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India's central bank requiring underlying foreign exchange exposure for exchange-traded rupee derivative transactions has confused brokers and left them worried about the potential impact on activity in this growing segment.
The Reserve Bank of India (RBI) in a Jan. 5 circular said that stock exchanges may offer forex derivative contracts involving the rupee to users "for the purpose of hedging contracted exposure". In 2008, the RBI had allowed transactions in dollar/rupee currency futures "to hedge an exposure to foreign exchange rate risk or otherwise".
The new rule comes into effect on April 5.
"The exposure requirement needs explanation," Abhilash Koikkara, head - forex and rates at Nuvama Professional Clients Group, said. "We and other brokers have written to the exchanges and are awaiting clarification."
The RBI's January circular differentiates between exposure requirements for rupee and non-rupee derivatives. Derivative contracts not involving the rupee can be offered without "any restriction in terms of purpose".
As per the new rule for rupee derivatives, the stock exchanges will inform clients that while they are not required to provide proof of underlying exposure for positions of up to $100 million, the clients have to ensure such exposures exist and that they have not already been hedged.
"The way we read this is that no matter the size of the position, you need an underlying exposure," the head of currency derivatives segment at a large broker said. The person did not want to be named since he is not authorized to speak to the media.
Only a very small percentage of his clients have an actual forex exposure and most are speculators and arbitrageurs. As such, a large number of clients may decide to not trade in forex derivatives anymore, hurting volumes, he said.
It will not be the broker's responsibility to ensure clients have exposure to FX, but they will need to inform clients that exposures are needed to transact in derivatives, the person said.
The RBI did not immediately respond to an email seeking clarity about the underlying exposure requirements for rupee derivatives offered by exchanges.
Exchange-traded futures and options have grown to occupy an important place in India's foreign exchange markets. Apart from speculators, exporters and importers, the RBI has at times used dollar/rupee futures to intervene in the forex markets. Banks arbitrage between currency futures and the over-the-counter market.
The open interest on dollar/rupee futures on the most popular National Stock Exchange is over $5 billion and average daily volumes were $2.8 billion last year.
(Reporting by Nimesh Vora; Editing by Mrigank Dhaniwala)