The banks would need to timestamp the rates quoted to retail users to ensure transparency.
- Abhishek Goenka
The RBI came out with the much-anticipated guidelines on exotic derivatives this week. The circular differentiates between retail and non-retail users. The eligible products for a retail user are forwards, purchase of Plain Vanilla calls and Puts, Purchase of Call spreads and Put spreads and swaps. The banks would need to timestamp the rates quoted to retail users to ensure transparency. Also in the case of derivatives, the mid-market mark would have to be disclosed to the client and the same shall have to be mentioned in the term sheet as well. This would help the client get a sense of the markup or spread that the bank is charging.
Non-retail users with a net worth above Rs 500 crore are permitted to enter into exotic derivatives. Exotic derivatives include barriers, digitals, touches, etc. The exotic derivatives permissible are ones in which the loss under any scenario would not be greater than if the underlying exposure had been left unhedged. This implies that leveraged derivatives are not permitted. For example, an exporter buying one put of strike 76 and selling two calls of 80 strike shall not be permitted. However, A buy put at 76 with a European sell call at 80 with a barrier level of 82 which gets knocked out if USDINR is above 82 at maturity would be permitted.
The non-retail Corporates have been allowed to swap rupee liabilities into Foreign currency liabilities. Contracts booked under past performance or probable exposure seems to have been replaced by those booked on the basis of anticipated exposure. The gain if any on cancellation of such contracts shall be passed on to the user only when the anticipated cash flow materializes (except under genuinely exceptional circumstances, when the reason for cash flow isn’t materializing and is beyond the control of the user). Clarification needs to be sought as to the limits that would be available for booking derivative contracts based on anticipated exposure.
Banks have been permitted to let users’ book derivative contracts up to USD 10 mn equivalent without having to establish the existence of underlying exposure. Access to exotic derivatives is likely to give corporates flexibility to better manage FX risk. The primary intent at this point, however, seems to be to give FPIs access to a range of derivative products onshore which currently they have access to only in the offshore market. The introduction of exotic derivatives is yet another step taken by the RBI towards its goal of moving offshore volume onshore. It would also act as a facilitator in the quest for inclusion in a global bond index.
Abhishek Goenka is Founder & CEO of IFA Global. Views expressed are the author’s personal.