RBI reiterates need for underlying forex exposure for rupee derivatives transactions

The Reserve Bank of India (RBI) has reiterated that underlying foreign exchange exposure is necessary for transacting in exchange-traded currency derivatives (ETCDs).

"There has been no change in RBI's policy. This need to have an underlying has been part of RBI's policy for many years," governor Shaktikanta Das said during the post-policy press conference on Friday.

The statement from the central bank comes a day after it deferred implementing its new rules on ETCDs by almost a month to 3 May.

According to an RBI circular dated 5 January, which was meant to come into effect from today, both proprietary traders and retail investors were required to show either contracted or anticipated currency exposure to engage in the currency derivatives segments offered by exchanges, such as the National Stock Exchange (NSE) and the BSE.

During today's press conference, RBI deputy governor Michael Patra said that the regulations of the Foreign Exchange Management Act clearly state that exchange traded currency derivatives are for hedging only.

To promote the ease of doing business, the RBI through a directive in 2014 had allowed users of ETCDs to assume positions up to $10 million per exchange without presenting proof of underlying exposure. However, it did not provide any exemption from the requirement of having the exposure altogether.

"Some market participants have been misusing this to understand that relaxation in documentary evidence is tantamount to no underlying, which is not the case and that is a violation of the law," said Patra.

The January directive had sent ripples of concern through the market, prompting brokers to either request proof of underlying exposure from their clients or advise them to close their positions.

ETCDs are jointly regulated by the RBI and the Securities and Exchange Board of India (Sebi). Apart from the currency derivatives segment, exchanges offer equities cash and derivatives, interest rate derivatives and commodity derivatives.

NSE is the market leader in the ETCDs segment, boasting 99% of the market turnover. In FY24, the daily average turnover in NSE's currency derivatives was ₹1.46 trillion, a 5.8% decrease from FY23.

Proprietary traders accounted for 62.3% of gross turnover, followed by retail investors (19%), others (8.3%), foreign portfolio investors or FPIs (6.2%), corporates (3.9%), and domestic institutional investors, or DIIs, at 0.2%.