The Hindu Business Line : OTC derivative contracts may soon get legal validity

OVER the counter (OTC) derivative transactions linked to interest rates, foreign exchange credit and loan may soon get legal validity. The Standing Committee on Finance that went into the Reserve Bank of India (Amendment) Bill, 2005, has endorsed the measures proposed for this purpose.

Legal validity is to be granted to certain OTC derivative contracts that would also involve a RBI regulated entity as one of the parties to the transaction.

As there is no specific legal validity for such OTC derivative contracts, the RBI has so far not been able to participate in interest rate swaps and options (in the international markets) to cover its risk. Apart from giving legal validity to certain OTC derivative contracts, the Bill would also enable the RBI to deal in derivatives.

At present, only derivative transactions that are traded in `a recognised stock exchange' are legal and valid (in terms of the Securities Contracts (Regulation) Act). OTC derivative contracts are excluded from the purview of the Securities Contracts Regulation Act.

The RBI (amendment) Bill, when enacted, would also empower it to lay down policy and issue directions to any agency dealing in various kinds of contracts in respect of Government securities, money-market instruments and derivatives and so on.

The Parliamentary panel has, in its report on the RBI (Amendment) Bill 2005, said that it expects that adequate care would be taken, while formulating the policy measures/regulatory framework for OTC derivative contracts, to ensure that there is no scope for ambiguity, particularly in regard to jurisdictional aspects relating to validation of such transaction.

It said that adequate care is required in view of the fact that following the enactment of the present legislation there would be two statutes governing derivative transactions — the Securities Contracts Act for exchange traded derivative transactions and the Reserve Bank of India (RBI) Act for OTC derivatives, which involves a Reserve Bank regulated entity as a party.

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