Exotic FX derivatives are making a comeback in India, reflecting central bank efforts to deepen financial markets.

After the Reserve Bank of India allowed lenders to offer derivatives earlier this month, banks such as ICICI Bank Ltd. and Axis Bank Ltd. have sold barrier forex options to clients such as Reliance Industries Ltd. and Supreme Petrochem Ltd.

The return of exotic currency derivatives as well as the introduction of swaptions are part of efforts to provide businesses with more risk management options as India’s global trade integration grows. Yet authorities have tightened the rules as India had to ban derivatives following the 2008 financial crisis, when a large number of companies ended up with huge losses on bets that have gone wrong.

“Exotic derivatives, especially activation barrier options for true import hedging, can offer an ideal combination of risk management at a reduced cost compared to traditional vanilla options,” said Alok Wadhawan, Deputy Managing Director. , corporate finance, at Jindal Steel & Power. ltd. “If banks price these derivatives correctly, there will eventually be an increase in demand for these products from businesses.”

The gain on these products depends on whether the underlying asset has reached a predetermined price or not.

Indian companies mainly hedge their foreign exchange exposures in onshore futures markets, with these contracts far exceeding options transactions. According to the latest survey by the Bank for International Settlements, the total daily average of outright Indian rupee futures trading was $62.7 billion in April 2019, compared to $5.7 billion for options-related trading. .

The authorities are acting with caution given the experience of 2006-2008, when banks sold products to customers who essentially bet on the movement of various currencies such as the Japanese yen, Swiss franc and euro, without any assessment of underlying business needs. These bets exploded in the aftermath of the global subprime mortgage crisis, leaving companies with huge losses.

Opening with caution

The central bank fined nineteen banks, including Citibank NA, Bank of America NA and Barclays Plc in 2011 for mis-selling these products, including failure to carry out due diligence on suitability and sale to companies that do not have adequate risk management practices. It also banned lenders from offering exotic forex derivatives, allowing only vanilla futures as hedging tools.

Today, while derivatives have made a comeback, regulations have become tougher with a distinction between businesses and individuals. Companies with a minimum net worth of Rs 5 billion are allowed to engage in such transactions. Permitted exotic derivatives are those for which the losses, whatever the scenario, will not be greater than if the underlying currency asset were not hedged, which implies that leveraged derivatives are not not allowed.

Initial trade sizes in derivatives, including barrier options, are still low at around $5 million to $10 million as companies explore new products, according to Axis Bank.

“There’s been quite a bit of evolution in terms of regulation,” said Neeraj Gambhir, group director and head of treasury, markets and wholesale banking products at Axis Bank. “The overall regulatory approach has shifted dramatically in favor of risk disclosures.”

This story was published from a news feed with no text edits. Only the title has been changed.

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