RBI’s new hedging guidelines – Impacts for Indian companies

Let us understand the guidelines first.
New Guidelines became applicable from 1st Sept 2020. does away with most of the restrictions on operational aspects and allows product flexibility for certain companies.

1.Users are classified as Retail and non-retail.

1) Non-retail users:

A. Companies with a minimum net worth of Rs 500 crores.

B. Exim Bank, National Bank of Agriculture and Rural Development (NABARD), National Housing Bank (NHB), and Small Industries Development Bank of India (SIDBI).

C. person resident outside India other than individuals.

2) Retail user: Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.

Any user who is otherwise eligible to be classified as a non-retail user shall have the option to get classified as a retail user.

2.Permissible products for Retail users –

Forwards, purchase of call and put options (Only European options), purchase of call and put spreads, swaps.
All other products are not permissible to retail users, like a seagull, range forwards, par forwards, rupee to FC swaps, any exotic products.

3.Permissible products for Non-Retail users –

Any derivative contract, including covered options, exotics, provided that the potential loss from the derivative transaction to the user, in any scenario, does not exceed the loss that the user would face if he had left the position unhedged.

4.Exposure classification –

Contracted exposure –

• As per the previous guidelines freely cancellation and rebooking are allowed
• Documents to be published within 15 days in either physical or electronic form including but not limited to email.

Anticipated exposure –

• Free cancellation and rebooking permitted
• Gain on cancellation will be passed upon showing the underlying cash flow.
• Part gain can be passed on upon demonstrating the cash flow as well.
• All gains/losses netted at each contract level and settled when delivered or when the proof is shown
• No need for a statutory auditors’ certificate to establish exposure, company declaration is enough.

Special 10 million facility –

• Not to be taken as a separate facility
• Until O/S hedge amount in a financial year does not exceed, no proof of underlying is required
• When the outstanding hedges cross 10 million, the underlying documents need to be shown for entire outstanding contracts
• This 10 million limit is a limit across all banks

Contracted and anticipated exposures are not interchangeable

Positives:

• Wider product flexibility for non-retail users as exotics are allowed with all other existing products.
• Exotics with a rider of the condition that the loss on the hedge +underlying does not exceed the loss on an unhedged position. This condition will keep a much-needed check on the risk of a runaway loss.
• Smaller users can do the call spreads and put spreads. This will allow the users to reduce the hedge cost burden with decent protection. Earlier less than 200 crores of net worth/non-listed companies were not allowed to do these spreads.
  Example: An importer with a very thin business margin can take a call spread of 73 to 74.75 by paying a premium of 75 paise for January end instead of paying 87 paise for a forward. Here he will enjoy the possible appreciation benefit with a lower cost of hedging along with decent protection.
• Lesser statutory requirements in the form of self-declaration instead of a statutory auditor’s certificate is a welcome change for small companies.
• Anticipated exposures and USD 10 million facilities are good steps for the new companies to hedge their future exposure where the bid is won but LC has not been opened.

Scope of improvement:

• The companies below a net worth of 500 crores cannot do Range forwards and seagull type of structures. These products are very useful in saving costs or dealing with uncertainties. Earlier companies with 200 cr plus networth could do such structures but now they also cannot unless net worth is INR 500 crores. Ideally, these products should be allowed to all companies subject to suitability and appropriateness.
• Range forward is a very conservative product where the worst case is defined with a limited benefit which is also well defined. For example, an exporter right now could be confused about whether to hedge or to wait for better levels. Range forward can ensure that 73.00 is protected whereas if INR depreciates, the exporter can get benefit till 76.00 or 77.00. The levels are dependent on tenor.
• Seagull is also an effective product where protection is limited and on the benefit side, it returns better than the forwards. This is very useful for importers. For example, an importer can protect themselves from 73.50 to 75.50 and can benefit from INR appreciation to 72.50.
• Rupee to foreign currency swap could have been continued as a permissible product for the exporters on the ground of natural hedge. It is a very good instrument to reduce the interest cost burden on loans.

We believe these products should be allowed for retail users as well.

Here is the relevant part of the RBI’s guidelines on hedging of foreign exchange risks, effective from 1st September 2020.

A.General directions

1. Authorized Dealers shall classify a user as per the User Classification Framework provided at Annex II to this direction and shall comply with the guidelines applicable in each case.
2. Authorized Dealers shall offer derivative contracts to a user as per the user’s classification in para (i) above. While offering a derivative contract involving INR, other than NDDCs, to a user, and during the life of such contracts, Authorised Dealers shall ensure that:

1. The contract is for the purpose of hedging as defined in these directions.
2. The notional and tenor of the contract does not exceed the value and tenor of the exposure.
3. The same exposure has not been hedged using any other derivative contract.
4. In case the exposure ceases to exist, in full or in part, the user has appropriately adjusted the hedge to ensure adherence to “2” above unless the original derivative contract is assigned against any other unhedged exposure. No adjustment to the hedge is required to be made if, in the considered opinion of the Authorised Dealer, the change in exposure is not material.
5. In cases where the value of the exposure falls below the notional of the derivative, the notional should be suitably adjusted unless such divergence has occurred on account of a change in the market value of the exposure, in which case the user may, at his discretion, continue with the derivative contract till its original maturity.
6. Where the value of the exposure is not ascertainable with certainty, derivative contracts may be booked on the basis of reasonable estimates. Such estimates should be reviewed periodically to ensure compliance with (d) and (e) above.

iii. Authorised Dealers shall allow users to freely cancel and rebook derivative contracts. However, net gains (gains over and above losses if any) on contracts booked to hedge an anticipated exposure shall be passed on to the eligible user only at the time of the cash flow of the anticipated transaction. In the case of part delivery, net gains will be transferred on a pro-rata basis.

1. Authorized Dealers may, in exceptional cases, pass on the net gains on contracts booked to hedge an anticipated exposure whose underlying cash flow has not materialized, provided it is satisfied that the absence of cash flow is on account of factors which are beyond the control of the user. Such instances along with specific justification shall be kept on record by the Authorised Dealer.
2. All derivative contracts shall be subject to the Suitability and Appropriateness policy prescribed vide circular no.DBOD.No.BP.BC.86/21.04.157/2006-07 dated April 20, 2007, on Comprehensive Guidelines on Derivatives (as amended from time to time).
3. Authorized Dealers specifically designated by a user for the purpose of monitoring of transaction on exchanges shall ensure that all positions of the user in all contracts involving INR on all the exchanges put together, is backed by a contracted exposure to INR.

vii. Authorised Dealers may call for such documents from the eligible users as they deem necessary for complying with the requirements of these directions.

viii. Authorised Dealers, unless permitted by Reserve Bank to run books in contracts not involving INR, shall offer such contracts on a fully covered back-to-back basis.

1. Existing contracts booked under the provisions of the earlier direction may be continued till the date of their expiry.
2. Banks in India having an Authorised Dealer Category-1 license under FEMA, 1999, and operating International Financial Services Centre (IFSC) Banking Units (IBUs) (as specified in circular no.RBI/2014-15/533.DBR.IBD.BC.14570/23.13.004/2014-15 dated April 1, 2015 (as amended from time to time)), shall be eligible to offer non-deliverable derivative contracts involving the Rupee, or otherwise, to persons not resident in India. Banks can undertake such transactions through their IBUs or through their branches in India or through their foreign branches (in case of foreign banks operating in India, through any branch of the parent bank).

B.Specific Directions

1. Domestic non-retail corporations having an INR liability may, at their discretion, convert it into a foreign currency liability through a currency swap.
2. For derivative contracts involving INR, Authorised Dealers shall allow a user to book derivative contracts up to USD 10 million equivalent of notional value (outstanding at any point in time) without the need to establish the existence of underlying exposure.
3. Authorized Dealers may deal with a non-resident user (or its central treasury or its group entity, where applicable) either directly or through the overseas bank of such user (including overseas branches of Authorised Dealer) or through other overseas entities eligible to deal in derivatives as per local regulations.
4. In the case of a central treasury of a non-resident user, the Authorised Dealer shall ensure that the central treasury is appropriately authorized by the user to deal for and on its behalf.
5. Authorized Dealer shall ensure that in the case of a non-resident user all payables incidental to the hedge are met by the user out of repatriable funds and/or inward remittance through normal banking channels.

3. Directions for Exchanges

1. Users may take positions (long or short), without having to establish the existence of underlying exposure, up to a single limit of USD 100 million equivalent across all currency pairs involving INR, put together, and combined across all exchanges.
2. Exchanges authorized by RBI to offer currency derivatives shall provide the facility to users, intending to take a position beyond USD 100 million (or equivalent) in contracts involving INR in all exchanges put together, to designate an Authorised Dealer/Custodian.
3. For users referred to in the previous part, the exchanges shall provide information on day-end open positions as well as intra-day highest position of the user to the designated Authorised Dealer/Custodian.
4. The onus of complying with the directions shall rest with the user. In case of any contravention, the user shall render itself liable to any action under the Foreign Exchange Management Act (FEMA), 1999.

User Classification Framework

1. User Classification

For the purpose of offering derivative contracts to a user, the Authorised Dealer shall classify the user either as a retail user or as a non-retail user.

1. The following users shall be eligible to be classified as non-retail users:

1. All entities regulated by a financial sector regulator subject to general or special permission of the concerned regulator
2. Exim Bank, National Bank of Agriculture and Rural Development (NABARD), National Housing Bank (NHB) and Small Industries Development Bank of India (SIDBI)
3. Companies with a minimum net worth of Rs 500 crores
4. A person resident outside India other than individuals

iii. Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.

1. Any user who is otherwise eligible to be classified as a non-retail user shall have the option to get classified as a retail user.
2. Directions in case of retail users

1. Eligible products – Forwards, purchase of call and put options (Only European options), purchase of call and put spreads, swaps.
2. All forward contracts with retail clients shall be executed at the ongoing interbank / market rates and shall be time stamped. For all other derivative contracts, the mid-market mark of the derivative shall be disclosed to the client before entering into the contract and the same must be included in the term sheet. The mid-market mark of a derivative is the price of the derivative that is free from profit, credit reserve, hedging, funding, liquidity, or any other costs or adjustments.
3. All applicable fees/commissions/service charges etc. related to the contract shall be charged by the authorized dealer separately and shall not be part of the price of the contract.

3. Directions in case of non-retail users

1. Eligible products – Any derivative contract, including covered options, which the Authorised Dealer can price and value independently and is approved by the board of the Authorised Dealer, provided that the potential loss from the derivative transaction to the user, in any scenario, does not exceed the loss that the user would face if he had left the position unhedged. The responsibility of adhering to this restriction would lie on the Authorised Dealer offering the product to the user.
2. All new products must be cleared by the Board (or its equivalent) of the Authorised Dealer before being offered to its customer

To discuss further you can call us at +91 9674933723 or email: advisor@quantartmarket.com
QuantArt is India’s best foreign exchange advisory company Our clients include Tata Group, AV Birla Group, Sterlite Group, Reliance group, Top Banks, NBFCs, MSMEs, and MNCs. Our senior advisors are specialists in treasury management and ex-bankers having worked with JPMorgan, HSBC, Goldman, etc before joining QuantArt. And have been in business for the last 8 years.

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