RBI Releases Final Norms On Hedging Commodity Price Risks Abroad

The Reserve Bank of India today tightened guidelines for hedging commodity price risks and freight risks in overseas markets, which will come into effect next financial year, by limiting the tenor of all bank instruments in trade finance areas.

Accordingly, a central bank circular said, “banks can issue standby letters of credit (SBLCs)/guarantees, for a maximum period of one year, in lieu of making a remittance of margin money for commodity hedging transactions. Banks should ensure that these SBLCs/guarantees are used by their clients for the intended purposes only”.

The guidelines come within a month of the nation’s largest banking fraud coming out in the open involving such instruments issued by a Punjab National Bank branch in the megapolis to diamond trader Nirav Mod and his uncle Mehul Choksi, and their companies during the past many years by getting letters of undertaking without proper records or guarantees.

The Rs 12,700-crore PNB scam, allegedly perpetrated by Modi and Choksi in collusion with a few officials of a branch of the state-run bank came to light last month, wherein the duo is alleged to have used a key loophole in the international trade finance front (SWIFT) to defraud the bank.

The duo allegedly got letters of undertaking from the Brady House branch of PNB without having the required securities and also proper trades records for many years.

With the new guidelines coming into force, all the previous circulars stand withdrawn from April 1, 2018, the Financial Markets Regulation Department of the central bank said in the circular.

It can be noted that the central bank had earlier constituted a working group under the chairmanship of Chandan Sinha to review the existing guidelines on the matter. The report was shared with all stakeholders on Jan. 12, 2018.

Hedging means undertaking a derivative transaction to reduce identifiable and measurable risks which could be a direct or an indirect exposure.

Eligible commodities whose price risks may be hedged include all commodities, except gold, gems and precious stones in case of direct exposure, and in regard to indirect exposures, whose price risks could be hedged include aluminum, copper, lead, zinc, nickel, and tin.

Also Read: New RBI Committee To Look Into Divergences, Frauds, Bank Audits

The quantity proposed to be hedged and the tenor of hedging are in line with the exposure. In case of OTC derivatives, the requirement to undertake OTC hedges is justified. In case of hedging using a benchmark price other than that of the commodity exposed to, the requirement to undertake such hedges is also justified, RBI said.

OTC contracts shall be booked with a bank or with non-bank entities which are permitted to offer such derivatives by their regulators.

Structured products may be permitted to eligible entities who are listed on recognised domestic stock exchanges or fully owned subsidiaries of such entities or unlisted entities whose networth is over Rs 200 crore, subject to the condition that such products are used for hedging as defined under these directions.

“All payments/receipts related to hedging of exposure to commodity price risks and freight risks shall be routed through a special account with the bank for this purpose,” RBI said, adding banks shall keep on full details of all hedge transactions and related remittances made by the entity.

The new rules also entail banks to obtain an annual certificate from the statutory auditors of the entity to ensure that the hedging and the margin remittances are in line with the exposure.

Banks shall undertake immediate corrective action in case of any irregularity or misuse of these directions and any breach should be reported to the RBI.

Also Read: PNB Fraud: Understanding The Deceptively Low Risk World Of Buyer’s Credit