The most recent regulation on currency derivatives trades from the Reserve Bank of India (RBI), which goes into effect on April 5, could affect exchange liquidity because users won’t be able to meet the underlying exposure criteria, according to analysts.
Statement by RBI
Users should make sure that there is a legitimate underlying contracted exposure that hasn’t been hedged using another derivative contract, and they should be able to prove it if necessary, according to a January 5 circular from the central bank.
What are the underlying elements stated in the derivatives contracts?
When we talk of underlying in derivatives contracts, we mean the order bill or receipt for exporters or importers, or the supporting documentation for remittances.
“Importers or exporters should have a receipt or payment of USD, EUR, etc,” Dilip Parmar, a foreign exchange analyst at HDFC Securities, stated.
Conventional Trend
“The exchange traded derivative volume is going to dip by nearly 80 percent as most of the volumes are coming from proprietary desk and retail which hardly have any underlying exposure,” Parmar at HDFC Securities added.
According to the NSE’s Market Pulse report released in March, the Average Daily Turnover (ADT) in currency futures dramatically decreased from the average recorded during FY23 and FY24 (April 2023 to February 2024), reaching a 29-month low of Rs 23,200 crore (-20.5 percent MoM) in February 2024.
RBI’s January 5 circular, simplified
According to the RBI circular from January 5, a user can enter into positions (long or short) without proving that there is underlying exposure, with a maximum of $100 million equivalent across all currency pairs involving the rupee, combined, and transacted across all authorized stock exchanges.
However, as stated in the paper, the central bank mandated that recognized stock exchanges guarantee the presence of a legitimate contracted exposure that hasn’t been hedged with another derivative contract.
“Most of the brokers have informed the changes to their clients and told them to comply with the RBI mandate. They also informed to square off position without underlying exposure to respective clients before April 5,” Parmar mentioned.
According to money market specialists, the majority of brokers have advised their clients to square off positions without underlying before to the circular’s introduction and have instructed them to abide by the RBI’s requirements.
