Forex Exchange Derivatives Market Faces Challenges with New RBI Rules

Tanushree Jaiswal Tanushree Jaiswal 5th April 2024 - 12:34 pm
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The Foreign Exchange Derivatives market in India is undergoing a substantial disruption on April 5, due to the implementation of newly announced regulations by the Reserve Bank of India (RBI). It is anticipated that the implementation of these regulations, which mandate an underlying foreign-exchange exposure for currency derivatives trading on stock exchanges, will significantly affect the market, specifically affecting retail traders and speculators, who make up a substantial proportion of the participants.

To comply with new regulations, brokerage firms have notified their clients to terminate their FX derivatives positions prior to a deadline. The move is anticipated to oust most of the most active participants in the market, drying up volumes that had reached $5 billion per day.

The recently implemented regulations are consistent with the Reserve Bank of India's overarching foreign exchange management strategy. Prior to June, when the country's bond markets will be included in global indexes, the RBI has taken measures to restrain fluctuations in the rupee. Globally, the rupee has exhibited one of the lowest levels of volatility among currencies of emerging markets.

For trading in currency derivatives on stock exchanges, the regulation mandates actual foreign-exchange exposure. This provision effectively excludes individual traders and speculators, who account for a significant proportion of the volume therefore, there are apprehensions that a minimum of 70% of the volume will vanish, with half of the market consisting of arbitragers.

Monday's reaffirmation by the exchanges of the circular issued by the RBI on January 5 mandating the requirement caught several market participants with unhedged positions off guard. Following an email to the Commodity Participants Association of India dated March 28 in which the RBI stated that anyone entering such contracts without an actual exposure would be in violation of foreign exchange regulations, the clarification was issued.

Nuvama reports that the effects of the new regulation will become apparent within the following month. “This underlying requirement will effectively eliminate volume in currency derivatives," said HDFC Securities Ltd. currency strategist Mr. Dilip Parmar.

The development in question refers to new regulations that require clients to terminate their FX derivatives positions prior to a deadline. This move is expected to remove a significant portion of the most active participants in the currency derivatives market on stock exchanges, effectively putting an end to retail traders' currency derivative trading. Regulatory risk is highlighted as the most significant peril for stockbrokers, as brokerage firms have the right to suspend or terminate services, and clients are responsible for any losses or financial charges resulting from the liquidation or closing out of positions.

Users will be permitted to liquidate existing currency positions beginning April 4, but will not be permitted to enter new positions. In order to assume new positions, individuals will be required to submit the declaration form.

Since September, when JPMorgan Chase & Co. made a seminal announcement, foreign funds have poured into the nation's bond markets. It is anticipated that the new regulations will reduce currency volatility. The governing body has amassed an unprecedented $643 billion in foreign exchange reserves as a safeguard against external disruptions.

Also check our Web-stories on No change in FX derivatives stance by RBI

To Summarize

Tt is anticipated that the Foreign Exchange Derivatives market in India will be profoundly affected by the new RBI regulations, especially as they pertain to retail traders and speculators. It is anticipated that the majority of the market's most active participants will be compelled to withdraw, resulting in daily volumes of $5 billion. Over the next month, the market's reaction to the novel regulatory landscape will be determined, and the rule's effects will become apparent.

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