Zerodha asks users to close forex derivative positions by April 5 in compliance with RBI norms. Zerodha also said that traders with exposures exceeding $100 million (notional contract value), will be required to appoint a custodian participant or an authorised dealer. Earlier, CEO Nithin Kamath had said, 'The RBI has its own reasons for restricting unhedged currency derivatives, but this means the death of currency derivative trading on stock exchanges by retail traders.'
Popular FX Derivatives Market Faces Crushing Blow in India Brokers ask clients to close out rupee derivatives positions RBI rules requiring an underlying exposure effective April 5.

RBI's new currency derivatives norms wipe out most exchange traded volumes. Experts suggest that the Reserve Bank of India's (RBI) latest regulation concerning currency derivatives trades, set to take effect on April 5, could potentially impact liquidity on exchanges. This is because users might struggle to meet the underlying exposure requirement mandated by the central bank.

The RBI's circular, issued on January 5, stipulates that users must ensure the presence of a valid underlying contracted exposure, which hasn't been hedged using any other derivative contract. Additionally, they should be capable of demonstrating this if necessary.

In the context of derivatives, the underlying refers to the original order bill or receipt for exporters or importers, and supporting documents for transactions involving remittances. According to Dilip Parmar, a foreign exchange analyst at HDFC Securities, importers or exporters ought to possess receipts or payments in USD, EUR, etc.
What was the prevailing practice until now? Currency traders had the freedom to engage in derivative market transactions, with the option to either disclose or withhold information regarding their underlying exposure. Currency derivatives serve as a mechanism for mitigating foreign exchange risk.

Experts noted that most transactions on exchanges were conducted by clients from the retail segment, as they were unable to engage in Over The Counter (OTC) market transactions, primarily because banks required information about the underlying exposure, which many users did not possess.

The spotlight fell on the RBI's directive three months after its issuance, when on April 1, the National Stock Exchange (NSE) and BSE Ltd directed their members to take note of the circular.

Dilip Parmar from HDFC Securities remarked, "The volume of exchange-traded derivatives is expected to plummet by nearly 80 percent, as the majority of volumes originate from proprietary desks and retail traders, who rarely have any underlying exposure."

According to the NSE's Market Pulse report published in March, the Average Daily Turnover (ADT) in currency futures plummeted to a 29-month low of Rs 23,200 crore (-20.5 percent MoM) in February 2024, significantly lower than the average recorded during FY23 and FY24 (April 2023 to February 2024).

Anil Kumar Bhansali, Head of Treasury and Executive Director at Finrex Treasury Advisors LLP, emphasized that these retail trades constituted 90 percent of total transactions and served as a source of liquidity in exchange-traded currency futures.

According to the January 5 RBI circular, users are permitted to take positions (long or short) without needing to establish the existence of underlying exposure, up to a single limit of $100 million equivalent across all currency pairs involving the rupee, aggregated across all recognized stock exchanges.

However, the central bank noted that recognized stock exchanges should inform users that although they are not required to establish the existence of underlying exposure, they must ensure the presence of a valid underlying contracted exposure that has not been hedged using any other derivative contract, and should be able to establish the same if necessary.

Bhansali added that through this circular, the RBI has opted to restrict trades on exchanges, which could potentially diminish liquidity, as it predominantly stemmed from retail traders who might not have the requisite underlying exposure.

When did the market become aware of the circular? Money market experts revealed that most brokers had notified their clients to adhere to the RBI's regulations and instructed them to close positions without underlying exposure before the circular's implementation on April 5.

Parmar added, "Most brokers have communicated the changes to their clients and instructed them to comply with the RBI's mandate. They also advised clients to close positions without underlying exposure before April 5."

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