The stir caused by a mere reiteration of the Reserve Bank of India's regulations on exchange-traded currency derivatives three months ago, has now turned into chaos, according to currency traders and brokerages.
India's top bourses National Stock Exchange and BSE Ltd Monday reaffirmed the central bank's circular from Jan. 5, which stated that exchange-traded rupee derivative transactions must have an underlying foreign exchange exposure. Or else, the transaction will not be in compliance with the provisions of Foreign Exchange Management Act of 1999.
While currency derivatives are a tool for hedging forex risk, they are also a hotbed for speculative trades. Until now, currency traders were free to trade in the derivatives market, with or without declaring underlying exposures, a trader from a brokerage firm said.
Interestingly, the RBI's direction on disclosing underlying exposures has been in place for many years. Yet, traders remained clueless on the rationale of this directive and are awaiting further clarifications.
Just a day later, several brokerages rushed to wind up open positions on behalf of their clients in the exchange-traded rupee derivatives market, according to another trader from a domestic brokerage.
This led to a single-day fall of nearly 20% in the open interest on most active dollar/rupee contract on Tuesday. On the NSE, the biggest platform for currency derivatives, the open interest for April contract stood at just 3.6 million lots, down from 7.4 million the previous session.
Open interest indicates how much money has flown in or out of a futures or options market. Decline in open interest suggests the lower demand for futures contracts, and closing out of futures positions.
The circular, which comes into effect on Apr. 5, came as a surprise for most currency market players. Hence, many of them approached RBI seeking for more clarity or for respite on the circular in the last one month, the first trader said.
Traders believe it would kill the currency derivatives market by filtering out speculators and arbitrageurs, who essentially bring in liquidity and depth to the market, according to Ritesh Bhansali, vice-president at Mecklai Financial Services.
The more the volumes, the better is the liquidity and more efficient pricing.
"My sense is that 60-70% of volumes will dry up ... some broking firms are waiting for clarifications. This doesn't make sense at all, no market can survive without speculators," Bhansali said.
"If nothing comes out, you will see a lot of impact coming on currency futures (market). Bid-ask spread will increase, volatility will increase," he added.
In a Feb. 28 email to Commodity Participants Association of India, the RBI stated that any trades in the rupee futures contract without an underlying exposure would be a breach of foreign exchange rules. A copy of the email has been reviewed by NDTV Profit.
The email clarification also spoke about earlier amendments to the directions that mandated the existence of underlying exposures for undertaking currency futures contracts. "Users with positions up to $10 million (later revised to $100 million) were, however, not required to produce evidence of such exposures," the RBI said in the email to the association.
Brokerages have inferred this as a requisite to ensure compliance with the RBI's regulations. They are asking clients to produce certificates declaring underlying exposure equivalent to the value of trading positions taken for hedging, Bhansali said. If one is unable to furnish such evidence, they will have to square off their positions, he added.
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