Foreign portfolio investors (FPIs) are in a bind over the new currency derivatives diktat from the Reserve Bank of India (RBI), even as the deadline for the applicability of the circular has been extended from April 5 to May 3.

Some of the investors will be compelled to square off their positions before May 3 or face penal action from the regulator. Custodians who handle trades for these investors had reached out to the RBI for clarity.

Deadline extension

On Thursday, the RBI deferred the applicability of the circular to May 3 from April 5. However, the central bank reiterated that both over-the-counter and exchange-traded currency derivative (ETCD) contracts involving the rupee are permitted only for the purpose of hedging exposure to foreign exchange rate risks and that users are required to have underlying exposure.

FPIs were allowed to participate in 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 an “underlying exposure.”

“FPIs who have no underlying exposure 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 exposure 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.

FPI dilemma

“The FPI community is 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 a sizeable position, which may have to be squared off before May 3,” said Anand Singh, Founder and Chief Executive Officer, Elios Financial Services.

There has been a drop in open interest positions across major currency pairs in the past few days. The total open interest in the USD-INR pair for the April 26 monthly contract stood at 31,42,470 as of April 3, a 30 per cent drop over three days.

The market is staring at a scenario where there would be no speculators or arbitrageurs and only hedgers. Hedgers include exporters, importers, and FPIs. Banks and brokers constitute the market makers.

“If banks and brokers move out, the supply side as well as the 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.

Amit Pabari, Managing Director, CR Forex Advisors, said the postponement of the circular will resolve the confusion and panic in the exchanges and suppress the volatility in the exchange-traded options of the Indian rupee.

“The option premiums had spiked multifold recently. Brokers are requiring clients to demonstrate underlying exposure or unwind their positions, adding pressure to the rupee. Once the panic subsides, the pressure from the rupee will also be released,” added Pabari.

“Overall, the circular aims to maintain consistency in the regulatory approach towards ETCDs involving the INR while enhancing operational efficiency and ensuring compliance with hedging practices,” Pabari said

(With inputs from K Ram Kumar)