RBI's new forex norms 'liberal': Experts

Kotak Mahindra BSE | NSE 30/05/12 Are Mutual Funds betting on Kotak Mahindra? Other Stocks in this news Mahindra and Mahindra |

The Reserve Bank of India (RBI) has announced draft rules for foreign exchange (forex) derivatives. The new rules are ushered in a whole new world. However, some say that it is the old world back again. The forex derivatives disaster of 2008 has pulled down the corporate balance sheets of even robust companies like Wockhardt. This led to a slew of companies dragging banks to court for miss-selling derivatives.

The majority opinion from bankers, corporates and RBI insiders is that the RBI has been liberal enough to take a step forward by allowing corporates to write options at a time when the world is so much pitted against allowing corporates.

Here is a verbatim transcript of an exclusive interview with AV Rajwade and K Chandrashekar on CNBC-TV18. Also watch the accompanying video.

Q: Would you say that by granting the right to write or sell options to companies, RBI has taken a step forward? Have they taken enough steps to ensure that this liberal reform is not misused?

Rajwade: I have question marks about whether this is the appropriate time to give a liberal twist to reform in the derivative market. They are all seeing what has happened globally in terms of deregulation on derivative market and how the bank themselves did not understand what they were doing the kind of losses that got incurred. We also have many cases in India of major losses being sustained through derivatives. Timing wise, one is not very happy about the liberalize currency derivatives. I don't think that the documentary requirement per se provided a balance against risk of writing options.

I my opinion, writing an option can never hedge an exposure. In fact, AS 30, the accounting standard 30, which is corresponding to IAS 39, explicitly says that a written option cannot be a hedge of any kind except under very limited circumstances. If I assume that liberalization was the objective, then we should not be using the word hedge at all. We should throw open whole thing to whatever the companies want to do.

However, if the idea is to limit the use of derivatives for hedging, then the writing option does not fall even if they are covered by commercial receipts of payments. They do not fall in the category of hedge as defined under standard text books or reference books. They have some special provisions for Small and Medium Enterprises (SMEs). In relation to this particular issue, the word used in draft guidelines, is that SMEs can use derivatives for managing exposures. Managing exposures definitely has a different connotation from hedging exposures. SMEs which are relatively unsophisticated, should they have less regulation than other larger industries? I have a serious question mark on that particular point.

Q: How will you react to this that enough mess has been created even when corporates has only limited freedom to set options? Why should the companies be given this right and ask for more trouble?

Chandrasekhar: Option writing, on the part of companies, is a new thing which has been introduced. It has been discussed for sometime. According to me, it is a good step. I would not say that it is in the nature of speculative or something. I would rather say that it is an experience that companies would get in terms of understanding the market. RBI has allowed it with a lot of ring fencing. You have to have an actual underlying and you can't offer zero cost structures. Therefore, you are clearly doing something on the underlying and it is clearly done to risk mitigate. To that extent, dealt in options market on the buying side and writing options is a step forward.

Q: The other part which has drawn a lot of flak is the excessive documentation which is required. There are some who believe that if all the paper work is done, the price at which a forward contract has been agreed to by the company. The bank will just pass and contracts cannot be done. Would you agree to this?

Chandrasekhar: The aim of the RBI is to create a solid Standard Operating Procedure (SOP), which is understandable in the current context of various kinds of miss-selling and other kinds of things that could go on. Therefore, the intention is correct and the documentation could have been made more convenient for all the people to follow because it is very important to have a convenient system of operation also. So in excessive documentation you should not forget you want to do something good and something to deepen the market in order to create liquidity in the market. There could be a much better way of addressing this issue of documentation.

Q: Do you think documentation requirements are so huge that forward premium or prices may change even before the paper work is completed?

Rajwade: I would agree that the documentation requirements are too onerous, but not necessarily on the grounds which you argue. Companies are not trading in currencies. So it is not as if every moment's change is going to make a difference to them. Hence, I don't think that it is the crux of matter. The crux of issue is whether any regulation should be principle based or rules based.

According to me, it is a sort of conflict between the administrative cultures in different countries. The Americans are famous for rule based regulations. The British historically was more principle based. Now they are moving towards the American style. My own bias is towards principle based regulations to many detailed rules, in regard to documentation, copies, recording, etc. because there is no way the central bank is going to be able to verify whether all these things are being implemented or not. So I would prefer a much more principle based regulation than rules based highly documentation oriented regulatory culture.

Q: Do you accept that the conditions introduced will restrict the misuse of this option writer? You know that the companies must follow higher accounting standards, that there must be a declaration from the statutory auditor about the extent of exposure and authorization by the board. Are all these caveats not enough?
Rajwade: I have a slight difference of opinion in it. The existing documentary requirements are not that really less onerous. If you go through the master circular, they are not that less onerous, and many of them have never been implemented. Adding some more documentation, which would also not be implemented, I don't think it is going to carry us much further in any case.

Q: There seems to be a Catch-22 in the rules. Only companies complying with the AS30 and AS32 rules will be allowed to write options. However, some of these accounting standards do not recognize these options as hedges.

Chandrasekhar: According to me, those who carry options on their books, for example M&M, follow AS30. According to experts it is covered. There are two kinds of opinions on that. So whether it directly of indirectly refers to it, there are two opinions. There are enough ways of addressing the issue. That should not be a reason to stop this. Companies that are following AS30 may not immediately be following AS32 that is the disclosure and other things. We should welcome anything that is done as progress to something better.

Q: What would you advice if you have to give feedback to these rules?

Rajwade: I have never believed that following the American pattern, is necessarily a reform. Reform to my mind means change. Change does not mean either opening your capital account to everybody or following a more deregulatory approach as the Americans have always done. Considering the no of cases that have taken place in India about disputes and huge losses on currency derivatives there is a case for tightening the rules and not for liberalizing them.

Q: Don't you think the new rules are doing that?

Rajwade: I don't think the new rules are doing that. They have banned complex structures and banned zero cost structures. However, writing of options which they have opened up and giving room for SMEs to do speculative activity and calling it managing rather than hedging are major negatives for me.