"Mera juta hai jaapaani, ye patalun ingalistaani, sar pe laal topi rusi, phir bhi dil hai hindustani", a famous Raj Kapoor song from the movie Shree 420. Now why am I referring to this song from 1955 is for an article on currency risks. This is because, like Raj Kapoor, even though the heart of the Rupee is in India, significant trading happens in offshore markets such as London, New York and Dubai. In October 2018, Moscow Exchange followed exchanges in Singapore, Dubai, USA, Canada as well as OTC markets in London and New York to offer derivative contracts in the Indian Rupee. Their press release said "USD/INR FX derivatives are one of the most heavily traded FX contracts globally, so the new instrument is a logical addition to our current offering of futures and options.1”
Offshore trading of the Rupee
According to the BIS, an average of US$ 35 bn worth of rupees is traded in India each day, as compared to global trading of US$ 79 billion across international venues of which London NDF market handles US$ 47 bn every day. In 2018, the Bank of England reported US$ 23 billion in offshore rupee trades, while RBI sources estimate deliverable daily onshore forwards at US$ 21 billion for 2019, indicating that rupee’s offshore market has become bigger than the domestic market. Trading in exchanges in Singapore, the US and Dubai have seen volumes soar between the period 2015 and 2019. It is also important to note that when seen in terms of value, the growth is even higher considering the value of INR has moved from 61 in 2014 to 76.5 now. A report by the Futures Industry Association (FIA) says that futures contracts on the US dollar/Indian rupee currency pair are among the top three instruments worldwide by trading volume.
Role of the Regulators in India
The Government and the regulators have been aware of these developments in global markets, and in response the Reserve Bank of India (RBI) announced an eight-member task force headed by its former deputy governor Smt. Usha Thorat to examine issues related to offshore rupee markets and recommend policy measures to ensure stability of the external value of the domestic currency. The task force recommended measures to address concerns arising out of offshore rupee trading besides proposing measures to generate incentives for non-residents to access the domestic market. The key recommendations of the Task Force included extending the onshore market hours and enabling Rupee derivatives (settled in foreign currency) to be traded in the International Financial Services Centers (IFSC) based exchanges.
Why Hedging currency risks is important
The Indian rupee has depreciated to an all-time low of 76.88 against the US dollar, as investors fled to safe haven US dollar amid weakening risk appetite due to the coronavirus pandemic. The INR’s annualized volatility is approximately 8.3% when measured as annualized volatility of monthly percentage changes over the past 25 years. Rupee volatility increases due to external factors such as 2012-13 taper tantrum episode as well as the current coronavirus situation. Thus, currency risk management is vital even if the underlying business is not affected. By not hedging currency risks, participants involved in global trade can run a risk of adversely affecting profits and competitiveness. Currency derivative contracts allow hedgers and investors to take position on change in the foreign exchange rates between pairs of two currencies, such as rupee and dollar. Under the current regulations, participants can take exposure upto a single limit of USD 100 million equivalent across all currency pairs involving INR, put together, and combined across all exchanges, without having to establish existence of underlying exposure.
Hedging Currency Risks at BSE
In India, currency derivatives trading commenced in August 2008, when USD-INR futures were launched at National Stock Exchange (NSE), followed by MSEI (formerly MCX-SX) shortly. Subsequently, SEBI approved trading in currency futures contracts on EUR - INR, GBP-INR and JPY-INR pairs and currency options contracts on USD-INR in 2010. BSE commenced rupee derivative operations much later only in November 2013. Despite this, BSE has taken market leadership position, with gradual increase since 2013 because of superior technology platform and competitive pricing. Participants at BSE can hedge their currency exposure of over INR 20,000 crores per month, at a maximum fee of about INR 3 lakh, making it the most cost-effective platform to hedge currency risks. Hedging at other exchanges for the same underlying value can cost upto INR 18 lakhs. Thus, BSE has enabled cost-effective hedging possible in India. It has also ensured downward revision in fees charged by other leading exchanges. This clearly indicates that presence of competition has not only led to price efficiencies for all, but also diversification of operational risk that multiple liquid trading avenues offer at any point of time.
Rupee Trading at GIFT City IFSC
Till recently, only cross-currency trades were permitted on exchanges situated in GIFT City IFSC. Rupee derivatives were permitted only when the Hon'ble Union Finance Minister Smt. Nirmala Sitaraman, in her budget announcement for 2020 allowed rupee derivatives to be traded in GIFT-IFSC, with an intention to bring all offshore rupee trading onshore. The 3 BSE - PUBLIC Government, soon, published a gazette notification amending the Foreign Exchange Management Act (FEMA) thereby paving the way for rupee derivatives at exchanges in GIFT City. Subsequently, RBI and SEBI, gave permissions to exchanges including India INX to launch Currency Future and Options Contracts involving Indian Rupee.
Union Minister of Finance and Corporate affairs Smt. Nirmala Sitharaman will inaugurate the INR-USD Futures and Options contracts on 8th May 2020, making India INX the first exchange to offer these contracts. They will be cash settled in US Dollars and cleared by India ICC, our Clearing Corporation shall act as Central Counterparty and offer settlement guarantee. All IFSC Banking Units and foreign customers (FPI’s & EFI’s) and trading members can now trade on these contracts and take positions of USD 1 Billion or 15 % of the total open interest, whichever is higher. All eligible foreign investors (EFI's) can open account directly with India INX trading members without any need for PAN, as part of the KYC laid down by SEBI.
India INX provides competitive advantage in terms of no transaction charges levied by the exchange. The IFSC zone offers tax and supportive regulatory framework comparable with any global financial centres. These include waiver of several taxes like transactions, dividend distribution, capital gains and GST. For global participants, India INX offers an opportunity to trade 22 hours a day in contracts traded and settled in USD – making it an ideal offshore gateway to India. This will enable India INX at GIFT IFSC to onshore the offshore rupee-dollar exchange traded derivatives which are presently dominated in global jurisdictions.
Overall, at BSE we believe in offering stakeholders and participants an effective tool from currency market uncertainties along with their underlying exposure in equities and commodities. BSE is dedicated to deepening the Indian capital markets by providing hedgers, traders, investors and all market participants convenient and cost-effective onshore product to hedge their currency risks.