Reserve Bank of India RBI Jaipur Forex Workshop - FEMA at Bhilwara


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Regional Director Dr Sathyan David Reserve Bank of India - RBI Jaipur and Team conduct First Time Ever workshop cum interactive session on ForEx Management at Bhilwara on 26 Aug 2013 in which Mewar Chamber of Commerce officials, Importers & Exporters, Charted Accountants & Company Secretaries, officials from Lead Banks, Vice Chancellor along with a team of MBA Faculty from Sangam University actively participated in the proceedings. Sri CD Srinivasan Chief General Manager from RBI Mumbai conducted the FEMA session including Derivatives with Clinical Precision. Ms Sunanda Batra from RBI Jaipur proposed vote of thanks and Sri ML Meena from RBI Jaipur anchored the proceedings.

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Reserve Bank of India RBI Jaipur Forex Workshop - FEMA at Bhilwara

  2. 2. Two issues  Derivatives (Currency) as Risk Management Tool  Risk Management of Derivatives (Currency)  So why is the first required?
  3. 3. First Issue  Derivatives (Currency) as Risk Management Tool  Derivatives as instrument of Risk Management do not eliminate risk from the market or the system  They are only a medium to transfer risk from a person who is risk averse and does not want to take risk (hedger) to a person who is prepared to take the risk.
  4. 4. First Issue  Derivatives (Currency) as Risk Management Tool  What are derivatives?  Types of derivative contracts  How to manage risk with derivatives?  What type of risks are managed?  Extant guidelines of currency derivatives in India  Crucial issues  Challenges ahead
  5. 5. What are derivatives?  A derivative instrument is a financial instrument whose performance is based on (derived from) the value of an underlying variable.  The variable can be anything  Price/Value of something  Foreign Exchange – Forex derivatives  Interest Rates – IRDs  Commodity – Commodity Derivatives  Equity – Equity Derivatives  Credit  Weather etc.
  6. 6. Types of derivatives – Basic  OTC derivatives  Forwards  Options  Swaps  Exchange traded derivatives  Futures  Options on futures  Options
  7. 7. Need for Derivatives  Risk – Is the probability of loss due to uncertainty in realisable value of an asset  Increases with increased volatility in the price/value of any underlying  Derivatives help in bringing certainty i.e. you exchange certainty for uncertainty  Each risk element can be managed separately and sold to willing parties  Identify the instrument that is most appropriate for the risk
  8. 8. How derivatives help in managing risk?  Facilitates isolation of risk elements  Each risk element can be managed separately and sold to willing parties  Identify the instrument that is most appropriate for the risk
  9. 9. How to manage risk with derivatives?  Identify the risk  Quantify the risk  Identify the instrument that is most appropriate for the risk
  10. 10. Indian forex market  One of the fastest growing markets in the world  BIS Triennial Survey indicate the global daily average turnover in USD – INR pair at USD 36 billion in April 2010, when compared to USD 17 billion in April 2007  The daily average turnover in INR accounted for 0.9% of the global turnover, as compared to 0.7% in 2007  The daily average turnover in June 2013 close to USD 52 billion in the OTC market and around USD 8 billion in the exchanges  Large flows are absorbed seamlessly  Customers have wider choice of instruments and markets
  11. 11. Regulatory Provisions  Section 45-U of the RBI Act, 1934(amendment 2006)- defines a derivative  Section 45-V of the RBI Act, 1934(amendment 2006)- validity of derivative contract  Section 45-W of the RBI Act, 1934(amendment 2006)- empowers RBI to regulate such contracts
  12. 12. Cont..  Notification 25 of 3rd May 2000 deals with Foreign Exchange Derivative Contract regulations  Subsequent revisions to the notification based on amendments to regulations  All guidelines consolidated into a Master Circular on Risk Management and Inter Bank Dealings (updated every July)  Comprehensive guidelines on OTC forex derivatives issued recently on 28th December 2010  Comprehensive Guidelines on Derivatives- DBOD circular dated April 20, 2007
  13. 13. What do the regulations state FEMA regulations state Who can undertake derivative transactions?  Residents  Non-residents Why to undertake?  Hedging of risk exposures  Transformation of risk exposures – currency What products can be used?
  14. 14. Cont..  Residents can enter in to forex derivatives contract only if they have exposure to the forex markets i.e. are exposed to fx rate risk  Mainstay : presence of an underlying exposure  For hedging their exchange rate risk only
  15. 15. Underlying principles  Presence of an underlying exposure is mandatory  Actual Underlying exposure as demonstrated by supporting documentation  Potential exposure for exporters and importers pending receipt of actual documentation  Declaration of an exposure for facilitating hedging without production of the documents  Economic exposure where indirectly exposed to exchange rate risk  Rupee exposures where a user can transform his long-term rupee liability to forex liability
  16. 16. Derivative Instruments allowed  Forwards  Foreign Currency – Rupee Options  Cross currency options  Swaps  Currency Futures (Started from August 2008)  Exchange traded Currency Options( Started in October 2010)
  17. 17. Cont..  Most of the instruments have been allowed for Residents  For non-residents – only forwards and foreign currency- rupee contracts are allowed  For ECB underlying – transactions not involving rupee  Interest Rate Swap / Currency Swap /  Coupon Swap / Foreign Currency Option /  Interest Rate Cap or Collar (purchases) / Forward Rate Agreement (FRA)
  18. 18. Exchange Traded Futures and Currency Options  Regulated jointly by SEBI and RBI  Expanded menu of exchange traded tools  Futures permitted in four currency pairs  Plain vanilla Currency Option on spot USD/INR  European Call and Put Options  Only residents are permitted to participate in the currency segments of the stock exchanges
  19. 19. Currency Futures- objectives  Provide an additional hedging tool  Development of domestic forex market  Allowing transactions beyond hedging, move towards fuller capital account convertibility  Provide a platform to retail segment that ensures efficient price discovery  Increasing integration and openness of the Indian economy  Demand from market participants and industry associations  Recommendations of various Committees
  20. 20. Issues in OTC derivatives  Losses to the users, both on complex and plain vanilla products  Use of exotic derivatives, without clearly establishing the suitability and appropriateness  Leverages in products and in underlying exposures  Derivative products have been used as a profit management tool than a risk mitigant  Transformation of Rupee liability, without natural hedges or proper appreciation of downsides
  21. 21. Approach to address the concerns  Leverage – establishing the exposure and limiting to plain vanilla products  Certification by statutory auditors and self declaration  Cost reduction structures, only with safeguards o Net worth/Turnover of the corporate, o Compliance with accounting/disclosure standards, as stipulated under AS 30 and AS 32 o No leverage structures o No exotic products o Risk management capabilities