrally Cleared OTC Derivatives) Directions, 2024[7]
Use of Government Securities – Short Positions	Government securities held to cover short positions can be: used in a repo transaction by eligible participants lent/placed as collateral under a government securities lending transaction by eligible market participants reckoned for statutory liquidity ratio for eligible government securities
Compliance with other Directions	Market makers Market makers will be required to comply with the Master Direction – Reserve Bank of India (Market-makers in OTC Derivatives) Directions, 2021[8] and the Reserve Bank of India (Prevention of Market Abuse) Directions, 2019[9] (“Market Abuse Directions”)   Users Users will be required to comply with the Market Abuse Directions Users that are regulated entities will also be required to ensure compliance with the directions and guidelines issued by their regulator

 Points to note: 

• Bond forwards have been permitted in government securities other than treasury bills.
• Non-resident users (including foreign portfolio investors) can undertake covered short positions in bond forwards for hedging purposes but cannot undertake long positions in bond forwards.
• The Bond Forward Directions permit entities regulated by different regulators in India to enter into bond forwards, but such entities will have to evaluate if they can enter into bonds forwards under their governing regulations and directions since some regulations and directions list out specific permitted products. 

Authors: Rahul Gulati – Partner: Ritika Singal – Managing Associate and Dwiti Goyal – Associate

Footnotes: 

^[1] Copy available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12784&Mode=0

² The 2010 Notification was issued by the RBI under Section 16 of the Securities Contracts (Regulation) Act, 1956 (“SCRA”). Section 16 of the SCRA empowers the Central Government to, by notification in the Official Gazette, declare that no person in the state or area specified in the notification shall, save with the permission of the Central Government, enter into any contract for the sale or purchase of any security specified in the notification except to the extent and in the manner, if any, specified in the notification. By a notification dated 1 March 2000, the Central Government had stated that powers of the Central Government under Section 16 of the SCRA can also be exercised by the RBI in respect of among other things, government securities.

  The 2010 Notification was issued on 8 January 2010 and notified in the Official Gazette on 8 September 2010.

³ Copy available at: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=57007

⁴ Covered short position means a position in bond forwards in which the seller of the forward contract holds an equivalent amount of the government security underlying the position.

⁵  Uncovered short position means a short position in a bond forward other than a covered short position.

    Uncovered short position is permitted only in respect of those government securities which are eligible for short sale under the RBI directions on short sale (i.e., Short Sale (Reserve Bank) Directions, 2018). Such uncovered short positions are reckoned in the security level limits on short sales and cannot remain uncovered for a period exceeding the maximum period specified for short sale in the Short Sale (Reserve Bank) Directions, 2018.

⁶  Copy available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11346&Mode=0#NT

⁷ Copy available at https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12682

⁸ Copy available at: https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12163

⁹ Copy available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11500&Mode=0

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