No change in policy, some 'misusing' currency derivatives norms: RBI

Justifying the recent norms on exchange-traded currency derivatives, the Reserve Bank of India Deputy Governor Michael Patra said that the relaxation in documentary evidence requirements is being misused by some market participants as implying a lack of underlying exposure, which is incorrect and constitutes a violation.

He said that the RBI's policy on foreign exchange risk management has stayed consistent in recent years, maintaining an unchanged approach. In 2008, when exchange-traded currency derivatives (ETCDs) debuted, they functioned under the Foreign Exchange Management Act. FEMA regulations explicitly outlined that ETCDs are designed exclusively for hedging purposes, indicating the imperative of having an underlying exposure.

 

“In 2014, the RBI aimed to facilitate ease of doing business by providing a relaxation. While underlying exposure is still required, for exposures up to 10 million, documentary evidence is not mandatory. Since then, over the next few years, that limit was raised to 100 million just to provide an incentive for market turnover and to expand the size of the market. But the main point is that it is only for hedging, and underlying exposure is a mandatory requirement,” said Patra. “The January 5, 2024, circular was issued in pursuance of a commitment made in the monetary policy statement of December 2023, in which we stated that there are various stipulations scattered throughout. We will consolidate them into a master direction, and the January 24 circular served as such. It simply reiterated what has been in place since 2014, so there was no change in that. Now, some market participants have been misinterpreting this to mean that a relaxation in documentary evidence is equivalent to having no underlying exposure, which is not the case. And that constitutes a violation of the law,” he added.

The Reserve Bank of India (RBI) on Thursday deferred the implementation of norms on exchange-traded currency derivatives (ETCDs) linked to the Indian rupee until May 3, following concerns by investors. The norms were scheduled to take effect starting Friday. Now, rupee-denominated currency contracts traded on the National Stock Exchange (NSE) and the BSE require underlying exposure. Though traders are not required to provide evidence of underlying exposure for positions up to $100 million, they must confirm the existence of such exposure.

Supplementing Deputy Governor Patra, RBI Governor Shaktikanta Das reiterated that there have been no changes to RBI's policy, emphasising that the necessity of underlying exposure has always been a fundamental aspect. He clarified that the reasons behind the issuance of recent circulars and the extension of implementation deadlines were in response to market feedback and requests for more time.

“There is no change pursuant to yesterday's (Thursday) circular or even earlier. There has been no change in RBI's policy. This policy of needing to have an underlying has always been a part of RBI's policy for the last so many years, so there was no change. And this is something that every market player knew. You cannot say that this is something new. If you read the circulars, past circulars very carefully, it has always been there. So, therefore, if somebody says it is new, it is not correct,” he said.

Transactions in currency futures were primarily driven by the retail segment who couldn't transact in OTC markets because banks demanded proof of underlying exposure, which they didn’t have. These retail trades accounted for more than 50 per cent of total transactions and contributed significantly to liquidity in exchange-traded currency futures.

“Majority markets require both segments of participants, the commercials and non-commercials. Even in the overseas market, there is a huge chunk of non-commercials,” said Hitesh Jain, strategist, institutional equities research, YES Securities India. “I really can't really read too much what the RBI members are trying to convey, but I can say there is a need for both segments of the market,” he added.

There was significant volatility in the rupee’s exchange-traded derivatives in the current week as brokers advised their clients to either unwind positions or provide evidence of underlying forex exposure.

“In the earlier regulation, as DG Patra has said, that provision was there, but there was no cut-off date,” said Ritesh Bhansali, vice-president at Mecklai Financial Services. “The RBI wanted to ensure there was no excess speculation and they came up with the cut-off date,” he added.