According to several brokers who spoke to news agency Reuters, the soon-to-be-implemented regulation by the Reserve Bank of India (RBI), stipulating that exchange-traded rupee derivative transactions can only be used for hedging purposes, is expected to lead to a significant decline in volumes, potentially plunging by more than 80 percent, dealing a major setback to the segment.
Brokers have expressed concerns since the regulation was proposed in January, fearing that many proprietary traders and individual investors, who account for over three-quarters of the volume, may struggle to meet the underlying exposure requirement.
Arnob Biswas, head of forex research at SMC Global Securities, stated, “Once this rule comes into effect, we expect a more than 90 percent fall in our volumes. The market volumes will likely drop by a similar margin.” He added that from their perspective, the market is practically over, at least for the time being.
The central bank’s regulation will limit exchanges to offering forex derivative contracts involving the rupee solely for hedging purposes, compared to the current allowance of up to $100 million without explicit underlying exposure.
An anonymous source familiar with the central bank’s thinking mentioned that small clients typically use the forward market via banks for hedging currency exposures and will always have an underlying. The rule, effective from April 5, was reiterated by exchanges on Monday following concerns raised by brokers about its impact on volumes.
Anindya Banerjee, head of research for FX and interest rates at Kotak Securities, commented, “The unintended consequence of this will be that liquidity will dry up significantly, and the small and medium-sized companies – the hedgers – will lose access to risk management tools.”
USD/INR April futures open interest dropped by $833.6 million, or 18.5 percent, on Tuesday. An official at a large brokerage noted that only a small portion of their clients, including corporates and foreign portfolio investors, would be able to meet the hedging specification.
According to a recent publication by NSE, corporates accounted for just 3.9 percent of the currency derivatives turnover based on notional turnover in February, while foreign investors contributed 6.2 percent. Proprietary traders and individual investors were responsible for 80 percent of the turnover.
The official further mentioned that hedging activity for foreign investors might shift to the local over-the-counter and non-deliverable forward markets. Biswas from SMC remarked, “This is completely unforeseen, and it is difficult to understand what brought this on.”
Exchange-traded rupee derivatives, introduced in 2008, have witnessed a significant increase in average daily trading volumes on dollar/rupee futures, climbing to $2.5 billion from $142 million in 2008, making it a crucial segment for India’s forex markets.
