ADVERTISEMENT

Access To Complex Forex Derivatives May Return For Large Firms

RBI may permit ‘non-retail’ clients to use so-called ‘exotic forex derivative’ products if its draft guidelines are finalised.  

Indian fifty and ten rupee banknotes are arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg) 
Indian fifty and ten rupee banknotes are arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg) 

If a set of draft guidelines proposed by the Reserve Bank of India in February are finalised, larger firms could once again get access to complex foreign exchange derivatives. Such products were banned in 2008 after incidents of rampant mis-selling came to light and a number of firms found themselves staring at losses related to such products.

More than a decade later, the RBI is considering bringing back such complex foreign exchange derivatives. The news was first reported by Economic Times on Wednesday morning.

In draft guidelines issued on Feb. 14, 2019, the RBI proposed the creation of two sets of users: retail and non-retail. The later category would include:

  • Companies with a net worth of Rs 200 crores or equivalent
  • Companies with outstanding foreign exchange derivatives exceeding $250 million
  • Insurance companies, mutual funds, pension funds and entities regulated by RBI
  • Foreign banks, foreign institutions whose main activity is to invest /transact in financial instruments

The guidelines go on to say that for such non-retail users, the set of eligible products will be wider than for retail users.

Eligible products for non-retail users include—any derivative contract, which the authorised dealer can price and value independently and is approved by the board of the authorised dealer, provided that the same is not a leveraged derivative.

For retail users, though, the suite of products remains restricted to plain vanilla derivative products. These include: forwards, purchase of call and put options, purchase of call and put spreads and swaps.

“All derivative contracts shall be subject to the Suitability and Appropriateness policy of the circular on Comprehensive Guidelines on Derivatives,” the RBI said in its draft guidelines.

According to a person familiar with the discussions, who spoke on condition of anonymity, the RBI has sought feedback from market participants on these guidelines, which has led to conversations around how such products would work in the current environment.

One feedback given is that the net-worth requirement of Rs 200 crore is quite low, which could expose even smaller companies to risks inherent in complex derivatives, said a market participant familiar with the discussions. This person, however, added that the risk of mis-selling may be lower in today’s environment since banks have to deal with an increased burden of ‘capital charges’ in the post global-financial crisis world.

Banking regulations have been tightened since the 2008-09 period and most global banks are subject to far greater scrutiny now.

The final guidelines on the subject may be issued in the next few months since the RBI had sought feedback from market participants by March 15.

The Dodgy Past

Complex forex derivatives have a dodgy past not just in India but across many emerging markets.

In a June 2009 paper, the IMF had said that many firms in emerging markets had been drawn into such transactions, which eventually caused losses. “An estimated 50,000 firms in the emerging market world have been affected,” the IMF said in its paper. Countries impacted had included Indonesia, India, Brazil, among others.

In the aftermath of the losses, the Reserve Bank of India banned such complex products and told banks that they should only sell simple rupee-dollar derivative products. It later allowed cross-currency derivatives linked to the Euro, Pound Sterling and Yen.

A number of banks were fined for mis-selling of complex derivatives as well. Penalties had been imposed on 19 banks, including large foreign and domestic lenders like Citibank and HDFC Bank Ltd., among others.