As per the market expectations, another long pending financial reform issue on currency futures trading has been approved by the government. Launch of trading in currency futures has come at such a time when several Indian corporates have burnt their fingers in another version of currency derivative called Over the Counter (OTC) products few months back, and the issue has turned into a legal battle between suffered companies and banks involved.

Though currency futures products like currency swap, currency forwards and currency options were already allowed to corporates in India after Reserve Bank of India's (RBI) circular as on April 2007, but they were not traded on any recognised exchanges in India and were available like OTC products only.

As per an official gazette of Government of India (GOI), which is available on RBI's site, a person who is resident of India can now hedge his currency risk by using advanced and complex derivatives like currency forwards, currency swaps and currency options not only through OTC products but also through exchange traded currency futures products.

With increased depth of foreign exchange market, which has reached to a daily turnover of $30.0 billion as on March 2007 from $27.0 billion in March 2006, it was felt that there should be some measures to protect the corporates from excess volatility in foreign exchange market, which otherwise would impact export performance and balance sheet of the companies and the country too.

More so, in an era when Indian companies are buying foreign companies and are going abroad for availing loans/funds there's an increased exposure of corporate India to various currencies of the world, in which they have to make payment or receive payments. In this direction this step of government, RBI and Securities and Exchange Board of India (SEBI) is a welcome move, which will create a full fledged foreign exchange derivative market in India and will bring India nearer towards capital account convertibility.

What is this new exchange traded currency option?

Exchange traded currency futures will work just like future and options (F&O) in stock. Only difference is that in case of stock future and option, the underlying are stocks while in case of currency futures and options underlying will be various currencies of the world. This new scheme will provide the provision to trade currency future and options to recognised exchanges, same as stock future and options are being traded on National Stock Exchange (NSE) or Bombay Stock Exchange (BSE).

How the OTC currency futures differ from exchange currency?

Though OTC future and options in currencies had same economic purpose as the newly introduced exchange traded currency futures and options, there is fundamental difference between the two.

If you have booked a currency forward (OTC) say US dollar- Indian rupee (INR) at certain rate then on maturity of forward contract, the obligations of individuals (forward purchaser and forward seller) equals forward price, at which contract was executed. So in case of OTC forward currency contract except on maturity, no money changes hands. While with the help of third party, ie clearing corporations of exchanges, on which contract will be traded, coming into picture between currency option, purchaser and currency option seller, there will be daily mark-to-market settlement between buyer and seller of contract based on the daily movement of prices of underlying currencies.

Hence, the exchange traded currency future will ensure that there will be no incidents of Indian corporates suffering due to unfavourable movements of currency rates in between option booking date and option expiry date since daily mark-to-market mechanism will ensure effective hedge. Had this facility been available to Indian corporates earlier, the extent of losses Indian corporates suffered could have been avoided.

Benefit of exchange traded currency future contracts

  • Daily mark-market obligations settlement between parties concerned.
  • Counter-party risk of non obligation of contract could be avoided due to intermediary like clearing corporation, which will become guaranteer for both the parties.
  • Introduction of exchange traded currency option will ensure equitable participation from both large and small investors in currency trading, as compared to OTC contract market, lot will be smaller. Minimum lot size of the newly introduced scheme has been fixed as US dollar 1000 only.
  • It will lead to greater transparency, efficiency and accessibility in currency futures and option market.

Features of exchange traded currency future

  • Initially only future contracts on US dollar- Indian rupee (INR) would be available. This means, the investors can hedge themselves when the exposure is in US dollar only.
  • Minimum contract size will be US dollars 1000.00.
  • The currency future contract shall have maximum maturity of 12 months only. Of course the contract of varied maturity from 1 month to 12 months will be available.
  • The currency future will be settled in Indian rupees only.
  • Settlement price will be RBI’s reference rate on the last trading date.

Introduction of exchange traded currency futures will bring depth in currency market in India. Corporates can now hedge their exposure in different currencies more effectively. Big losses what the corporates have incurred recently can be avoided in future effectively.

Source: Merinews