Exotic Currency Derivatives

BE/RBINOTE/19/2019

After almost a Decade Reserve Bank of India, the country’s Regulator has come out with a proposal to lift the ban on Exotic Currency Derivatives.

1. Exotic Currency Derivatives were the double edged fancy products which had brought a huge destruction in 2007-08 amidst allgegations of mis-selling and court batles which was due to bets by Corporates backfired.
2. The then reason was said to be surge in Euro, Yen and Swiss Francs.

Background:

• During the past few months, senior RBI officials have been holding meetings with banks and discussed ways and means to permit these products with the required safeguarding measures being brought in lace.
• RBI wants firms with a net worth of over Rs. 200 crore or more to freely choose derivatives
• Foreign investors require a platform to freely cancel and rebook contracts.

Reaction:

1. There is a two way reaction amongst the bankers. Some feel that sale f exotic instruments would end up in extra margins.
2. Others feel that who had faced issues in the past and had to run behind courts are sceptic about this move, more so those from the compliance area.
3. Hundreds of Corporates had entered into such tailor made, over the counter derivative contracts with banks, who were mostly private and foreign lenders
   1. to get better exchange rate on export earnings
   2. trim loan costs
   3. board the bottom line areas.

Conclusion:

• A surge in rupee made the exporters to go for complex currency option packages instead of Loking in gains through conventional way of selling dollar incomem in the forward market.
• This move with an expected improved earnings should take adequate steps in strengthening the safeguards required therein.

Note:

• An exotic derivative, is a Derivative which is more complex than commonly traded “vanilla” products. This complexity usually relates to the determination of payoff;
• The category may also include derivatives with a non-standard subject matter (i.e., underlying), developed for a particular client or a particular market.
• The term “exotic derivative” has no precisely defined meaning.
• Certain derivative instruments are considered exotic when first conceived of and sold, but lost this status when they were traded with significant enough volume.
• Examples of this phenomenon include Interest rate- and currency-swaps.