RBI rule ambiguity stifles FX derivatives boom, exposes regulatory gaps in India: Report

livemint.com:

FX derivatives market, a playground for speculative bets on the rupee, now faces a regulatory reckoning. The central bank's crackdown, demanding underlying exposure for all trades, has sent shock waves through the market. This disconnect between the regulator's intent and market understanding exposed potential gaps in India's regulatory framework, raising concerns for investors and jeopardizing the country's image as a stable investment destination, according to a report by Reuters.

"There seems to be a disconnect between the regulator's intent and market perception," said Smrithi Nair, a legal advisor. "This confusion creates a negative image for India as an investment jurisdiction." For years, the market thrived on bets on the rupee's movement, even without traders holding underlying assets. A rule allowing transactions up to $100 million without proof of exposure was interpreted by many as a green light for speculation, the report added.

This all came crashing down in late March when the Reserve Bank of India (RBI) reaffirmed a long-standing rule: rupee derivatives can only be used for hedging actual foreign currency exposure from April 5. This move effectively pushed out a large portion of the market--speculators who formed the bulk of trading volume. The RBI claimed its rules have always mandated underlying exposure for derivative trades.

Deputy Governor Michael Patra accused some participants of "misusing" the system, the Reuters report noted. Traders, however, argue they understood the $100 million threshold as an exemption for exposure proof. This ambiguity persisted even after a January circular from the RBI reminding exchanges of the underlying exposure requirement, as per the Reuters report.