Forex market turmoil: Exchanges' poor communication and not RBI's circular causing losses in currency-derivatives, say sources

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Retail traders have been hastily exiting their currency-derivative positions, incurring significant losses, after brokers alerted them to an impending RBI circular just days before its implementation deadline. However, experts said that the requirement outlined in the circular is not new and has been in place since at least 2020.

The recent circular merely underscored this requirement and mandated exchanges to inform traders accordingly, they said.

The Reserve Bank of India (RBI) had sent out a circular on January 5, asking stock exchanges to inform users that they must be able to establish (if required) that they have an underlying exposure to a currency—for example as an importer or exporter—before they can trade in the currency's derivative. The circular's directive was to come into effect from April 5.

In a circular issued on April 4, the central bank said that they have extended the deadline to May 3.

Also read: USDINR derivatives' premiums shoot up, wipe out lakhs of rupees in investor capital

The January circular was followed by an uproar from various quarters claiming that the central bank has effectively killed the currency derivatives market. But legal experts and market insiders told Moneycontrol that the central bank's position on this derivative segment has not changed significantly for years, atleast when it comes to retail traders.

In the April 4 circular, the RBI stated, "it is emphasised that the regulatory framework for ETCDs has remained consistent over the years and that there is no change in the RBI’s policy approach."

The experts and insiders explained that the only additional directive in the January circular, which could impact retail traders, was that exchanges were asked to inform traders of an existing regulatory requirement.

This is where a large lapse seems to have occurred, which led to traders having to exit their positions at whatever price. Leading exchange issued circulars in this regard to brokerages only on April 1, which was just few days before the earlier deadline of April 5.

'No clarity given'

Market insiders, including traders and dealers, told Moneycontrol that there was no clear communication from the exchanges or the brokerages on this matter till few days before the deadline.

A currency dealer, who spoke on condition of anonymity to Moneycontrol, said, "We have been asking for clarity on RBI's circular since January 15 but no one from the exchanges or the brokerages told us anything definitively. They kept telling us that the regulatory requirement could be reversed or the deadline (April 5) might be extended."

The dealer said that they have been squaring off positions of their clients for the past two days.

The option premiums have been shooting up, with some option premiums even going up by 100x in a few minutes, but the dealer said that the traders have no choice but to exit at whatever price they can find.

Another trader said that some of the brokerages hinted that this directive may come into force but then assured that there will be a roll back done by RBI or by the market regulator. A broker, on condition of anonymity, seconded this. The roll back was never made. The central bank only gave an extension of the deadline, which is now May 3.

Not a new regulatory requirement

The regulatory requirement, that users have to establish contracted or anticipated currency-risk exposure, is not new. It was there even from 2020, said legal experts.

Also read: RBI consolidates norms of Currency Futures, Exchange Traded Currency Options in one direction

They pointed to an earlier communication from RBI, which was through a circular dated April 7, 2020.

"The major  difference between directives issued by RBI to the exchanges on April 7, 2020, and that on January 5, 2024, is that the exchanges have been explicitly asked to inform users (traders) of the need to establish the existence of the exposure to currency risk. That is, they have been told to inform users (traders) of this requirement only in the January 2024 circular," said Smrithi Nair, Partner at Juris Corp.

"Users had to establish the exposure even earlier (before the January circular) if asked," she added.

Jidesh Kumar, managing partner at King Stubb & Kasiva, said that the RBI circular does not clearly give a timeframe within which exchanges have to inform the traders.

Kumar said, "While the circular lacks a specific time frame for exchanges to inform users/traders about regulatory decisions, timely communication is crucial for compliance."

Legal consequences

Brokerages have responded to the RBI circular in different ways. While some have said that open positions will be squared off if the trader does not submit evidence of underlying exposure, others have offered an option of self-declaration to traders who want to hold on to their positions.

Both options may not work to traders' best interests.

While the first could mean that they get an exit at extremely high prices, the second--if it involves a false declaration--could mean legal consequences. If a trader tries to hold on to his/her positions by submitting a false declaration that there is an underlying exposure, then the trader may even find themselves in violation of Foreign Exchange Management Act (FEMA).

King Stubb & Kasiva's Kumar said, "Violations may infringe FEMA regulations, with penalties potentially reaching: a) Up to three times the sum involved in the contravention (if quantifiable); b) Up to ₹2,00,000 (if the amount is not quantifiable); c) Additional penalties for ongoing contraventions (up to ₹5,000 per day)."

Juris Corp's Nair said that, with a false declaration, traders could be asked to bear the losses or penalty a broker incurs from this mispresentation.

"If users give a false declaration to brokers saying that they have an underlying exposure, and use this declaration to hold on to their positions and avoid brokers forcibly squaring off their positions, then such users can be held liable for any penalty or loss that the broker has to bear because of regulatory action. That is, if there is penalty levied on the broker because the user is holding positions contrary to RBI directions, the brokers may pass on that penalty to the user," she said.