28 January 2020 EY Regulatory Alert Introduction of Rupee Derivatives at International Financial Services Centre Regulatory Alerts cover Executive summary significant regulatory news, developments and changes in The Foreign Exchange Management (International Financial Services Centre) legislation that affect Indian Regulations, 2015 (2015 Regulations), permit a financial institution or a branch businesses. They act as technical of a financial institution setup in an International Financial Services Centre (IFSC) summaries to keep you on top of to conduct business in foreign currency as may be determined by a regulatory the latest regulatory issues. For authority governing such financial institution. more information, please contact your EY advisor. The Reserve Bank of India (RBI) has recently amended the provisions of the 2015 Regulations permitting a financial institution or branch of a financial institution to conduct business in Indian Rupees in an IFSC. The amendment comes into effect from 7 January 2020. Further to the above amendment, the RBI has now, vide a Circular1 dated 20 January 2020 (Circular), allowed the trading of Rupee Derivatives (with settlement in foreign currency) in IFSCs starting with Exchange Traded Currency Derivatives. This alert summarizes the key features of this Circular. 1 RBI/2019-20/145 A.P. (DIR Series) Circular No. 17 Page 2 Background Rupees in the IFSC. The amendment comes into effect from 7 January 2020. ► As per the Foreign Exchange Management ► Further to the above amendment, the RBI has (International Financial Services Centre) now, vide a Circular1 dated 20 January 2020 Regulations, 2015 (2015 Regulations), a (Circular), allowed Rupee Derivatives (with financial institution or a branch of a financial settlement in foreign currency) to be traded in institution set-up in an International Financial the IFSC starting with Exchange Traded Services Centre (IFSC) is permitted to conduct Currency Derivatives. business in foreign currency as may be determined by a regulatory authority governing ► The Circular inter alia deals with the following: such financial institution. - Currency Futures in International Financial ► Gujarat International Finance Tech City (GIFT Service Centre (Reserve Bank) Directions, City) is India’s first IFSC developed near the cities 2020 (Currency Futures Directions) of Ahmedabad and Gandhinagar in Gujarat, as a - Currency Options in International Financial global financial and information technology Service Centre (Reserve Bank) Directions, services hub, designed to be at, or above par with 2020 (Currency Options Directions) globally benchmarked financial centres. ► This alert contains the key features of the ► The Task Force on Offshore Rupee Markets Circular. chaired by former RBI Deputy Governor, Smt Usha Thorat, in its report dated Currency Futures Directions 30 July 2019, had recommended measures to incentivize non-residents to access the onshore Permission foreign exchange market. One of the recommendations included allowing Rupee ► Currency Futures contracts2 are permitted in Derivatives (with settlement in foreign currency) any currency pair involving the Indian Rupee to be traded in the IFSC. or otherwise. ► Accepting the above recommendation, the ► Persons resident in India3 as defined under Reserve Bank of India (RBI) has recently the Foreign Exchange Management Act, amended the provisions of the 2015 Regulations 1999 (FEMA), unless specifically permitted permitting a financial institution or branch of a by RBI, shall not be eligible to undertake financial institution to conduct business in Indian Currency Futures contracts. 2 ‘Currency Futures contract’ means a standardised intention to stay outside India for an foreign exchange derivative contract traded on a uncertain period; recognised stock exchange in IFSCs to buy or sell one currency against another on a specified future date, at a (B) A person who has come to or stays in India, price specified on the date of contract, but does not in either case, otherwise than; include a forward contract. (a) For or on taking up employment in India, or 3 ‘Person resident in India’ means: (b) For carrying on in India a business or (i) A person residing in India for more than one vocation in India, or hundred and eighty-two days during the course of (c) For any other purpose, in such the preceding financial year but does not include: circumstances as would indicate his intention to stay in India for an (A) A person who has gone out of India or who uncertain period; stays outside India, in either case: (a) For or on taking up employment outside (ii) any person or body corporate registered or India, or incorporated in India, (b) For carrying on outside India a business (iii) an office, branch or agency in India owned or or vocation outside India, or controlled by a person resident outside India, (c) For any other purpose, in such (iv) an office, branch or agency outside India owned circumstances as would indicate his or controlled by a person resident in India. Page 3 ► Persons resident outside India4 as defined Risk management measures under FEMA shall be eligible to undertake Currency Futures contracts. ► The trading of Currency Futures shall be subject to maintaining initial, extreme loss Features of Currency Futures and calendar spread margins and the Clearing Corporation/ Clearing House of the ► All Currency Futures contracts shall be settled recognised stock exchange shall ensure in a currency other than the Indian Rupee. maintenance of such margins by the participants on the basis of the guidelines ► The settlement price for Currency Futures issued by SEBI from time-to-time. contracts involving the Indian Rupee shall be the FBIL Reference rate5, where available, on Currency Option Directions the last trading day of the contract. Permission For Currency Futures contracts involving the Indian Rupee, where FBIL reference rates are ► Currency Option contracts6 are permitted in not available, and for other currency pairs, the any currency pair involving the Indian Rupee mechanism for arriving at the settlement price or otherwise. shall be decided by the recognized stock exchange where these futures will be traded in ► Persons resident outside India as defined consultation with the Securities and Exchange under FEMA shall be eligible to undertake Board of India (SEBI). Currency Option contracts. ► The size, maturity and other specifications of ► Persons resident in India as defined under the Currency Futures contracts shall be FEMA, unless specifically permitted by RBI, decided by the recognized stock exchange shall not be eligible to undertake Currency mentioned above, in consultation with the Option contracts. SEBI. Features of Currency Options Position limits ► All Currency Option contracts shall be settled ► The position limits for various classes of in a currency other than the Indian Rupee. participants in the currency futures market shall be subject to guidelines issued by the ► The settlement price for Currency Option SEBI. contracts involving the Indian Rupee shall be the FBIL Reference rate5, where available, on ► IFSC Banking Units shall operate within the expiry date of the contract. prudential limits as laid down in the instructions issued by the RBI. 4 ‘Person resident outside India’ means a person who is of the option has the right but not the obligation to not resident in India. purchase (call option)/ sell (put option) and the seller (or writer) of the option agrees to sell (call option)/ 5 ‘FBIL Reference rate’ means the rates of currency pairs purchase (put option) an agreed amount of a specified computed and published on a daily basis, on all Mumbai currency at a price agreed in advance and denominated business days, by Financial Benchmarks India Private in another currency (known as the strike price) on a Limited. specified date in the future. 6 ‘Currency Options contract’ means a standardised foreign exchange derivative contract traded on a recognised stock exchange in IFSCs where the purchaser Page 4 For Currency Option contracts involving the Indian Rupee where FBIL reference rates are Comments not available, and for other currency pairs, the mechanism for arriving at the settlement price Stock exchanges in the IFSC are presently shall be decided by the recognized stock permitted to offer a diversified range of products spanning various asset classes which include exchange in consultation with the SEBI. derivatives on Indian indices, derivatives on Indian stocks, derivatives on foreign stocks, cross ► The size, maturity and other specifications of currency derivatives, commodity futures on gold, the Currency Option contracts shall be decided silver and base metals, etc. Also, while listing and by the recognized stock exchange in trading of the Rupee denominated Bonds (popularly consultation with the SEBI. known as Masala Bonds) is permitted in the IFSC, hedging Rupee exchange rate risk on it is not permitted. Position limits Further, the size of the offshore Rupee derivative ► The position limits for various classes of market and its present rate of growth pose a participants in the Currency Option market significant challenge to the efficiency of price shall be subject to guidelines issued by the discovery as well as the effectiveness of exchange rate management policy. The possibility that the SEBI. exchange rate of the Rupee, not a fully convertible currency, being materially determined by ► IFSC Banking Units shall operate within transactions largely outside the legal and prudential