Hedging mandatory for ECBs, says central bank

In a bid to effectively address currency risk at the systemic level, the Reserve Bank of India on Monday said borrowers tapping External Commercial Borrowings (ECBs) will be required to cover the principal as well as the coupon through financial hedges.

In a circular to banks authorised to deal in foreign exchange (designated AD Category-I banks), the RBI said financial hedge for all exposures on account of ECB should start from the time of each such exposure (that is, the day the liability is created in the books of the borrower). The designated AD Category-I banks will have the responsibility of verifying that 100 per cent hedging requirement is complied with.

Hedging is an investment mechanism to cut the risk of adverse price movements in an asset. Usually, a hedge involves taking an offsetting position in a related security.

ECBs are commercial loans – bank loans, securitised instruments (eg. floating rate notes and fixed rate bonds, non-convertible/optionally convertible/partially convertible preference shares/debentures), buyers’ credit, suppliers’ credit, foreign currency convertible bonds, etc – raised by eligible resident entities from recognised non-resident entities.

The RBI said a minimum tenor of one year of financial hedge would be required, with periodic roll-over duly ensuring that the exposure on account of ECB is not unhedged at any point.

Natural hedge (eg, for entities having export earnings), in lieu of financial hedge, will be considered only to the extent of offsetting projected cash flows/revenues in matching currency, net of all other projected outflows. For this purpose, an ECB may be considered naturally hedged if the offsetting exposure has the maturity/cash flow within the same accounting year. Any other arrangements/structures, where revenues are indexed to foreign currency, will not be considered naturally hedged.

The framework for raising loans through ECB comprises three tracks: Track I – medium-term foreign currency denominated ECB with minimum average maturity of three to five years; Track II – long-term foreign currency denominated ECB with minimum average maturity of 10 years; and Track III – rupee-denominated ECB with minimum average maturity of three to five years.