RBI sets up working group for launching currency futures

Mumbai: The Reserve Bank of India (RBI) has set up a working group to suggest a suitable framework for the introduction of currency futures in the country.

The RBI also released the revised report of the internal working group on currency futures, which has suggested a suitable legal and regulatory framework for the introduction of currency futures.

The report has suggested greater flexibility for hedging exchange rate risk, and a suitable framework to operationalise the currency futures market in the Indian context.

The RBI had posted the report on its website on 16 November 2007 for public comments. The review has been done following feedbacks received from the public, banks, market  participants, academicians and the Government of India, the RBI said.

Currency hedging in India is currently limited to the over-the-counter (OTC) products, such as forwards, swaps and options, and the markets for these are quite deep and liquid. However, in the context of growing integration of the Indian economy with the rest of the world, as also the continued development of financial markets, a need has been felt to make available a wider choice of hedging instruments to the market participants to enable them to cope better with their currency risk exposures, the report said.

Select countries like South Africa and South Korea have already introduced currency futures alongside the OTC currency markets and amidst capital controls. A few emerging market economies have also set up currency futures exchanges onshore, even though they retained some controls on the capital account, it said.

India has been experiencing heightened cross-border flows in recent times with globalisation and relaxations in the rules governing external transactions. The flows have been strong on both current and capital accounts. There has also been some increase in volatility in exchange rates due to global imbalances and changing dimensions of the capital flows, the report noted.

According to the Bank for International Settlements (BIS) Triennial Central Bank Survey 2007, the share of India with daily turnover at $34 billion (daily average) has increased from 0.3 per cent in 2004 to 0.9 per cent in 2007, the report pointed out.

 Currency and interest rate swaps are permissible for hedging long-term exposures. The use of these products, however, is subject to certain requirements as laid down in terms of FEMA Notification 25, which normally permits hedging of transactions backed by underlying exposures.

However, as part of capital account liberalisation and simplification of procedures, resident individuals and small and medium enterprises (SME) sector have been granted flexibility in hedging their underlying or anticipated exposures without going through the rigors of complex documentation formalities.

The Committee on Fuller Capital Account Convertibility (FCAC) has observed that internationally, many investors use futures rather than the cash market to manage the duration of their portfolio or asset allocation because of the low upfront payments and quick transactions. Entities also trade in futures with the hope of making profit out of speculation or arbitrage opportunity between the futures market and the underlying market.

By having wide spread membership and bringing together a large number of interested parties, the futures market provides liquidity, making transactions possible and providing immediate information on prices.

Since futures, like any other derivatives are linked to the underlying cash market, its availability improves trading volumes in the cash market as it provides an arrangement for handling risk. Speculative activity also tends to shift risk to a more controlled and organised
market, away from the underlying cash market.

The terms of reference of the group are:

a) To study the product specifications, regulatory frameworks and international experience in respect of currency futures.

b) To study the current legal and regulatory framework in India and suggest changes, if any.

c) To suggest a suitable framework for introduction of currency futures, which could include suggestions on contract design, specifications, maturities/deliveries (months), settlement, expiries, margins, minimum price fluctuations (tick size), accounting norms, etc.

d) To examine the infrastructure requirements for introduction of currency futures.

e) To make suggestions about the entity/entities which would serve as the exchange.

f) To study the constraints if any, imposed by Foreign Exchange Management Act (FEMA), 1999 on the functioning of prospective currency futures exchange.

g) To assess the likely impact of currency futures trading on the prices in the spot and forward markets as also on the effectiveness of intervention (if any) by the Reserve Bank of India.

h) To understand the liquidity implications for the spot market, if any.

i) To examine the desirability of banks becoming members on the exchange.

j) To analyse the risks and benefits of allowing brokers on the exchange and their regulation.

The working group, headed by Salim Gangadharan, has Mridul Saggar, Sumitra Sarangi, G. Ramesh, Andrew Joseph, Indranil Chakraborty, as members.

The group, which held a preliminary meeting today, has invited presentations from a wide cross section of market participants, including existing securities and commodities exchanges in India, Foreign Exchange Dealers' Association of India, Fixed Income Money Market and Derivatives Association of India, Authorised dealers, clearing and settlement agencies, the Chicago Mercantile Exchange, brokers, legal experts, etc.