A clutch of forex trading experts Moneycontrol spoke to on April 18 said the recent circular by the Reserve Bank of India (RBI) on the currency derivatives market could have been triggered by rising instances of rule violations by participants due to lack of clarity. The circular had triggered a major sell-off.
The RBI on January 5 said investors must ensure the existence of a valid underlying contracted exposure which has not been hedged using any other derivative contract, and they should be in a position to establish the same if required.
The initial implementation date of the RBI circular was April 5, which was later extended to May 3, after some concerns were raised about participation in the exchange-traded currency derivatives (ETCD) market.
Misunderstanding of norms?
“Possibly, some players have mis-utilised the ETCD market as indicated by the RBI governor, which is the reason for banning the participants not having underlying assets,” said Anil Kumar Bhansali, head of treasury and executive director, Finrex Treasury Advisors LLP.
In the April monetary policy, RBI deputy governor Michael Patra reiterated that some market participants had been misusing the market and taken this to understand that a relaxation in documentary evidence was tantamount to no underlying, which was not the case and was a rule violation.
Patra added that the idea is that it is only for hedging and underlying exposure is a mandatory requirement.
According to Dilip Parmar, a foreign exchange analyst at HDFC Securities, the central bank might not want unwarranted volatility in the case of global uncertainties and participants with exposure to hedge positions and don't speculate for direction.
“The RBI has its own reasons for restricting unhedged currency derivatives but it's going to harm trading for sure,” said Jigar Trivedi, senior research analyst, commodities, Reliance Securities.
Trivedi added that the central bank had tightened rules on currency derivatives to curb speculative trading. The RBI in December last year and in January did mention also however got in the limelight no early then March end.
Participants pitch for additional measures
As the RBI’s new deadline to implement the currency derivative norms nears, market participants have also pitched for some rule relaxations to arrest the sharp slide in currency derivative trading volumes in recent weeks.
Foreign exchange dealers said it is imperative that the RBI should announce additional measures to address the falling volumes in this segment, including introducing a cap on trading limits.“Measures could be like giving a limit of, say, $1 million to all individuals to trade without any underlying, maybe trade against the limit of $25,0000, which is allowed to be remitted outside, or allow trade against gold held by Indians," Bhansali said.
“If market participation declines further, the RBI will have to think of some measures to increase the same,” Bhansali added.
Amit Pabari, managing director, CR Forex Advisors, said that there is scope for the RBI to introduce a cap on trading limits, which could align the interests of both parties involved.
Also read: Bourses ask brokers to ensure compliance with RBI directive on currency derivatives' trading
The numbers
According to National Stock Exchange data, open interest currency derivatives futures contracts fell to 36,81,742 on April 16, from 73,87,055 on March 22.
Due to the steep fall-off in volumes, experts said that the market will gum up as most traders without underlying assets are winding up their open position contracts.
“The market will become illiquid as participants will close out positions and not take fresh exposure,” said Rajeev Pawar, head Of treasury, Ujjivan Small Finance Bank.
Growth in volumes
Since the launch of currency futures back in August 2008, volumes in terms of open interest contracts recorded a compound annual growth rate of about 70 percent till 2013. But volumes began tapering off that year due to a currency crisis in India, a dealer with a brokerage firm said.
In 2014, the RBI provided a relaxation where an underlying exposure up to $10 million did not require documentary evidence of underlying assets, which again boosted volumes in the market.
Over the years, the limit was raised to $100 million. Between 2014 and 2024, before the January 5 circular, currency derivatives volumes saw a moderate growth of 15-40 percent on an annual basis.
This was because even as the norms were not changed, the relaxation in terms of documentary evidence was taken to mean as no underlying by traders, forex dealers added.
Pabari of CR Forex Advisors said that until recently, traders were freely speculating on the fluctuations of the rupee without holding underlying assets, leveraging a rule allowing transactions of up to $100 million without proof of actual foreign-currency exposure, assuming implicit approval of speculative trading by regulatory authorities.
“It (the RBI) reaffirmed a rule permitting the use of rupee forex derivatives solely for hedging purposes, effectively ejecting traders and speculators, who constituted the majority of trading volume, from the market,” he added.
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