Currency futures volumes key to RBI plan on FIIs’ forex hedging

MUMBAI: The Reserve Bank of India’s plan to allow foreign institutional investors (FIIs) to hedge their foreign exchange positions may not gain steam unless the market for currency futures returns encouraging volumes. The RBI is expected to come out with the final modalities shortly.

“When FIIs are finally allowed to hedge in currency futures, it will be an extra avenue for them to hedge their exposure,” said Anindya Das Gupta, MD, Barclays Bank. “They have to see their total hedging costs as they are already doing it in over-the-counter (OTC) market. Initially, volumes may not be very high as liquidity and volumes in currency futures market have gone down.”

FIIs have already been hedging their currency exposure in the OTC market to an extent, but in many cases they do not hedge the risk fully as the cost of hedging affects their investment returns. When an investor or customer transacts with a bank at an individual level to protect his or her currency risk, it is called OTC hedging which is not exchange-traded derivatives, like futures.

Hedging in the currency futures through exchanges is considered as a safer bet with ‘margin call’, a mechanism to ensure smooth settlement process of future contracts that asks for security deposits. Corporations and individuals trade in futures to mitigate the currency fluctuation risks. “Liquidity in futures market would be driven by importers and exporters rather than banks as well as retail participation,” said Harihar Krishnamoorthy, head treasurer, FirstRand Bank. “Its popularity depends on the depth of the market as well as finer pricing and impact costs.”

“Most banks have very small net open positions (NOPs), which are not closed overnight. What you see coming in markets are importer and exporter outflow/ inflows,” he said. NOP is the difference between buying/selling and selling/ buying positions. Small net open positions imply that long and short positions are almost matched with balanced requirements from bank clients.

The RBI proposed to allow all resident individuals, firms and companies with actual foreign exchange exposures to book foreign exchange derivative contracts up to $250,000 on declaration, subject to certain conditions. In July 2013, regulators the Securities Exchange Board of India and the RBI had imposed stricter curbs amid high volatility in exchange rates. Those measures included doubling of margin requirements and ceiling on position limits on exchangetraded currency futures. That led to currency futures volumes declining with more than 60% drop in the daily average turnover per month. The capital market regulator on April 7 has issued a circular restoring the margins for USD-INR contracts to pre-July 8, 2013 rates.