FOREIGN CURRENCY DERIVATIVES – RBI REGULATIONS A REVIEW

Reserve Bank of India (RBI) has recently brought out draft comprehensive guidelines on derivatives. The guidelines cover derivatives Over The Counter (OTC) i.e derivatives offered by banks and counter parties in respect of foreign exchange. The guidelines also cover foreign currency derivatives transacted through recognized stock exchanges. A close scrutiny of these guidelines is important to ensure safety of Indian Business as well as banking sector from massive foreign exchange risk which may arise otherwise. The RBI guidelines permit users (Indian Businesses) and market makers (Banks and Primary Dealers) to undertake only specific transaction. The guidelines prohibit "zero cost options" to be contracted by the users and permit only vanilla (single leg) options to be purchased/sold (written) by the Indian Businesses. The transactions can be undertaken only against an underlying exposure. In case of OTC derivatives, Indian market has witnessed reverse complaints and large number of court cases in last two years, arising out of extraordinary huge losses which
option writing brought in case of large number of exporters. The banks also suffered losses arising out of counter party risk and litigation. It is important to consider restricting Indian Business to write options even in case of underlying exposure, being coupled with unlimited risk. The underlying exposure may be illusory or may not materialize/fail in cae of extreme/deep exchange rate movement. The Indian Companies insisting on this facility should be having large net worth (deep pockets) and proper risk management team in place. This facility can be allowed only subject to

• Value at risk margin to be deposited with an independent bank or closely corporation and
• Daily/weekly mark to market margin collection system in place.