RBI’s Revised Master Direction on Risk Management & Forex Trading: Key Updates & FAQs

Revised Master Direction on Risk Management and Inter-Bank Dealings: Key Updates, FAQs, and Compliance Guide

The Reserve Bank of India (RBI) has issued the Revised Master Direction on Risk Management and Inter-Bank Dealings through A.P. (DIR Series) Circular No. 13, dated January 5, 2024. This revised direction, effective April 5, 2024, aims to streamline foreign exchange risk management practices by consolidating various regulations and incorporating stakeholder feedback.

Key Highlights of the Revised Directions

1. Consolidation of Regulatory Framework

The revised framework consolidates the regulations from the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000, and various amendments made since then. It integrates provisions from the Currency Futures and Exchange Traded Currency Options Directions, ensuring a comprehensive approach to risk management.

2. Expansion of Hedging Facilities

The updated guidelines provide enhanced hedging options for foreign exchange risks. Key changes include:

• Inclusion of Non-Deliverable Foreign Exchange Derivative Contracts (NDDCs) in hedging instruments.

• Classification of users into retail and non-retail categories based on financial exposure and net worth.

• Introduction of specific eligibility criteria for different market participants, including NBFCs, mutual funds, pension funds, and foreign investors.

3. Eligibility and User Classification

Under the new classification:

• Non-retail users include entities such as banks, financial institutions, and large corporations with a minimum net worth of ₹500 crore or turnover of ₹1000 crore.

• Retail users encompass smaller market participants who do not meet the above criteria but are still eligible to access risk management tools.

4. Permitted Foreign Exchange Contracts

The revised Master Direction allows various foreign exchange and interest rate derivative contracts, including:

• Foreign exchange forward, swap, and currency swaps.

• Foreign exchange options (European), including call and put options.

• Interest rate derivatives, such as forward rate agreements and interest rate swaps.

5. Free Cancellation and Rebooking of Contracts

A major relief for businesses, the RBI now permits free cancellation and rebooking of derivative contracts. Additionally:

• Net gains from anticipated exposure hedging contracts will be passed on only at the time of cash flow realization.

• In exceptional cases where the underlying cash flow does not materialize, RBI allows gains to be passed on, subject to bank approval.

6. Compliance and Reporting Requirements

To ensure regulatory compliance:

• Authorized Dealers (AD Category-I Banks) must report foreign exchange transactions and ensure transparency in derivative pricing.

• Recognized stock exchanges must monitor user exposure and compliance with underlying exposure limits.

• Financial Benchmark India Pvt. Ltd. (FBIL) Reference Rates will be used for settlement of INR-denominated contracts.

Frequently Asked Questions (FAQs) on Forex Transactions by Residents

1. Can a resident person undertake forex transactions?

Yes, residents are permitted to undertake forex transactions only with authorized persons and for permitted purposes as defined under FEMA. Engaging in transactions with unauthorized persons or for unauthorized purposes can lead to penal action.

2. Who are authorized persons?

Authorized persons are entities authorized by the RBI to deal in forex. This includes authorized dealers, money changers, offshore banking units, or any other entities authorized under Section 10(1) of FEMA.

3. Can a resident person undertake forex transactions on internet/electronic trading portals?

Permitted forex transactions executed electronically should be conducted only on Electronic Trading Platforms (ETPs) authorized by the RBI or on recognized stock exchanges such as NSE, BSE, and MSE. Engaging on unauthorized ETPs is prohibited and may result in penal action.

4. What is an Electronic Trading Platform (ETP)? Do they require authorization from RBI to operate in India?

An ETP is any electronic system where transactions in securities, forex instruments, derivatives, etc., are conducted. Operating an ETP in India requires prior authorization from the RBI under the Electronic Trading Platforms (Reserve Bank) Directions, 2018.

5. Is there information available about entities not authorized to deal in forex?

Yes, the RBI has published an Alert List containing names of entities neither authorized to deal in forex under FEMA nor authorized to operate ETPs.

6. Can a resident individual remit margin overseas under the Liberalised Remittance Scheme (LRS) for online forex trading?

No, remittances under LRS can only be made for permissible current and capital account transactions. Remitting funds for margins or margin calls to overseas exchanges is not allowed under the scheme.

Can Residents Trade in Foreign Currency Derivatives Through Overseas Entities?

As per RBI regulations, Indian residents are not permitted to trade in foreign currency derivatives through overseas entities in which they have invested via Overseas Direct Investment (ODI). This would be considered a violation of FEMA guidelines.

Implications for Businesses and Investors

1. Enhanced Risk Management Tools

Corporates and financial institutions can now access a wider range of hedging instruments, allowing better risk mitigation strategies against foreign exchange volatility.

2. Increased Market Liquidity

The inclusion of NDDCs and the consolidation of exchange-traded currency derivatives into the Master Direction are expected to boost market liquidity and efficiency.

3. Greater Flexibility in FX Transactions

With relaxed rebooking norms and higher exposure limits without prior approvals, businesses have greater flexibility in managing their foreign exchange exposure.

Conclusion

The Revised Master Direction on Risk Management and Inter-Bank Dealings marks a significant step in enhancing India’s foreign exchange market regulations. Businesses, financial institutions, and investors must familiarize themselves with these updates to effectively leverage new opportunities and mitigate risks in the evolving global financial landscape.

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For further information, visit the official RBI FAQs on Foreign Exchange Transactions here.