Open interest contracts fall 47% despite RBI’s deadline extension

As per FEMA regulations of May 3, 2000, though clients are not obliged to furnish evidence of underlying exposure for positions upto $100 mn, but clients must ensure the existence of such exposures. RBI in 2014 had issued similar instructions with limits upto $10mn, but did not implement it seriously - Anil Kumar Bhansali, Head (Treasury) & ED, Finrex Treasury Advisors, tells Bizz Buzz

Mumbai: Even as the RBI extended the April 5 deadline for meeting currency derivatives norms, Open Interest (OI) in currency derivatives contracts on the exchanges fell around 47 per cent during the past fortnight. New instructions from RBI will be applicable from May 3.

When currency futures were launched on August1, 2008, the stance of RBI in its circular was that the transactions in dollar-rupee currency futures were permitted to hedge an exposure to foreign exchange (forex) rate risk or otherwise. The reason was that most participants avoided taking fresh positions and continued to unwind their existing contracts.

Open Interest is the total number of outstanding derivative contracts for an asset-such as options or futures-that have not been settled.

The circular sent in January applicable from April 5 clearly says that recognised stock exchanges may offer foreign exchange derivatives contracts involving rupee to users for the purpose of hedging contracted exposure and those derivatives contracts not involving rupee without any restriction.

Talking to Bizz Buzz, Anil Kumar Bhansali, Head (Treasury) and Executive Director, Finrex Treasury Advisors, said: “They also gave a caveat sighting FEMA regulations of May 3, 2000 schedule IA1a (the authorised dealer through verification of documentary evidence is satisfied about genuineness of underlying exposure) that though clients are not obliged to furnish evidence of underlying exposure for positions upto $100 million, but clients must ensure the existence of such exposures. RBI in 2014 had issued similar instructions with limits upto $10mn, but did not implement it seriously.”

The transactions in exchange were done by clients from the retail segment who could not transact in OTC (over the counter) as banks asked for the underlying there, and they did not have any underlying for the transactions. These trades formed 80 per cent of the total transactions and were the source of liquidity in the exchange traded currency futures.

By the above circular RBI has decided to curb trades on exchanges and this has the potential to virtually kill the trading on exchanges since the liquidity came from Retail and may not be available henceforth since retail does not have underlying.

Stock exchanges have meanwhile sought clarifications from RBI on the above circular, but have stopped new trades completely without underlying/certificate of having an underlying which needs to be produced when exchange asks for it. A few brokers have asked clients to close all trades while others have allowed existing trades to continue, while no new trades are to be concluded.

RBI, at its press conference on April 5, said that the underlying clause was always there and that positions in exchange were to be taken based on underlying only. This has also been clearly mentioned in circular of 2014.

Before the RBI policy, most brokers had asked their clients to submit an underlying letter or close their trades. With positions mostly from short side the buy side volumes spiked up and traders had to cut positions in losses. Rupee traded at 83.45 until RBI sold dollars, extended due date to May 3, and calmed the market through press conference.

However, the damage had been done as after positions got squared, the Open Interest began to fall, with low volumes spreads have increased and there are hardly any market makers. It looks like a virtual death knell for exchange futures unless RBI and Sebi come up with a new plan to revive the currency futures segment. A number of broking houses will also have to shut shop due to this.

According to the National Stock Exchange of India (NSE) data, Open Interest contracts fell to 33,18,699 on April 8, from 62,59,762 on March 27.

People have been trading in forex without any underlying exposure. Underlying exposure is either export receivables or import payables. Since it was not mandatory to present the documents to the bankers or the exchange those who did not have the merchandise exposure also traded heavily because it was a good opportunity to make money.

RBI in a recent clarification said that there is no need to submit the documents, but only those who have merchandise exposure alone could take positions. RBI also clarified that the position was the same earlier also.

Therefore, it is not possible now to indulge in currency trading without underlying exposure.That is the reason why there is a fall on contract and unwinding of existing contracts. This will continue till all the excess contracts are eliminated, said a forex expert on condition of anonymity.

Speculative building of positions in cash, forward or derivatives clouds the change rate discovery process by building up long and short positions without any basis in trade or investments.