RBI revises Master Direction on FX Risk Management and Interbank Dealings

RBI on Friday (January 5, 2024) issued revised Master circular in respect of Foreign Exchange Derivative Contracts, Overseas Commodity & Freight Hedging, Rupee Accounts of Non-Resident Banks and Inter-Bank Foreign Exchange Dealings etc. These directions lay down the modalities as to how the foreign exchange business has to be conducted by the Authorised Persons with their customers / constituents with a view to implementing the regulations framed.

The revised directions shall come into effect from April 05, 2024, replacing the existing Directions in Part A (Section I) of the Master Direction – Risk Management and Interbank Dealings dated July 5, 2016.

According to the amended direction, Authorised Dealers (ADs) may offer foreign exchange Cash, TOM, and Spot contracts, involving INR or otherwise, to retail and non-retail users for permissible current or capital account transactions. They may also offer deliverable foreign exchange derivative contracts involving INR to users for hedging. (Note: Money-changing transactions are not in the scope of these Directions and shall be governed by the Master Direction – Money Changing Activities dated January 01, 2016, as amended from time to time, or any other rule, regulation, or Direction issued in this regard).

As per the direction, there is no restriction to ADs to offer deliverable and non-deliverable foreign exchange derivative contracts not involving INR to users. They may offer foreign currency interest rate derivatives to users without any restriction in terms of purpose. Further, there is no restriction to offer currency swaps to resident users, other than individuals, to convert their INR liability into a foreign currency liability. However, in the case of resident retail users, such conversion shall be subject to the existence of a natural hedge.

Authorized Dealer Category-I banks with an operating IFSC Banking Unit may offer a Non-deliverable derivative contract (NDDC) involving INR to resident users for hedging and to non-resident users without any restriction in terms of purpose. Derivatives allow investors to hedge against price fluctuations, speculate on market movements, diversify portfolios, and enhance overall risk management strategies.

While offering a foreign exchange derivative contract involving INR to a user, other than Non-deliverable derivative contract (NDDC) involving INR offered to non-resident users, and during the life of such contracts, recognized Stock Exchanges shall provide a facility to users intending to take position beyond USD 100 million (or equivalent) in contracts involving INR, in all exchanges put together, to designate an Authorised Dealer / Custodian to monitor transactions of the user to ensure that:

(i) All positions of the user in all contracts involving INR, across all the Recognized Stock Exchanges put together are backed by contracted exposure;

(ii) The same exposure has not been hedged using any other derivative contract;

(iii) The notional amount and tenor of the derivative contract does not exceed the value and tenor of the exposure;

(iv) In case the exposure ceases to exist, in full or in part, the user has appropriately adjusted the hedge to ensure adherence to (iii) above, unless the original derivative contract is assigned against any other unhedged exposure. No adjustment to the hedge is required to be made if, in the considered opinion of the Authorised Dealer, the change in exposure is not material;

(v) In cases where the value of the exposure falls below the notional of the derivative, the notional should be suitably adjusted unless such divergence has occurred on account of changes in the market value of the exposure, in which case the user may, at his discretion, continue with the derivative contract till its original maturity. No adjustment to the hedge is required to be made if, in the considered opinion of the Authorised Dealer, the change in exposure is not material;

(vi) Where the value of the exposure is not ascertainable with certainty, derivative contracts may be booked based on reasonable estimates. Such estimates should be reviewed periodically to ensure compliance with (iv) and (v) above.

However, the  Authorised Dealers (ADs) shall permit users to take position up to USD 100 million equivalent of notional value (outstanding at any point of time), across all Authorised Dealers, for hedging contracted exposure without the requirement to establish the existence of underlying exposure.  Further, ADs shall inform users that while they are not required to establish the existence of underlying exposure, they must ensure the existence of a valid underlying contracted exposure that has not been hedged using any other derivative contract and should be in a position to establish the same, if required.

User Classification Framework:

While offering foreign exchange derivatives contracts and foreign currency interest rate derivative contracts, ADs shall classify users as retail or non-retail users.

Retail user:

Any user who is not eligible to be classified as a non-retail user shall be classified as a retail user.

Note: Any user who is otherwise eligible to be classified as a non-retail user shall have the option to get classified as a retail user.

 Non-retail users:

The following types of users are classified as Non-retail users:         

(a) All India Financial Institutions (AIFIs) and Non-Banking Finance Companies (NBFCs) (including Standalone Primary Dealers (SPDs) and Housing Finance Companies (HFCs));

(b) Insurance Companies regulated by the Insurance Regulatory and Development Authority of India (IRDAI);

(c) Pension Funds regulated by the Pension Fund Regulatory and Development Authority (PFRDA);

(d) Mutual Funds and Alternative Investment Funds regulated by the Securities and Exchange Board of India (SEBI);

(e) Resident users with (a) minimum net worth of ₹500 crore; or (b) minimum turnover of ₹1000 crore, as per the latest audited financial statements; and

(f) Persons resident outside India other than individuals.

Note: Any user who is otherwise eligible to be classified as a retail user shall have the option to get classified as a non-retail user subject to the condition that the user makes a request to an AD in this regard and the AD is satisfied that the user has the risk management capabilities suitable for classification as a non-retail user.

Readers may refer to RBI circular RBI/2023-24/108 -A. P. (DIR Series) Circular No. 13 dated 05.01.2024 for detailed clarification.