21 January 2016 14:28:48 IST

The fall and rise of exchange-traded currency derivatives


Businesses must be nimble in hedging forex positions, and the regulator’s moves will help

The rupee is making headlines once again. It closed below 67 (on a weekly basis) for the first time in its history, last week. The recent bout of volatility is due to the ongoing turbulence in China and the falling price of crude oil. But rupee volatility is now becoming a norm. This makes it imperative for businesses with foreign currency exposure to hedge their positions.

Initially, there was just the inter-bank foreign exchange market that was an over-the-counter market. That is, you had to go to the bank and ask for a quote to buy or sell foreign currency. The price quoted to you over the counter by the bank employee was the one you had to settle for.

This created many problems, especially for smaller businesses, which were sometimes short-changed by banks. The RBI, therefore, introduced Exchange Traded Currency Derivatives (ETCD) in association with the Securities Exchange Board of India (SEBI) in 2010 to create a more transparent channel for small businesses to hedge their currency exposure.

But in the wake of the currency crisis in 2013, the RBI had to clamp down on the ETCD segment as these instruments were used by currency manipulators to hammer down the rupee. With stability returning post-September 2013, the RBI again went all out to revive this segment.

Ups and downs

In India, exchange-traded currency derivatives include futures on the dollar-rupee, euro-rupee, yen-rupee and pound-rupee that are currently traded on the National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and Metropolitan Stock Exchange of India (MSEI, earlier called as MCX-SX). Options are available on only the dollar-rupee pair.

The rupee crashed to its life-time low of 68.85 in July 2013 and, in August, the RBI had to impose numerous curbs on the currency derivatives segment. It banned banks from conducting proprietary trades in currency derivatives. This ban led to currency derivative volumes falling sharply by about 40 per cent in just one month as banks are the major participants in this segment. But as the rupee recovered from its all-time low of 68.85 to 60 levels by May 2014 and started to stabilise around 60 levels, the central bank revoked the ban in June 2014.

Measures to resuscitate

The RBI went one step ahead and allowed the foreign portfolio investors (FPIs) to participate in the currency derivates market. The FPIs were allowed to take positions up to $10 million in currencies without having any underlying exposure. Earlier, only resident Indians were allowed to participate in the ETCD market. Similarly, domestic participants were also allowed to take position up to $10 million per exchange without establishing any underlying exposure.

Last year, the central bank increased the limit for the FPIs in USD-INR pair up to $15 million from $10 million. In addition, FPIs were also allowed to take positions in the other three rupee futures (EUR-INR, JPY-INR and GBP-INR) of up to $5 million per exchange.

Recently, the RBI has allowed cross-currency futures in euro-dollar, dollar-yen and pound-dollar and exchange-traded currency options in euro-rupee, pound-rupee and yen-rupee. While this move will facilitate direct hedging of exposures in foreign currencies, it will also give a fillip to volumes.

Longer sessions

SEBI and the RBI are currently in talks to extend the trade timings on currency derivatives. The ETCD market is now open from 9 am to 5 pm. There is a proposal to extend the timing to 11.30 pm. Extending the trade timing in currencies will be a good move as the major economic news that comes out of the US can then be factored into the prices immediately. Since the currency market closes at 5 pm, any important data from the US that comes after that makes an impact on the currency only the next day. This results in large gaps in the opening price of the rupee.

Globally, currencies are traded round the clock — it is a 24-hour market. The move to extend the currency derivative trade timings will align the Indian currency market more closely with the rest of the world.