The Hindu Business Line : RBI moves forward on currency futures exchange

At a glance
Currency futures to enable better price discovery, greater transparency in pricing of hedges,
Currently, the only available hedges are over the counter (OTC), mostly forward rates or options..
To widen participation to smaller corporates, SMEs that have exchange rate exposures.

Our Bureau

Bangalore, April 29 In a bid to improve price discovery mechanisms and bring greater transparency, the Reserve Bank of India has proposed to prepare the framework for a currency futures exchange in consultation with the Securities and Exchange Board of India (SEBI).

Currency futures are expected to be introduced in the eligible exchanges, once the framework is finalised by May-end. A RBI-SEBI standing committee has been set up to advise on the operational aspects of currency futures.

The currency futures exchange received mention in the Finance Minister’s Budget speech. The mechanism essentially allows importers, exporters and any entity with foreign currency exposures to buy hedges through an exchange. A currency futures is a foreign exchange contract, allowing for buying or selling a currency at a future date on the basis of an exchange rate that is fixed only on the last trading day. The future date is also referred to as the settlement date.

Currently, the only available hedges are over the counter (OTC), mostly forward rates or options. Pricing of OTC hedges, however, is not transparent. Exchange traded currency futures are intended to bring about greater transparency in the pricing of hedges. Besides, the mechanism is also intended to aid price discovery of hedges. The exchange is also expected to broadbase the markets. At present only large corporates use hedging tools for covering their foreign currency risks.

Introduction of the futures exchange is intended to widen the participation to smaller corporates, small and medium enterprises that have exchange rate exposures. Users are also expected to include corporates with the cross border liabilities – external commercial borrowing. The RBI’s working group pointed out that full convertibility was not a necessary criterion for introduction of futures. Countries such as Korea and South Africa with capital controls, have already introduced future exchanges.

Besides, the Credit Policy announced a separate settlement arrangement for OTC-traded rupee derivatives. The settlement of the derivatives is proposed to be done through the Clearing Corporation of India Ltd (CCIL). Rupee interest derivatives allow hedging for interest rate risks, by banks and corporates. The interest rates are usually in the form of swaps between fixed and floating rates of interest.

STRIPS soon

The RBI’s Credit Policy also initiated the introduction of Separate Trading of Registered Interest and Principal of Securities (STRIPS). Introduction of STRIPS has been in the offing for quite some time, though it is yet to find favour among the major institutional participants. STRIPS refer to removing the coupon cash flows of government securities and securitising them into separate instruments, particularly in the case of securities in the held to maturity category of investments. STRIPS, the bankers said, would allow for improving the liquidity in the debt markets.

Lack of depth

However, bankers said, that among the major issues involved was the continued lack of depth in the debt markets. This implied that the number of players in the debt markets is still dominated by the banks and large institutions such as Life Insurance Corporation of India. Besides, there were also other issues involved. This included the eligibility of STRIPS of G-Secs as part of the Statutory Liquidity Ratio. Moreover, bankers said grey areas included stamp duties. Currently, G-Secs are exempted from stamp duties. Bankers said, they were not sure, whether coupon strips would be eligible for such benefits.