RBI Directive for Currency Derivatives
- April 5, 2024
- Posted by: OptimizeIAS Team
- Category: DPN Topics
No Comments
RBI Directive for Currency Derivatives
Subject: Economy
Sec: Financial MarketĀ
- RBI Directive for Currency Derivatives:
- Effective from April 5, all market participants, including Foreign Portfolio Investors (FPIs), must declare any underlying position in the currency derivatives market.
- This declaration is necessary even for a single lot, or else all positions must be squared-off.
- Previously, FPIs were allowed to participate in Exchange-Traded Currency Derivatives (ETCD) without establishing “underlying exposure” in equities, bonds, or other financial instruments.
- FPIs could take long or short positions in all currency pairs up to a limit of $100 million across all recognized stock exchanges.
- Impact on FPIs:
- FPIs, along with other market participants, have been crucial in providing liquidity to ETCD contracts listed on exchanges.
- Some FPIs and foreign brokers, particularly those engaged in prop trading or high-frequency trading, may now need to square off positions by April 5.
- Failure to comply could result in penal action.
- Custodians handling trades for FPIs are seeking clarity from the RBI regarding this directive.
- Concerns and Confusion:
- The FPI community is confused and uncertain about the necessary actions to take.
- Large hedge funds and quant-based funds, active in the ETCD market, may have significant positions that require attention.
- Lack of clarity has led to a situation where many market participants are considering squared-off positions before the deadline.
- Market Outlook:
- The market anticipates a shift towards a landscape dominated by hedgers, including exporters, importers, and FPIs.
- Banks and brokers, traditionally market makers, might consider their position in light of the new directive.
- The circular raises concerns of a reduction in liquidity if banks and brokers withdraw from the market.
- Risk Factors:
- FPIs’ positioning in the USD-INR pair typically leans towards being long (more foreign currency, less rupee).
- With positive FPI flows into India and a current account deficit, the risk is perceived as Indian currency depreciation.
ETD – Exchange Traded Derivative:
- An Exchange Traded Derivative is a standardized financial contract traded on stock exchanges in a regulated manner.
- These derivatives are subject to rules drafted by market regulators such as the Securities and Exchange Board of India (SEBI).
Derivatives Overview:
- Derivatives are financial contracts deriving their values from price fluctuations of underlying assets like stocks, currency, bonds, commodities, etc.
- There are essentially two types of derivatives:
- Exchange Traded Derivatives (ETDs):
- Subject to standardized terms and conditions.
- Traded on stock exchanges.
- Over the Counter (OTC) Derivative:
- Traded between private counter-parties.
- Transactions occur directly between parties without a formal intermediary.
ETD Characteristics:
- ETDs are standardized, meaning they have pre-defined terms and conditions.
- Traded on regulated exchanges, ensuring transparency and market oversight.
- Buyers and sellers of ETDs do not need to know each other, as the exchange acts as the counter-party for both sides.
- Prices and terms are publicly available and visible on the exchange, allowing for price discovery and market liquidity.
- ETDs often include various financial instruments such as futures and options contracts.
Examples of ETDs:
- Futures Contracts: Agreements to buy or sell an asset at a future date for a specified price.
- Options Contracts: Contracts giving the buyer the right (but not the obligation) to buy or sell an asset at a set price within a specific time frame.
Exchange Traded Derivatives play a crucial role in financial markets, providing investors with opportunities for risk management, speculation, and portfolio diversification. Their standardized nature and regulated trading environment contribute to market efficiency and transparency.