Short positions in G-Secs on cards to improve liquidity

It also laid down a detailed framework for trading in “when-issued” securities, which are bonds that have been announced by the government but have not yet been issued.

Market participants are required to send their inputs by July 17.

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) will be allowed to take both long and short positions of up to 25% of the notified auction amount, while all other eligible participants will be subject to a 10% limit, the draft proposal said.

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“This would establish a market-clearing price before the bond even enters circulation,” a bond trader at a PD said. “More active when-issued trading could also reduce uncertainty around auction outcomes and improve secondary market liquidity once the bonds begin trading.”
For other, illiquid government bonds, the limit for short positions has been set at 1% of the outstanding stock or ₹250 crore, whichever is higher, the draft said.Short selling allows traders to sell bonds they do not currently own, with the expectation of buying them back later at a lower price.

The RBI has stipulated that such positions must be covered within three months through outright purchases in the secondary market, primary auctions or the when-issued market.

Clearer limits on position and operational guidelines could improve liquidity and price discovery in government securities, by allowing traders and primary dealers to express views on interest rates more efficiently, market participants said.

The draft directions also lay down a detailed framework for trading in “when-issued” securities. RBI announces bonds on a Monday, while the auction is held on a Friday.