FX derivatives fiasco puts spotlight on regulatory risk in India
derivatives thrived in India for over a decade, fueled by retail investors and proprietary traders. Then the central bank broke up the party.
Until recently, traders were betting freely on the rupee’s rise and fall without holding underlying assets. A rule that allowed transactions of up to $100 million without providing proof of an actual foreign-currency exposure had been interpreted by them as tacit acceptance of speculative trade by the authorities.
A booming market where volumes had reached $5 billion per day was dealt a body blow by the Reserve Bank of India late March after it reaffirmed a rule that permits the use of rupee forex derivatives only for the purpose of hedging. The directive effectively ousts traders and speculators who comprise the bulk of the volume.
The episode highlights the uncertainty around regulations and their interpretation in India, and undermines the nation’s image as a hot investment destination. Foreigners have been flocking to the country’s equities, lured by its high-growth prospects, and have been putting billions in sovereign debt ahead of the inclusion in global bond indexes.
“There seems to be some disconnect between what the regulator thought was very clearly mentioned in the laws and how the market perceived it,” said Smrithi Nair, partner at Juris Corp., a legal advisory firm. “This sort of confusion creates a negative image at a global level for India as a jurisdiction.”
The RBI contends that its regulations have always required participants in the exchange-traded
