For brokers worried over currency derivatives, clarity may be on way

The Reserve Bank of India's (RBI) 5 January circular said that users can take exposure up to $100 million across all contracts involving the rupee, without any existing underlying exposure. However, it adds that exchanges have to inform users that if required, they have to establish the existence of a "valid underlying contracted exposure", which has been not hedged using any other derivatives contract. Currency derivatives are offered by NSE, BSE and the Metropolitan Stock Exchange. The new rule takes effect on 5 April.

Brokers are confused by the term "valid underlying contracted exposure", as participants like proprietary traders and individual investors use the product to speculate, rather than hedge. Since the introduction of currency derivatives in 2008, retail and proprietary traders have speculated without either underlying or contracted exposure.

"Clarity is required by Sebi or exchanges on the circular, with only three days being left for it to take effect," said Anindya Banerjee, vice-president (currencies and commodities research), Kotak Securities. Banerjee said most brokerages will discuss the issue with their compliance teams on Monday, though the over-the-counter (OTC) currency market will remain shut.

Broker associations such as Association of National Exchanges Members of India (ANMI) and Commodity Participants Association of India (CPAI) reached out to Sebi for a clarification last week as the import of the circular began to sink in.

Queries sent to Sebi, NSE and BSE remained unanswered.

If the RBI rule stays, it could spell the end of the ETCD segment, according to brokers who spoke on condition of anonymity.

"Speculators act as counterparties to hedgers, providing depth to the market and reducing the impact cost (how quickly an asset can be liquidated for cash)," said a director from a leading brokerage. "A market remains vibrant if it has a cross section of participants. A hedgers-only market will literally mean the end of the ETCD segment."

While actual users including importers, exporters, SMEs, corporates and FPIs can hedge their currency risk on the OTC currency market which is dominated by banks, the smaller ones hedge their forex risk on ETCD, as banks tend to give relatively more attractive bids (buy)-ask (sell) quotes to larger hedgers. He added that a circular from Sebi or the exchanges was expected on Monday.

To trade a derivatives contract, a user must put up a margin at a fraction of the contact cost. If a company imports raw material and needs dollar at a future date, it can buy a dollar-rupee futures contract on the exchange if it feels the USD can appreciate. The counterparty, a retail investor or prop trader, believes the dollar will depreciate and sells the dollar to the company.

If the dollar falls at the end of the contract tenure, the company's loss on the exchange is offset by buying the dollar for fewer rupees on the OTC spot market. If the dollar rises as it expects, the gain on the exchange is used to buy the more expensive dollar on the spot market. In the above instances, the speculator loses or gains from the company .

Jay Prakash Gupta, national vice-president-designate of CPAI, said that brokers were expecting a Sebi or exchange circular on Monday.

NSE is the market leader in ETCD, with almost 99% share of turnover. In FY24, average daily turnover on NSE currency derivatives was ₹1.46 trillion, down 5.8% from FY23.

Apart from equities cash and derivatives segments, exchanges offer currency, commodity and interest rate derivatives.