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TMI BlogComprehensive Guidelines on Over the Counter (OTC) Foreign Exchange Derivatives and Overseas Hedging of Commodity Price and Freight RisksX X X X Extracts X X X X X X X X Extracts X X X X ..... in the domestic and international financial markets, the extant guidelines on OTC foreign exchange derivatives, commodity price and freight risks have been revised in consultation with the banks, corporates and other stake holders. The Comprehensive Guidelines on Foreign Exchange Derivatives and Overseas Hedging of Commodity Price and Freight Risks are furnished in the Annex. The revised guidelines would be effective from February 01, 2011. 3. All the guidelines given in the Comprehensive Guidelines on Derivatives issued vide Circular DBOD.No.BP.BC. 86/21.04.157/2006-07 dated April 20, 2007 and subsequent amendments thereto would also apply, mutatis mutandis, to the foreign exchange derivatives. 4. The necessary amendments to Notification No. FEMA.25/RB-2000 dated May 3, 2000 [Foreign Exchange Management (Foreign Exchange Derivatives Contracts) Regulations, 2000] are being notified separately. 5. AD Category - I banks may bring the contents of this circular to the notice of their constituents and customers concerned. 6. The directions contained in this circular have been issued under Sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999 (42 of 1999) and are w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ises (SMEs)1 - Permitted to book forward foreign exchange contracts without production of underlying documents for hedging their direct /indirect exposure to foreign exchange risk. • Product : Forward Foreign Exchange Contracts ii) Resident Individuals - To hedge their foreign exchange exposures arising out of actual or anticipated remittances, both inward and outward, 1 SME as defined by the Rural Planning and Credit Department, Reserve Bank of India vide circular RPCD.PLNS. BC.No.63/06.02.31/2006-07 dated April 4, 2007. without production of underlying documents, up to a limit of USD 100,000, based on self declaration. • Product : Forward Foreign Exchange Contracts III. Persons resident outside India- The following categories are permitted to hedge their contracted foreign exchange exposures: i) Foreign Institutional Investors (FIIs) ii) Persons having Foreign Direct Investment (FDI) in India iii) Non-resident Indians (NRIs) For these categories, subject to terms and conditions enumerated later, the following products are permitted: a) Forward Foreign Exchange Contracts b) Foreign Currency-INR Options IV. Authorised Dealers Category I (AD Category I) - H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sure, irrespective of the transaction being a current or a capital account. Full particulars of the contracts should be marked on the original documents under proper authentication and retained for verification. However, in cases where the submission of original documents is not possible, a copy of the original documents, duly certified by an authorized official of the user, may be obtained. In either of the cases, before offering the contract, the AD Category I banks should obtain an undertaking from the customer and also quarterly certificates from the statutory auditor (for details refer section B para II (b) for General Instructions). While details of the underlying have to be recorded at the time of booking the contract, in the view of logistic issues, a maximum period of 15 days may be allowed for production of the documents. If the documents are not submitted by the customer within 15 days, the contract may be cancelled, and the exchange gain, if any, should not be passed on to the customer. In the event of non-submission of the documents by the customer within 15 days on more than three occasions in a financial year, booking of permissible derivative contracts in future may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e contract may be booked on the basis of reasonable estimates. However, there should be periodical review of the estimates. c) Foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve Bank, where such approval is necessary or Loan Registration Number is allotted by the Reserve Bank. d) Global Depository Receipts (GDRs)/American Depository Receipts (ADRs) will be eligible for hedge only after the issue price has been finalized. e) Balances in the Exchange Earner's Foreign Currency (EEFC) accounts sold forward by the account holders shall remain earmarked for delivery and such contracts shall not be cancelled. They are, however, eligible for rollover, on maturity. f) All non-INR forward contracts can be rebooked on cancellation subject to condition (h) below. Forward contracts, involving the Rupee as one of the currencies, booked by residents to hedge current account transactions, regardless of the tenor, and to hedge capital account transactions, falling due within one year, may be allowed to be cancelled and rebooked subject to condition (h) below. This relaxation of cancellation and rebooking will not be available to forw ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on a fully covered back-to-back basis. The cover transaction may be undertaken with a bank outside India, an Off-shore Banking Unit situated in a Special Economic Zone or an internationally recognized option exchange or another AD Category I bank in India. AD Category I banks desirous of writing options, should obtain a one-time approval from the Chief General Manager, Reserve Bank of India, Foreign Exchange Department, Forex Markets Division, Central Office, Amar Building 5th Floor, Mumbai, 400001, before undertaking the business. iii) Foreign Currency - INR Options Participants Market-makers - AD Category I banks, as approved for this purpose by the Reserve Bank. Users - Persons resident in India Purpose a) To hedge foreign currency exposures in accordance with Schedule I of Notification No. FEMA 25/2000-RB dated May 3, 2000, as amended from time to time. b) To hedge the contingent foreign exchange exposure arising out of submission of a tender bid in foreign exchange. Operational Guidelines, Terms and Conditions a) AD Category I banks having a minimum CRAR of 9 per cent, can offer foreign currency- INR options on a back-to-back basis. b) For the present, AD c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s k) AD banks running an option book are permitted to initiate plain vanilla cross currency option positions to cover risks arising out of market making in foreign currency-INR options. l) Banks should put in place necessary systems for marking to market the portfolio on a daily basis. FEDAI will publish daily a matrix of polled implied volatility estimates, which market participants can use for marking to market their portfolio. m) The accounting framework for option contracts will be as per FEDAI circular No.SPL-24/FC-Rupee Options/2003 dated May 29, 2003. iv) Foreign Currency-INR Swaps Participants Market-makers - AD Category I banks in India. Users - i. Residents having a foreign currency liability and undertaking a foreign currency-INR swap to move from a foreign currency liability to a Rupee liability. ii. Incorporated resident entities having a rupee liability and undertaking a INR -foreign currency swap to move from rupee liability to a foreign currency liability, subject to certain minimum prudential requirements, such as risk management systems and natural hedges or economic exposures. In the absence of natural hedges or economic exposures, the INR-forei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Participants Market-makers - AD Category I banks Users - Listed companies or unlisted companies with a minimum net worth of Rs. 100 crore ( subsidiaries or affiliates of listed companies which follow AS 30/32, having common treasuries and consolidate the accounts with parent companies are exempted from the minimum net worth criteria), which are complying with the following: • Adoption of Accounting Standards 30 and 32. Companies which are not complying fully with AS 30 and 32 should follow the accounting treatment and disclosure standards on derivative contracts, as envisaged under AS 30/32. • Having a risk management policy and a specific clause in the policy that allows using the type/s of cost reduction structures. Purpose To hedge exchange rate risk arising out of trade transactions and External Commercial Borrowings (ECBs). Operational Guidelines, Terms and Conditions a) Writing of options by the users, on a standalone basis, is not permitted. b) Users can enter into option strategies of simultaneous buy and sell of plain vanilla European options, provided there is no net receipt of premium. c) Leveraged structures, digital options, barrier options, ran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... goods and services Purpose To hedge currency risk on the basis of a declaration of an exposure and based on past performance up to the average of the previous three financial years' (April to March) actual import/export turnover or the previous year's actual import/export turnover, whichever is higher. Probable exposure based on past performance can be hedged only in respect of trades in merchandise goods as well as services. Products Forward foreign exchange contracts, cross currency options (not involving the rupee), foreign currency-INR options and cost reduction structures [as mentioned in section B para I 1(v)]. Operational Guidelines, Terms and Conditions a) Corporates having a minimum net worth of Rs 200 crores and an annual export and import turnover exceeding Rs 1000 crores and satisfying all other conditions as stipulated in section B para I 1(v) may be allowed to use cost reduction structures. b) The contracts booked during the current financial year (April-March) and the outstanding contracts at any point of time should not exceed the eligible limit i.e. the average of the previous three financial years' actual import/export turnover or the previous year's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be provided until submission of the audited figures. j) AD Category I banks must institute appropriate systems for validating the past performance limits at pre-deal stage. In addition to the customer declarations, AD Category I banks should also assess the past transactions with the customers, turnover, etc. k) AD Category I banks are required to submit a monthly report (as on the last Friday of every month) on the limits granted and utilised by their constituents 3 SME as defined by the Rural Planning and Credit Department, Reserve Bank of India vide circular RPCD.PLNS. BC.No.63/06.02.31/2006-07 dated April 4, 2007. under this facility as prescribed in Appendix J. 3) Special Dispensation i) Small and Medium Enterprises (SMEs) Participants Market-makers - AD Category I. Users - Small and Medium Enterprises (SMEs) 3 Purpose To hedge direct and / or indirect exposures of SMEs to foreign exchange risk Product Forward foreign exchange contracts Operational Guidelines: Small and Medium Enterprises (SMEs) having direct and / or indirect exposures to foreign exchange risk are permitted to book / cancel / rebook/ roll over forward contracts without production of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ific foreign exchange derivatives, certain general principles and safeguards for prudential considerations that are applicable across the OTC foreign exchange derivatives, are detailed below. In addition to the guidelines under the specific foreign exchange derivative product, the general instructions should be followed scrupulously by the users (residents in India other than AD Category I banks) and the market makers (AD Category I banks). a) In case of all forex derivative transactions [except INR- foreign currency swaps i.e. moving from INR liability to foreign currency liability as in section B para I(1)(iv)] is undertaken, AD Category I banks must take a declaration from the clients that the exposure is unhedged and has not been hedged with another AD Category I bank. The corporates should provide an annual certificate to the AD Category I bank certifying that the derivative transactions are authorized and that the Board (or the equivalent forum in case of partnership or proprietary firms) is aware of the same. b) In the case of contracted exposure, AD Category I banks must obtain: i) An undertaking from the customer that the same underlying exposure has not been covered ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ell as the downsides and sensitivity analysis identifying the various market parameters that affect the product. j) The provisions of comprehensive guidelines on Derivatives issued vide DBOD.No.BP.BC. 86/21.04.157/2006-07 dated April 20, 2007 and as amended from time to time are also applicable to forex derivatives. k) Sharing of information on derivatives between banks is mandatory and as detailed vide circular DBOD.No.BP.BC.46/08.12.001/2008-09 dated September 19, 2008 and DBOD.No. BP. BC. 94/ 08.12.001/ 2008-09 dated December 8, 2008. Section C Facilities for Persons Resident outside India For persons resident outside India, only capital account transactions as enumerated hereunder, subject to verification of underlying exposure, are permitted to be hedged. Transactions arising out of trade in merchandise goods as well as services with residents or non residents are not permitted to be hedged. Participants Market-makers - In respect of FIIs, designated branches of AD Category I banks maintaining accounts of FIIs. In all other cases, AD Category I banks. Users - Foreign Institutional Investors (FII), Investors having Foreign Direct Investments (FDI) and Non Resident ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oked only after ensuring that the overseas entities have completed all the necessary formalities and obtained necessary approvals (wherever applicable) for the investment. (ii) The tenor of the contracts should not exceed six months at a time beyond which permission of the Reserve Bank would be required to continue with the contract. (iii) These contracts, if cancelled, shall not be eligible to be rebooked for the same inflows. (iv) Exchange gains, if any, on cancellation shall not be passed on to the overseas investor. iii) NRI related Purpose a) To hedge the exchange rate risk on the market value of investment made under the portfolio scheme in accordance with provisions of FERA, 1973 or under notifications issued there under or in accordance with provisions of FEMA, 1999. b) To hedge the exchange rate risk on the amount of dividend due on shares held in Indian companies. c) To hedge the exchange rate risk on the amounts held in FCNR (B) deposits. d) To hedge the exchange rate risk on balances held in NRE account. Products a) Forward foreign exchange contracts with rupee as one of the currencies, and foreign currency-INR options. b) Additionally, for balanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ter into forward contracts with their constituents (exporters of gold products, jewellery manufacturers, trading houses, etc.) in respect of the underlying sale, purchase and loan transactions in gold with them, subject to the conditions specified by the Reserve Bank in this regard. The tenor of such contracts should not exceed six months. iii) Hedging of currency risk on capital Users - Foreign banks operating in India Product - Forward foreign exchange contracts Operational Guidelines, Terms and Conditions a) Tier I capital - i) The capital funds should be available in India to meet local regulatory and CRAR requirements and, hence, these should not be parked in nostro accounts. Foreign currency funds accruing out of hedging should not be parked in Nostro accounts but should remain swapped with banks in India at all times. ii) The forward contracts should be for tenors of one or more years and may be rolled over on maturity. Rebooking of cancelled hedges will require prior approval of the Reserve Bank. b) Tier II capital - i) Foreign banks are permitted to hedge their Tier II capital in the form of Head Office borrowing as subordinated debt, by keeping it swappe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ppendix H (A & B). b. Hedging of anticipated imports of crude oil Participants Users: Domestic companies engaged in refining crude oil. Facilitators: AD Category I banks specifically authorized by the Reserve Bank in this regard. Purpose: To hedge the price risk on crude oil imports on the basis of past performance. Products: Standard exchange traded futures and options (purchases only) in international commodity exchanges. If risk profile warrants - may use OTC contracts overseas. Operational Guidelines: a) Hedging to be permitted up to 50 per cent of the volume of actual imports during the previous year or 50 per cent of the average volume of imports during the previous three financial years, whichever is higher. b) Contracts booked under this facility will have to be regularized by production of supporting import orders during the currency of the hedge. An undertaking may be obtained from the companies to this effect. c) All other conditions and guidelines as per Appendix H should be complied with. c. Hedging of price risk on domestic purchase and sales (i) Select Metals Participants Users: Domestic producers/ users of aluminium, copper, lead, nickel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l commodity exchanges. If risk profile warrants - may use OTC contracts overseas. Operational Guidelines: a) The hedging will be allowed strictly on the basis of underlying contracts. b) AD Category I banks should retain necessary documentary evidence. c) All other conditions and guidelines as per Appendix H (A & B) should be complied with. d. Hedging of price risk on Inventory Participants Users: Domestic oil marketing and refining companies. Facilitators: AD Category I banks specifically authorized by the Reserve Bank in this regard. Purpose: To hedge commodity price risk on Inventory. Products: Over-the-counter (OTC) / exchange traded derivatives overseas with tenor restricted to a maximum of one-year forward. Operational Guidelines: a) Hedge is allowed to the extent of 50 per cent of their inventory based on the volumes in the quarter proceeding the previous quarter. b) All other conditions and guidelines as per Appendix H (A & B) should be complied with. II) Approval Route Participants Users: Residents in India, other than companies listed on recognized stock exchanges, engaged in import and export of commodities or customers who are exposed to s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... facility is divided into following categories: I) Delegated Route Participant: Users: Domestic oil-refining companies and shipping companies. Facilitators: AD Category I banks, specifically authorized by the Reserve Bank i.e. those who have been delegated the authority to grant permission to listed companies to hedge commodity price risk in the international commodity exchanges / markets, subject to the conditions mentioned therein. Purpose: To hedge freight risk. Products: Plain vanilla Over the Counter (OTC) or exchange traded products in the international market / exchange. Operational Guidelines: i) The maximum tenor permissible will be one year forward. ii) The exchanges on which the products are purchased must be a regulated entity in the host country. iii) AD Category I banks should ensure that the entities hedging their freight exposures have Board Resolutions which certify that the Board approved Risk Management policies, defines the overall framework within which derivative transactions should be undertaken and the risks contained therein. AD Category I banks should approve this facility only after ensuring that the sanction of the company's Board h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o hedge freight risk Products: Plain vanilla Over the Counter (OTC) or exchange traded products in the international market / exchange. Operational Guidelines a) The maximum tenor permissible will be one year forward. b) The exchanges on which the products are purchased must be a regulated entity in the host country. c) Applications of companies/ firms which are not covered by the delegated authority of AD Category I may be forwarded to the Reserve Bank for consideration through the International Banking Division of their AD Category I bank concerned along with the latter's specific recommendations. Section G Reports to the Reserve Bank i) Authorised Dealers Category I should consolidate the data on cross-currency derivative transactions undertaken by residents and submit half yearly reports (June and December) as per the format indicated in the Appendix A. ii) Authorised Dealers Category I should forward details of exposures in foreign exchange as at end of every quarter as per format indicated in Appendix B. The AD banks should submit this report based on bank's books and not based on corporate returns. iii) Authorised Dealers Category I should forward details ..... X X X X Extracts X X X X X X X X Extracts X X X X
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