RBI relaxes norms for margin for derivative contracts and maintenance of Non-resident deposits and accounts

RBI has recently issued two notifications. The first notification is about Margin for Derivative Contracts and the second notification is on an amendment to Master Instructions issued on the maintenance of deposits and accounts under the Foreign Exchange Management Act, 1999.

The first Direction dated May 8, 2024, shall apply to Authorised Dealer Category-I (AD Cat-I) banks and Authorised Dealer Category – III Standalone Primary Dealers (AD Cat-III SPDs).  These dealers can now post and collect margins in and outside India for a permitted derivative contract entered into with a person resident outside India and receive and pay interest on such margin. This rule will also be applicable for a derivative contract between two ADs, provided one of them is a branch of a foreign bank. Authorised dealers will also be permitted to post and collect margins, in India or abroad for their customers doing derivative transactions with a non-resident.

The Authorised Dealers are permitted to;

(i) Post and collect margin, in India and outside India, for a permitted derivative contract entered into with a person resident outside India and receive and pay interest on such margin; and

(ii) Post and collect margin, in India and outside India, for derivative transactions of their overseas branches and IFSC Banking Units and receive and pay interest on such margin.

Further, the Authorised Dealer Category-I banks may post and collect margin, in India and outside India, on behalf of their customers for a permitted derivative contract entered into with a person resident outside India and receive and pay interest on such margin.

The Margin posted and collected in India shall be in the form of:

(i) Indian currency;

(ii) Freely convertible foreign currency;

(iii) Debt securities issued by Indian Central Government and State Governments;

(iv) Rupee bonds issued by persons resident in India which are:

(a) Listed on a recognized stock exchange in India; and

(b) Assigned a credit rating of AAA issued by a rating agency registered with the Securities and Exchange Board of India. If different ratings are accorded by two or more credit rating agencies, then the lowest rating shall be reckoned.

(v) Certificate of Deposits; and

(vi) Commercial Papers which are assigned a minimum credit rating of A1 issued by a rating agency registered with the Securities and Exchange Board of India. If different ratings are accorded by two or more credit rating agencies, then the lowest rating shall be reckoned.

The margin posted and collected outside India shall be in the form of:

(i) Freely convertible foreign currency; and

(ii) Debt securities issued by foreign sovereigns with a credit rating of AA- and above issued by S&P Global Ratings / Fitch Ratings or Aa3 and above issued by Moody’s Investors Service. If different ratings are accorded by two or more credit rating agencies, then the lowest rating shall be reckoned.

With these new directions, foreign investors will find it easy to invest in derivative investments as the Reserve Bank of India has amended the FEMA (Foreign Exchange Management Act) regulation to facilitate margin management for trading in permitted derivatives. The directive is applicable for transactions taking place in or outside India. A similar arrangement will be for derivative transactions undertaken through overseas branches and International Financial Services Centre Banking Units.

It may be noted that under derivative trading, one needs to keep a specific percentage of the value of the outstanding position as cash in his trading account. This specific percentage is commonly referred to as ‘margin money’. This helps minimise the risk exposure for the stock exchanges one trades on.

According to RBI, the meaning of ‘Permitted derivatives contract’ shall be as assigned to it in the Foreign Exchange Management (Margin for Derivative Contracts) Regulations, 2020. They are;

a) Foreign Exchange Derivative Contract undertaken in terms of the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000

b) Interest Rate Derivative Contract undertaken in terms of the Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019

c) Credit Derivative Contract undertaken in terms of notification no.IDMD.PCD.No.10/14.03.04/2012-13 dated January 7, 2013, as amended from time to time, and

d) Any other derivative contract as may be specified by the Reserve Bank;

Second notification:

Reserve Bank of India issued a notification vide reference No. Notification FEMA 5(R)/(4)/2024-RB dated May 6th, 2024, amending the Foreign Exchange Management (FEM) (Deposit) Regulations of 2016.  Under the above notification, an amendment has been made in Regulation 7 of the Foreign Exchange Management (Deposit) Regulations, 2016. A new sub-regulation 6 has been added in Regulation 7 which deals with the ‘Other deposits made or held by authorised dealer’. As per the above notification ADs in India are permitted to allow a person resident outside India to open, hold, and maintain an interest-bearing account in Indian Rupees and foreign currency for posting and collecting margin in India for a permitted derivative contract.

Previously, an Authorized Dealer in India could only allow a Foreign Portfolio Investor and a Foreign Venture Capital Investor, both registered with the Securities and Exchange Board of India (SEBI) under the relevant SEBI regulations, to open and maintain a non-interest bearing foreign currency account. The above amendment to (FEM) (Deposit) Regulations of 2016 will help non-residents in various ways. First, non-residents who wish to participate in derivative contracts permitted under Indian regulations will be able to open and maintain interest-bearing accounts with authorized dealers in India specifically for posting and collecting margins related to these derivative contracts. Second they can earn interest on the funds they maintain in these accounts for margin purposes, instead of keeping the funds idle.