Foreign portfolio investors (FPIs) are in a bind over the new currency derivatives diktat from the Reserve Bank of India.

From April 5, all market participants will have to declare any underlying position in the currency derivatives market, even if it is for a single lot, or square-off all the positions.

FPIs were allowed to participate in exchange-traded currency derivatives (ETCD) from 2014 and a framework was designed to allow them to take long or short positions in all currency pairs up to a single limit of $100 million combined across all recognised stock exchanges, without the need to establish “underlying exposure” in the form of equities, bonds, mutual funds, or any other permissible financial instruments.

FPIs, along with other market participants, have played a major role in bringing liquidity to the ETCD contracts listed on the bourses, said experts. Some of these investors will be compelled to square off their positions before April 5; they would face penal action if they fail to do so. Custodians who handle trades for these investors have reached out to the RBI for clarity on the matter.

“FPIs who have no underlying positions, as well as foreign brokers who have set up their India shop for prop or high frequency trading and have taken a view on the market without an underlying, will have to square off their positions,” said an industry official.

Proprietary traders account for about 60 per cent of gross turnover in the currency derivatives market, while FPIs contribute 5-6 per cent.

“The FPI community is confused as they are unclear on the course of action to be taken. Some of the large hedge funds, and quant-based funds participate actively in the ETCD market and may have sizeable positions as we speak. In the absence of any clarity, they would have to square off their positions before April 5,” said Anand Singh, Founder and Chief Executive Officer, Elios Financial Services.

There has been a significant drop in open interest across major currency pairs in the past few days as most of the open positions in the March expiry didn’t get rolled over to April. The total open interest in USD-INR for the April 26 monthly contract, for instance, stood at 45,17,268 as on March 28. As on April 3, the open interest has reduced to 31,42,470, a 30 per cent drop. The open interest may drop by 60-80 per cent by April 6, said experts.

The market is looking at a scenario where are no speculators or arbitrageurs, but only hedgers. Hedgers in the market include exporters, importers and FPIs. Banks and brokers are the market makers.

“Given the RBI circular, if banks and brokers move out, the supply side as well as demand will go out. So, indirectly, the exchange traded currency derivatives market will see huge outflows,” said the official quoted above.

“If net FPI flows in India are positive and the net Indian current account is in deficit, the risk is that of the Indian currency depreciating. The hedges will always be long foreign currency and short rupee. Hence, the net positioning in USD-INR will always be long (exchange traded and OTC combined),” added Singh.