RBI’s currency derivatives diktat puts FPIs in a spot
Foreign investors may need to square positions with no underlying exposure before May 3
Foreign portfolio investors (FPIs) are in a bind over the RBI’s new currency derivatives diktat, even as the deadline for the applicability of the circular has been extended by a month to May 3.
Some of the investors will be compelled to square their positions before that date or face penal action by the Reserve Bank of India. Custodians handling trades for these investors had reached out to the RBI for clarity.
DEADLINE EXTENDED
On Thursday, the RBI deferred the applicability of the circular to May 3 from April 5. However, the central bank reiterated that both overthecounter and exchangetraded currency derivative (ETCD) contracts involving the rupee are permitted only for the purpose of hedging exposure to foreign exchange rate risks and that users are required to have an underlying exposure.
FPIs were allowed to participate in ETCD from 2014, and a framework was designed to allow them to take long or short positions in all currency pairs up to a single limit of $100 million combined across all recognised stock exchanges without the need to establish an “underlying exposure”.
“FPIs with no underlying exposure as well as foreign brokers that have set up India shop for prop or high frequency trading and have taken a view on the market without an underlying exposure will have to square their positions,” said an industry official.
Proprietary traders account for about 60 per cent of gross turnover in the currency derivatives market, while FPIs contribute 56 per cent.
FPI DILEMMA
“The FPI community is unclear on the course of action to be taken. Some of the large hedge funds and quantbased funds participate actively in the ETCD market and may have sizeable positions, which may have to be squared off before May 3,” said Anand Singh, Founder and Chief Executive Officer, Elios Financial Services.
DROP IN OPEN INTEREST
There has been a drop in open interest positions across major currency pairs in the past few days. The total open interest in the USDINR pair for the April 26 monthly contract stood at 31,42,470 as of April 3, a 30 per cent drop over three days.
The market is staring at a scenario where there would be no speculators or arbitrageurs and only hedgers. Hedgers include exporters, importers, and
FPIs. Banks and brokers constitute the market makers.
CAN LEAD TO OUTFLOWS
“If banks and brokers move out, the supply side as well as the demand will go out. So, indirectly, the exchangetraded currency derivatives market will see huge outflows,” said the official quoted above.
“If net FPI flows in India are positive and the net Indian current account is in deficit, the risk is that of the rupee depreciating. The hedges will always be long foreign currency and short rupee. Hence, the net positioning in USDINR will always be long (exchange traded and OTC combined),” added Singh.
Amit Pabari, Managing Director, CR Forex Advisors, said the postponement of the circular will resolve the confusion and panic in the exchanges and suppress the volatility in the exchangetraded options of the rupee. The option premiums had spiked multifold recently. Brokers are requiring clients to demonstrate underlying exposure or unwind their positions, adding pressure to the rupee. Once the panic subsides, the pressure from the rupee will also be released,” added Pabari.