ITBs: A Risk-Free Debt Instrument as Market Benchmark

Benchmarks can provide a valuable share when they are used appropriately in markets.

For instance, a benchmark may be useful to manage financial risks efficiently as a hedging tool for other risky investments.

Financial system’s core functions of valuation, capital allocation and risk are mostly aligned with benchmarks. The impact of benchmarks is tremendous on credit products such as loans, mortgages, structured products, short-term money market instruments, fixed income products and derivatives.

Iran has been relying solely on money market rates as Interbank Offered Rates, which do not entirely match the function of a benchmark since it is dealt in less transparent lending markets and its long-term sustainability by banking system and financial institutions is a matter of concern.

Islamic Treasury Bills, launched about two years ago as debt instruments issued by the government of Iran and guaranteed by the Department of Treasury, would be a suitable runner to gradually become an appropriate benchmark vehicle. Such a guarantee by treasury on principal repayment without any other internal or external factor interference would create risk-free borrowing/lending function among users.

Despite controversies surrounding the utility of such debt instruments for the Iranian government, the ITB is widely viewed as a constructive benchmark for domestic Iranian financial and money markets.

Considering a benchmark and its establishment in the market, two overarching aspects of appropriateness and contingency planning would lead to market reliance on such benchmarks. In this case, ITBs hold the potential of having both attributes with a progressive trend.

Features for market users on appropriateness of a benchmark include determination of size, liquidity, potential evolution of a market that is being measured by a benchmark, transparent methodology of measurements, how prices, rates, index or value of benchmark can be effected by several factors and not only by a solo factor or a decision, dissemination, fair provisions of cessation with transparent circumstances and not through traditional formats.

There could be more measures on how to evaluate the appropriateness of a benchmark which ITB in Iran and other risk-free rate benchmarks in the world could be compared with IBORs. Such an assessment by market users are not only limited to the initial selection of a benchmark, but subjected periodically on an ongoing basis as circumstances indicate.

Cessation or change of a benchmark in a market would create absolute uncertainty for contracts, instruments and in cases makes them invalid, causing loss and adverse impact to market functioning and stability. Market and users should, therefore, consider their contingency plans on cessation or changes to moderate risks.

Islamic Treasury Bills have maturity dates that could provide accurate contingency for market and investors to hedge future risks or dynamic fallback provisions with considerations of other factors of macroeconomic elements. Such provisions could help users safeguard the continuity as a result.

Notwithstanding the above, complementing IBORs with a series of suitable alternatives where a close proxy could be available to normalize the uncertainty and disruption for domestic market participation, creating adequate confidence for the long term, would benefit financial soundness and stability of a dynamic market.

Investment requires such alternatives or provisions in any economy that may want to have inbound or outbound factor movements.

Islamic Treasury Bills are significantly contributing to Iran’s economy and could be a dominant factor for attracting solid infrastructural foreign investments that could ultimately lead to economic prosperity.