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Risk Management and Inter-bank Dealings: Hedging of foreign exchange risk by Residents and Non-Residents - Liberalisation


A .P. (DIR Series) Circular No.

February , 2019

All Category - I Authorised Dealer banks

Madam / Sir,

Risk Management and Inter-bank Dealings: Hedging of foreign exchange risk by Residents and Non-Residents - Liberalisation

Attention of Authorized Dealers Category – I (AD Category – I) banks is invited to the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 dated May 3, 2000 (Notification No. FEMA. 25/RB-2000 dated May 3, 2000), as amended from time to time and Master Directions on Risk Management and Inter-Bank Dealings dated July 5, 2016, as amended from time to time.

2. As announced in the Statement on Developmental and Regulatory Policies February, 2018 and August, 2018, the existing facilities for non-residents and residents to hedge their foreign exchange risk on account of transactions permitted under FEMA, 1999 have been revised. The revised directions are provided at Annex – I to this circular. All previous operational guidelines, terms and conditions in this regard stand withdrawn.

3. Necessary amendments (Notification No. FEMA /2018-RB dated ____, 2018) to Foreign Exchange Management (Foreign Exchange Derivatives Contracts) Regulations, 2000 (Notification No. FEMA.25/RB-2000 dated May 3, 2000) (Regulations) have been notified in the Official Gazette vide G.S.R. No. ___ (E) dated ______, 2018, a copy of which is annexed to this circular. These regulations have been issued under clause (h) of sub-Section (2) of Section 47 of FEMA, 1999 (42 of 1999).

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 without prejudice to permissions/ approvals, if any, required under any other law.

Yours faithfully,

(T Rabi Sankar)
Chief General Manager

Annexure - I

1. Definitions:

i. Anticipated exposure - An exposure to the exchange rate of Rupee against a foreign currency on account of current and capital account transactions permissible under FEMA, 1999 or any rules or regulations made thereunder, which are expected to be entered into in future.

ii. Contracted exposure - An exposure to the exchange rate of Rupee against a foreign currency on account of current and capital account transactions permissible under FEMA, 1999 or any rules or regulations made thereunder, which have already been entered into.

iii. Hedging - The activity of undertaking a derivative contract to offset the impact of an anticipated or a contracted exposure.

iv. Users – Any person as defined under para 2 (u) of FEMA, 1999 whether resident in India or resident outside India.

2. Directions for Authorised Dealers:

A. General directions

i. Authorised dealers shall classify a user as per the User Classification Framework provided at Annex II of this circular and shall comply with the guidelines applicable in each case.

ii. Authorised dealers shall offer derivative contracts to a user as per the user’s classification in para (i) above. While offering contracts involving Rupee, 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 another derivative contract.

  4. In case the exposure ceases to exist, fully or in part, the notional of the related contract has been appropriately reduced by the user, unless it is assigned against any other unhedged contracted or anticipated exposure.

  5. In cases where the value of the exposure falls below the notional of the derivative, the derivative should be suitably adjusted unless such divergence has occurred on account of change in 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 the 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 case of part delivery, net gains will be transferred on a pro-rata basis.

iv. All derivative contracts shall be subject to the Suitability and Appropriateness policy of the circular on Comprehensive Guidelines on Derivatives (as amended from time to time).

v. Authorised 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 Rupee.

vi. Authorised dealers may call for such documents from the eligible users as they deem necessary for complying with the requirements of para 2 A (ii).

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

viii. Existing contracts booked under the provisions of the earlier circular may be continued till the date of its expiry. The user may also be permitted to continue booking contracts under the provisions of the earlier circular for a period of 3 months from the date of this circular.

B. Specific Directions

i. Authorised dealer banks may offer foreign exchange derivative contracts to a user upto USD 1 million and with whom they have a banking relationship. Para 2 (A) (ii) of this circular shall not be applicable in such cases.

ii. Authorised Dealers may deal with the non-resident user (or its central treasury, 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.

iii. In case of a central treasury of a non-resident user, the Authorised Dealer shall ensure that the central treasury is appropriately authorised by the user to deal for and on its behalf.

iv. Authorised 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:

i. Exchanges authorised by RBI to offer currency derivatives shall provide facility to users, intending to take position beyond USD 100 million (or equivalent) in contracts involving Rupee in all exchanges put together, to designate an Authorised Dealer.

ii. For users referred to in the previous para, 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.

Annexure – II

User Classification Framework

1. User Classification:

i. 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.

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

  1. Insurance companies

  2. Mutual Funds, Pensions Funds and other collective investment schemes

  3. Entities regulated by RBI

  4. Exim Bank, NABARD, NHB and Small Industries Development Bank of India (SIDBI)

  5. Companies meeting any one of the following:

    1. Listed on an exchange in India or any FATF compliant jurisdiction

    2. Net worth of ₹ 200 crores or equivalent

    3. The notional amount of the user’s outstanding foreign exchange derivatives exceeded USD 250 million or equivalent at any point in each of the previous 4 quarters.

  6. Foreign banks, central banks, international and supranational institutions and similar international organisations

  7. Foreign institutions whose main activity is to invest /transact in financial instruments

iii. 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:

i. Eligible products – Forwards, purchase of call and put options (Only European options), purchase of call and put spreads, swaps.

ii. All contracts with retail clients shall be executed at the ongoing interbank / market rates and shall be time stamped.

iii. All applicable fees / commissions / service charges etc. related to the contract shall be charged by the authorised dealer separately and shall not be part of the price of the contract.

3. Directions in case of non-retail users:

i. Eligible products – Any derivative contract, which the authorised dealer can price and value independently and is approved by the board of the authorised dealer, provided that the same is not a leveraged derivative.

Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 - Draft