RBI defers exchange traded currency derivatives norms to May 3

In January this year, the RBI released a new framework for hedging of foreign exchange risks, which was to be implemented from April 5, 2024. The new norm allowed users to take positions (long or short) in foreign exchange derivatives market, without having to establish existence of underlying exposure, up to a single limit of $100 million equivalent across all currency pairs involving the rupee, put together, and combined across all recognized stock exchanges.

However, the regulator asked stock exchanges to inform users that while they are not required to establish the existence of underlying exposure, they must ensure the existence of a valid underlying contracted exposure which has not been hedged using any other derivative contract and should be in a position to establish the same when required.

On Thursday, the RBI said the regulatory framework for participation in ETCDs involving the rupee (INR) is guided by the provisions of the Foreign Exchange Management Act (FEMA), 1999 and regulations framed thereunder which mandate that currency derivative contracts involving the rupee – both over-the-counter (OTC) and exchange traded – are permitted only for the purpose of hedging of exposure to foreign exchange rate risks.

The regulatory framework has been reiterated in the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, which states that a person may enter into an ETCD contract involving the rupee only for the purpose of hedging a contracted exposure.

For the purpose of ease of doing business, the RBI permitted users of ETCDs to take positions up to $ 10 million per exchange without having to provide documentary evidence to establish the underlying exposure but did not provide any exemption from the requirement of having the exposure, the release said.

“Accordingly, users are expected to ensure compliance with the requirement of having underlying exposure,” the regulator said. The limit of $10 million per exchange was subsequently amended and currently stands at a single limit of $100 million combined across all exchanges.

The RBI said its January 5, 2024 master direction reiterates the regulatory framework for participation in ETCDs involving the rupee without any change. “As hitherto, participants with a valid underlying contracted exposure can continue to enter into ETCDs involving the rupee up to a limit of $100 million without having to produce documentary evidence of the underlying exposure,” the release said.

In order to comply with the RBI’s April 5 deadline, foreign exchange brokers asked their clients to close their derivative positions before the stipulated time period to meet the regulatory norms.

In a run up to this deadline, the forex market saw an increase in volatility. On Wednesday, the rupee closed at a record low of 83.44 against the US dollar. The domestic currency ended flat on Thursday.

According to a forex market broker the new norms did not give any clarity. “Every broker has their own set of guidelines which they are communicating to clients and the clients are confused. The entire forex derivative market has become illiquid,” he said.

The new rules would impact brokers who are providing forex derivative contracts to clients.

According to some market participants, the RBI new rules will reduce the speculators from the market. “The new guidelines on hedging of foreign exchange risk will reduce the speculated activity and the number of players on the currency exchanges. It may lead to dry up of liquidity in the currency pairs on the exchanges. However, the market continues to be available for the players having the valid contracted exposure within the $100 million limit. For genuine hedgers, there will be no impact,” said V R C Reddy, Head Treasury, Karur Vysya Bank.