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 ..... 2. In the light of developments 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 Excha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ial Dispensation - The following categories are permitted under special dispensation: i) Small and Medium Enterprises (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 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing documents so that the existence of underlying foreign currency exposure can be clearly established. AD Category I banks, through verification of documentary evidence, should be satisfied about the genuineness of the underlying exposure, 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is different from the currency of the underlying exposure, the risk management policy of the corporate, approved by the Board of the Directors, should permit such type of hedging. b) Where the exact amount of the underlying transaction is not ascertainable, the 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons. c) These transactions may be freely booked and/ or cancelled subject to verification of the underlying. d) All guidelines applicable for cross currency forward contracts are applicable to cross currency option contracts also. e) Cross currency options should be written by AD Category I banks 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The 'Delta' of the option contract would form part of the overnight open position. j) The 'Delta' equivalent as at the end of each maturity shall be taken into account for the purpose of AGL. The residual maturity (life) of each outstanding option contract can be taken as the basis for the purpose of grouping under various maturity buckets 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... absence of such a factor. g) The notional principal amount of the swap should not exceed the outstanding amount of the underlying loan. h) The maturity of the swap should not exceed the remaining maturity of the underlying loan. v) Cost Reduction Structures i.e. cross currency option cost reduction structures and foreign currency -INR option cost reduction structures. 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 tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rrency. c) The notional principal amount of the product should not exceed the outstanding amount of the foreign currency loan. d) The maturity of the product should not exceed the unexpired maturity of the underlying loan. e) The contracts may be cancelled and rebooked freely. 2) Probable exposures based on past performance Participants Market-makers - AD Category I banks in India. Users - Importers and exporters of 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... performance limits once utilised are not to be reinstated either on cancellation or on maturity of the contracts. i) AD Category I banks must arrive at the past performance limits at the beginning of every financial year. The drawing up of the audited figures (previous year) may require some time at the commencement of the financial year. However, if the statements are not submitted within three months from the last date of the financial year, the facility should not 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ident individual has banking relationship, on the basis of an application-cum-declaration in the format given in Appendix G. The AD Category I banks should satisfy themselves that the resident individuals understand the nature of risk inherent in booking of forward contracts and should carry out due diligence regarding " user appropriateness " and "suitability " of the forward contracts to such customer. B II . General Instructions for forex derivative contracts entered by Residents in India While the guidelines indicated above govern specific 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price independently. This is also applicable to the products offered even on back to back basis. The pricing of all forex derivative products should be locally demonstrable at all times. h) The market-makers should carry out proper due diligence regarding 'user appropriateness' and 'suitability' of products before offering derivative products (except forward contracts) to users as detailed in DBOD.No.BP.BC. 86/21.04.157/2006-07 dated April 20, 2007. i) AD Category I may share with the user the various scenario analysis encompassing both the possible upside as well 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 per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te risk on proposed investment in India Products Forward foreign exchange contracts with rupee as one of the currencies and foreign currency-INR options. Operational Guidelines, Terms and Conditions a) In respect of contracts to hedge exchange rate risk on the market value of investments made in India, contracts once cancelled are not eligible to be rebooked. The contracts may, however, be rolled over. b) In respect of proposed foreign direct investments, following conditions would apply: (i) Contracts to hedge exchange rate risk arising out of proposed investment in Indian companies may be allowed to be booked 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 Pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ging of Gold Price Risk Users - i. Banks authorised by the Reserve Bank to operate the Gold Deposit Scheme ii. Banks, which are allowed to enter into forward gold contracts in India in terms of the guidelines issued by the Department of Banking Operations and Development (including the positions arising out of inter-bank gold deals) Purpose - To hedge price risk of gold Products - Exchange-traded and over-the-counter hedging products available overseas. Operational Guidelines, Terms and Conditions a) While using products involving options, it may be ensured that there is no net receipt of premium, either direct or implied. b) Authorised banks are permitted to enter 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 Operation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngaged in import and export of commodities Facilitators: AD Category I banks specifically authorized by the Reserve Bank in this regard. Purpose: To hedge price risk of the imported/exported commodity Products: Standard exchange traded futures and options (purchases only) in international commodity exchanges. If risk profile warrants -may use OTC contracts overseas. Operational Guidelines AD Category I banks satisfying certain minimum norms, and authorized by the Reserve Bank may grant permission to companies listed on a recognized stock exchange to hedge price risk on import/ export in respect of any commodity(except gold, silver, platinum) in the international commodity exchanges/ markets. The guidelines are given in Appendix 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cessary documentary evidence. c) AD Category I banks would require the user to submit a Board resolution certifying Board approved policies which define the overall framework within which derivatives activities should be conducted and the risks controlled. d) All other conditions and guidelines as per Appendix H (A B) should be complied with. (iii) Domestic purchases of crude oil and sales of petro-products Participants Users: Domestic crude oil refining companies. Facilitators: AD Category I banks specifically authorized by the Reserve Bank in this regard. Purpose: To hedge commodity price risk on domestic purchases of crude oil and domestic sales of petroleum products, which are linked to international prices. 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) 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 wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inancial contacts with its parent or subsidiary in the mainland or within the SEZs as far as its import/export transactions are concerned.) NOTE: The detailed guidelines in respect of Delegated Route and Approval Route are given in the Appendix H and I respectively. Section F Freight Hedging Domestic oil refining companies and shipping companies exposed to freight risk, are permitted to hedge their freight risk by the AD Category I banks authorized by the Reserve Bank. Other companies exposed to freight risk can seek prior permission from the Reserve Bank through their AD Category I bank. It may be noted that the role of Authorized Dealer banks here is primarily to provide facilities for remitting foreign currency amounts towards margin requirements from time to time, subject to verification of the underlying exposure. This facility must not be used in conjunction with any other derivative product. The 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ained from the company to this effect. (b) For shipping companies: (i) The hedging will be on the basis of owned / controlled ships of the shipping company which have no committed employment. The quantum of hedge will be determined by the number and capacity of these ships. The same may be certified by the statutory auditor and submitted to the AD Category I bank. (ii) Contracts booked will have to be regularized by production of underlying documents i.e. employment of the ship during the currency of the hedge. An undertaking may be obtained from the company to this effect. (iii) AD Category I banks may also ensure that the freight derivatives being entered into by the shipping companies are reflective of the underlying business of the shipping companies. II) Approval Route Participants Users: Companies (other than domestic oil-refining companies and shipping companies) who are exposed to freight risk Facilitators: AD Category I banks Purpose: To 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 permissi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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