Currency derivative positions without exposure risk regulatory rap, but is there any escape hatch?

Lying on the self-declaration given to brokerages, to hold on to currency positions, could land the trader with a penalty or liable for any financial loss caused to the broker from the misrepresentation.

Commenting on RBI's directive on currency derivatives, market participant Deepak Shenoy who runs a PMS service posted on social media platform X that exchanges should leave the compliance worry “to the end of investors”, and hoped that they reverse the freeze on traders' currency-derivatives' positions.

The central bank is saying that traders do not need to demonstrate exposure upto $100 million, and exchanges should take note of this and reverse the freezing of traders' currency-derivatives' positions and leave compliance worries to investors, Deepak Shenoy, founder and CEO of Capital Mind PMS posted.

There is "very small but non-zero odd chance” that the Enforcement Directorate (ED) would investigate them, Shenoy added, commenting on RBI's directive to exchanges to inform users that they cannot trade in currency derivatives if they do not have an underlying exposure.

Also read: Exchanges' poor communication and not RBI's circular causing losses in currency-derivatives, say sources

While this view is being shared by many, traders should be warned that there are legal consequences to taking positions if they have no contracted exposure.

Risk of FEMA Violation

Legal experts Moneycontrol spoke to earlier said that if traders take such positions, that are not in compliance with the central bank's directives, then they could even be found in violation of Foreign Exchange Management Act (FEMA).

Shenoy tweeted, "Apparently the RBI is saying, thankfully with an explanation that upto $100m traders can trade the USD INR without any need for demonstrating underlying exposure. Hope the exchanges take note and reverse their freeze process."

He added, "What RBI now says is listen upto 100m USD is fine, you don't have to demonstrate this."

Investors should know that if they speculate using currency derivatives "there is the very small but non zero odd chance the ED (enforcement directorate) will ask them, where is exposure", Shenoy added.

While the odds of being investigated by the ED may be small, traders should know that if they are investigated and found in violation of RBI's directive, the consequences are likely to be severe.

In an earlier interaction with Moneycontrol, Jidesh Kumar, managing partner at King Stubb & Kasiva, said that holding onto currency derivatives positions in contravention to the RBI directive can cause the trader to be in violation of FEMA.

"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)," Jidesh Kumar said.

Chance of Penalty

Some brokerages are allowing users to hold on to their positions by giving self-declaration that there is an underlying exposure. But if this self-declaration is a misrepresentation of facts--that is, the trader lies about having underlying contracted exposure--then the trader could find himself/herself facing another kind of financial liability.

Also read: 'It didn't come late, it came very, very late:' Currency traders on RBI extension of FX derivatives deadline

Smrithi Nair, Partner at Juris Corp said, "If users give a false declaration to brokers saying 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."

During the post-MPC interaction with journalists, RBI Deputy Governor Michael Patra clarified on the matter that has been a raging debate among currency market participants. Patra reiterated that the RBI policy on forex risk management has been consistent and there has been no change. The Exchange Traded Currency Derivatives (ETCDs) were meant only for hedging, Patra added, and RBI had only provided a relaxation from providing proof of the underlying. Some participants have been misusing this, and the relaxation does not imply that no underlying was needed.