Rajwade Forex E Bücher

Forex-Buch, lesen Sie Forex Book, kaufen Sie Forex Book 1.1 Die 1990er Jahre markiert erhebliche Änderungen in der Währungsregelung in Indien und in der Entwicklung des Devisenmarktes. Der Wechselkurs der Rupie, der an einen nicht geoffenbarten Währungskorb gebunden war, wurde im März 1992 und im März 1993 teilweise geschwommen. Die Vereinheitlichung des Wechselkurses war maßgeblich für die Entwicklung eines marktbestimmten Wechselkurses der Rupie , Basierend auf Nachfrage und Angebot auf dem Forex-Markt. Es war auch ein wichtiger Schritt auf dem Weg zu einer konjunkturellen Konversion, der im August 1994 erreicht wurde, als Indien die Verpflichtungen nach Artikel VIII des IWF-Übereinkommens akzeptierte. Ein weiterer Impuls war die Ernennung einer Expertengruppe für Devisenmärkte in Indien, die ihren Bericht am 27. Juni 1995 vorlegte. Das Sodhani-Komitee hat, wie es allgemein bekannt war, Empfehlungen, die weitreichende Konsequenzen hatten Die Entwicklung im Allgemeinen und die Vertiefung der Ausweitung, insbesondere der indischen Forex-Markt. Seitdem ist fast ein Jahrzehnt vergangen, und es wurde gefühlt, dass es angebracht wäre, eine Bestandsaufnahme der aufgetretenen Entwicklungen zu machen und den Weg für die Zukunft zu planen. Dementsprechend, als Teil der anhaltenden Bemühungen zur Liberalisierung und Entwicklung der Devisenmarkt in Indien, Gouverneur ernannt eine Internal Technical Group auf Forex Markets, um eine umfassende Überprüfung der Maßnahmen von der Reserve Bank bisher initiiert und identifizieren Bereiche für weitere Liberalisierung Entspannung von Beschränkungen sowie einen mittelfristigen Rahmen für Fragen der Liberalisierung des Kapitalverkehrs. Die Mitglieder der Gruppe stammen aus DEIO, IDMD, FED, DBOD und DEAP. Allgemeine Geschäftsbedingungen 1.2 Das breite Mandat des Konzerns stellt sich wie folgt dar: - i) Überprüfung der Marktentwicklungen und des Liberalisierungsprozesses seit 1995 in Bezug auf die Produktteilnehmer und ihre Auswirkungen auf die Marktdynamik ii) Respektierung der Marktliberalisierung in bestimmten wichtigen Schwellenländern iii) das derzeitige Regulierungsregime für den Devisenmarkt zu untersuchen und es unter den derzeitigen und sich entwickelnden Umständen zu bewerten, wobei die Fortschritte bei der Liberalisierung in verwandten Sektoren zu beachten sind und iv) Identifizieren verschiedene Optionen für eine weitere Liberalisierung mit ihren Auswirkungen und geben einen möglichen Ansatz an v) Jede andere Frage von Bedeutung Ansatz der Gruppe 1.3 Die Gruppe stellte fest, dass das Vorhandensein eines funktionierenden Marktes für Kassageschäfte und Terminkontrakte für eine lange Zeit in Verbindung mit der Verfügbarkeit Der beruflichen Kompetenzen und des Fachwissens waren wichtige Faktoren, die es Indien ermöglichten, Liberalisierungsmaßnahmen leicht einzuführen. Der Konzern nahm eine Bestandsaufnahme des gesamtwirtschaftlichen Umfelds ein, um einen optimalen Ansatz für die Liberalisierung der Devisenmarkt - und Kapitalkontrolle zu finden. Er stellte fest, dass das Haushaltsdefizit und die hohen Auslandsverschuldungen nach wie vor Bedenken sind, obwohl der externe Sektor grundsätzlich stärker und widerstandsfähiger als je zuvor ist. Der Konzern berücksichtigte ferner die vom Tarapore-Ausschuss für die Kapitalkonvertierbarkeit festgelegten Voraussetzungen, während er seine Empfehlungen abschloss. Um eine weitere Deregulierung des Devisenmarktes, einschließlich der Lockerung der Kapitalkontrollen, voranzutreiben, ist ein Umfeld erforderlich, um die Reformen nachhaltig fortsetzen zu können. In diesem Zusammenhang muss die Liberalisierung der verschiedenen Sektoren gemeinsam erfolgen, um Synergien der Reformen in mehreren Sektoren herbeizuführen. Angesichts dieser Erwägungen und unter Berücksichtigung der mit der Internationalisierung der Rupie verbundenen Risiken kam die Gruppe zu dem Schluss, dass ein schrittweiser und bedarfsorientierter Ansatz besser auf die vorherrschende Lage abgestimmt wäre. Die Gruppe hatte die Vorteile von Präsentationen von ausgewählten Marktteilnehmern und Experten wie Citibank, ICICI Bank, State Bank of India, IDBI Bank, Standard Chartered Bank, YES Bank, eine gemeinsame Präsentation von Canara Bank und Bank of India, Devisenhändler Indien, Vedanta Group, Hindustan Petroleum Corporation Limited und Shri AV Rajwade auf relevanten Gebieten. Die internationalen Erfahrungen in Bezug auf die Marktliberalisierung in einigen wichtigen Schwellenländern wie Brasilien, Russland, den Philippinen, Thailand und Mexiko wurden ebenfalls untersucht. Struktur des Berichts 1.4 Die Organisation des Berichts ist wie folgt: Der Hauptbericht besteht aus vier Kapiteln 8211, während Kapitel 1 beschäftigt sich mit der Einführung, Kapitel 2 bietet einen Überblick über die indischen Forex-Markt, spiegelt sich auf dem Umfeld für die Reformen in der Region Forex-Markt sowie gibt einen Einblick in die Cross-Country-Erfahrungen in der Entwicklung der Devisenmärkte. In Kapitel 3 werden die Vorschläge der Marktteilnehmer zur weiteren Liberalisierung zusammen mit ihren Auswirkungen aufgeführt, während in Kapitel 4 kurz die Zusammenfassung der Empfehlungen für die Umsetzung aufgeführt ist. Anhang I präsentiert eine Perspektive auf den indischen Devisenmarkt. Länderübergreifende Erfahrungen in der Entwicklung von Devisenmärkten sind in Anhang II zusammengefasst. Danksagung 1.5 Das Sekretariat der Gruppe wurde von der Devisenabteilung (Forex Markets Division) bereitgestellt. Die Gruppe möchte ihre Anerkennung für die unbestrittene Unterstützung von allen Beamten der Forex Markets Division, Devisen Devisen-Abteilung zur Verfügung gestellt. Von HSBC, JP Morgan und der Deutschen Bank wurden ebenfalls wertvolle Beiträge gezahlt, die dankbar anerkannt werden. Schließlich verdankt sich der Bericht den Vorträgen, die von den Marktteilnehmern und Fachleuten bereits erwähnt wurden. Ihre Präsentationen trugen wesentlich zum Abschluss des Berichts bei. Die Gruppe dankt ihnen für ihre Bemühungen. Perspektive auf den indischen Devisenmarkt Länderübergreifende Erfahrungen bei der Entwicklung von Devisenmärkten 2.1 Dieses Kapitel gibt einen Überblick über den indischen Devisenmarkt, reflektiert das Umfeld für Reformen im Devisenmarkt und gibt einen Einblick in die Erfahrungen aus dem Ausland In der Entwicklung der Devisenmärkte. Eine detaillierte Zuschreibung zu diesen Bereichen ist in den Anhängen I und II enthalten. Perspektive auf dem indischen Devisenmarkt 2.2 Der indische Devisenmarkt besteht aus Banken, die zum Devisenhandel zugelassen sind und als Devisenhändler, Geldwechsler und Kunden - sowohl Gebietsansässige als auch Gebietsfremde - bekannt sind Währungsrisiken. Dabei handelt es sich überwiegend um einen transaktionsbasierten Markt mit dem Vorliegen einer zugrunde liegenden Forex-Exposure, die im Allgemeinen eine wesentliche Voraussetzung für Marktbenutzer darstellt. 2.3 Der indische Devisenmarkt ist in den letzten Jahren vielfältig geworden. Der durchschnittliche tägliche Gesamtumsatz stieg von 3,67 Mrd. US-Dollar in den Jahren 1996-77 auf US 97,1 Mrd. 2003/04. Das normale Spotmarktzitat hat eine Spanne von 0,50 bis 1 Paise, während Swap-Quotes bei 1 bis 2 Paise Spread zur Verfügung stehen. Der Markt für Derivatemarkt zeigt sich auch nach der im Jahr 2000 entwickelten MIFOR-Swap-Kurve MIFOR (Mumbor Inter-Bank Forward Offered Rate) enorm. 2.4 Viele politische Initiativen wurden unternommen, um den Devisenmarkt zu entwickeln. ADs wurde erlaubt, eine größere offene Position und aggregierte Lücke Grenzen, die mit ihrem Kapital verbunden sind. Sie haben die Erlaubnis erhalten, im Ausland bis zu 25 Prozent ihres Kernkapitals zu leihen und bis zu den von ihren jeweiligen Organen genehmigten Limiten zu investieren. Die Barreservevoraussetzungen wurden für Interbankverbindlichkeiten freigestellt. 2.5 Importeure und Importeure sind grundsätzlich berechtigt, frei gebuchte Devisentermingeschäfte für ihre Devisentermingeschäfte frei zu kündigen und umzubuchen, mit Ausnahme von Terminkontrakten, die zur Deckung von Einfuhr - und Nichthandelszahlungen gebucht werden, die über ein Jahr hinausgehen. Es ist ihnen auch gestattet worden, Terminkontrakte auf der Grundlage der vergangenen Performance (ohne Produktion der zugrunde liegenden Dokumente, die Transaktionen zum Zeitpunkt der Buchung des Vertrages belegen) zu buchen. Unternehmen wurden erlaubt, den Zugang zu Fremdwährungsfonds zu erhöhen. Allgemeine Zulassungen wurden ADs für die Zulassung von externen kreditwirtschaftlichen Darlehen ihrer Kunden bis zu einer Grenze von US 500 Million gegeben, die angemessene Beschränkungen für die Endnutzung solcher Fonds gelegt worden sind. Während Tauschverdiener in ausgewählten Kategorien wie Export Oriented Units (EOU) 100 Prozent ihrer Exporterlöse behalten dürfen, dürfen andere 50 Prozent ihrer Devisenbelege in EEFC-Konten behalten. Die Einwohner können auch Vorverträge mit ADs für Transaktionen, die auf Fremdwährung lauten, in indische Rupien abschließen. Sie können das Wechselkursrisiko aus ausländischen Direktinvestitionen in Eigenkapital und Darlehen absichern. Im Exportimportgeschäft tätige Personen sind zugelassen, um das damit verbundene Rohstoffpreisrisiko an den internationalen Rohstoffmärkten durch börsengehandelte sowie OTC-Kontrakte abzusichern. 2.6 Gebietsfremde sind zur Absicherung des Währungsrisikos berechtigt, das aufgrund ihrer Investitionen in Indien entsteht. Nach der Stornierung können diese Verträge jedoch nicht für dieselbe Forderung umgebucht werden. 2.7 Um eine weitere Deregulierung des Devisenmarktes, einschließlich der Lockerung der Kapitalkontrollen, zu ermöglichen, ist ein förderliches Umfeld notwendig, um die Reformen nachhaltig fortsetzen zu können. In diesem Zusammenhang muss die Liberalisierung der verschiedenen Sektoren gemeinsam erfolgen, um Synergien der Reformen in mehreren Sektoren herbeizuführen. 2.8 Eine solide makroökonomische Politik und ein wettbewerbsfähiger heimischer Sektor verbessern die Fähigkeit der Wirtschaft, höhere Kapitalzuflüsse zu absorbieren und Kissen gegen unerwartete Schocks bereitzustellen. Einige der vom Tarapore-Komitee für Kapitalverkehrskonvertibilität empfohlenen Parameter wie die Verringerung des kombinierten Finanzdefizits, die Inflation zwischen 3 und 5 Prozent und die weitere Senkung der Brutto-NPA des Bankensektors müssen für die Schaffung eines geeigneten Umfelds erreicht werden Weitere Liberalisierung in den Devisenmärkten. Länderübergreifende Erfahrungen bei der Entwicklung von Devisenmärkten 2.9 Das Jahrzehnt der 90er Jahre war durch bemerkenswerte Entwicklungen in Schwellenländern gekennzeichnet, die auf ein flexibles Wechselkursregime, die Erschließung der Kapitalbilanz und die Integration ihrer heimischen Finanzmärkte hindeuteten Globalen Systems. Dies war eine Reflexion bewusster Anstrengungen in dieser Richtung, entweder als integraler Bestandteil des Gesamtprozesses der Liberalisierung oder durch einen Anpassungsmechanismus, der im Zuge von Finanzkrisen initiiert wurde. Für die Neuorientierung ihrer Finanzmärkte wurde in Bezug auf die Verfügbarkeit einer breiten Palette neuer Produkte und Instrumente, die Entwicklung institutioneller und Marktinfrastruktur sowie die Neuausrichtung der regulatorischen Strukturen im Einklang mit dem liberalisierten operationellen Rahmen bemerkt. Die sich wandelnden Konturen der Devisenmärkte spiegeln sich in einer raschen Expansion der Teilnehmer, der Produktinnovation, der steigenden Transaktionsvolumina und der Senkung der Transaktionskosten sowie eines effizienteren Mechanismus des Risikotransfers wider. Der Prozess der Devisenmarktliberalisierung beschleunigt sich im Allgemeinen mit zunehmender Liberalisierung der Kapitalkonsolidierung. Dies äußert sich in einem liberaleren Ansatz für Beschränkungen der Investitionsströme. Die Regulierungsbehörden ziehen es jedoch vor, die Marktteilnehmer bei der Verwendung von Instrumenten des Risikomanagements, insbesondere von Derivaten, uneingeschränkt zu unterstützen. 2.10 Unterstützt von den technologischen Durchbrüchen, dem schnellen Wachstum der Investmentfonds und dem Rohstoffhandel hat sich das tägliche Handelsvolumen an den Devisenmärkten weltweit auf US 2,408 Mrd. im Jahr 2004 von US 1,076 Mrd. im Jahr 1992 mehr als verdoppelt. Es wird geschätzt, Fünftel aller Devisengeschäfte steht in direktem Zusammenhang mit den Bedürfnissen der Importeure und Exporteure, während die verbleibenden Finanzabläufe im Zusammenhang mit Investitionen und Gewinn suchenden Transaktionen stehen. Bereinigt um lokale und grenzüberschreitende Doppelzählungen erhöhte sich der weltweite Devisenmarktumsatz von einem Tagesdurchschnitt von 1.200 Milliarden US-Dollar im Jahr 2001 auf 1.880 Milliarden US-Dollar im Jahr 2004. 2.11 Ländererfahrungen zeigen, dass ein Umstieg auf ein flexibles Wechselkursregime erforderlich ist Erleichtert auch die Entwicklung der Devisenmärkte. Eine Reihe von EMEs haben entweder verwaltete schwimmende oder unabhängig schwimmende Wechselkursregelungen eingeführt. Trotz eines Umsatzwachstums, der mit einer zunehmenden Flexibilität der Wechselkurse und einer stärkeren Devisenmarktentwicklung einhergeht, sind die EME nach wie vor im Hinblick auf ihren Anteil am weltweiten Devisenumsatz und auch im Derivatsegment des Devisenmarktes unbedeutend. Sie behalten weiterhin eine Reihe von Devisenvorschriften und müssen ihre Währungen auf das Kapitalkonto umwandeln. Die Märkte für zugrunde liegende Vermögensgegenstände selbst lassen Raum für die Entwicklung. Diese Faktoren begrenzen die Größe ihres Marktumsatzes. 2.12 Die Wechselkursflexibilität macht die Marktteilnehmer Risiken aus Währungsschwankungen ausgesetzt. Das Marktrisiko spielt in global integrierten Devisenmärkten eine große Rolle, was die Marktteilnehmer dazu veranlasst, Risikomanagementinstrumente einzusetzen. Die Verfügbarkeit dieser Instrumente sowie die Freiheit, diese Instrumente zu nutzen, hängt von der bestehenden Regulierungsumgebung in einem Land ab. Das betriebliche Umfeld ist in Ländern mit laufender Kontenverträglichkeit und offenen Kapitalkonten relativ flexibler. Wechselkursregelungen beeinflussen den regulatorischen Rahmen, wenn es darum geht, den Marktteilnehmern in bezug auf ihre Devisengeschäfte operative Freiheit zu bieten. Während der Einsatz von Risikomanagementinstrumenten von EME zur Absicherung von echten Expositionen in Verbindung mit realen und finanziellen Strömen gefördert wird, blieb ihr Gesamtansatz für das Risikomanagement mit einem klaren Schwerpunkt auf der Notwendigkeit, sich gegen potentielle finanzielle Instabilität, Spekulationen auf dem Devisenmarkt, auch wenn die makroökonomischen Fundamentaldaten einigermaßen gut sind. Dies wurde auch in jenen Ländern beobachtet, in denen der Einsatz von Sicherungsinstrumenten nicht mit dem Forderungsprinzip 8216real8217 verbunden ist. 2.13 Länderpraktiken, die den Banken erlauben, in Fremdwährungsderivatgeschäften mit Fremdwährungsgeschäften in Fremdwährungen zu tätigen, weisen mit einigen Einschränkungen einen Weg zur relativen Freiheit auf. Flexibilität ist auch in der Gründung und Hebung von Absicherungen in mehreren Ländern erlaubt. Nicht lieferbare Forwards onshore sind in vielen Ländern eingeschränkt. Verordnungen über Devisentransaktionen für Privatpersonen und Unternehmen werden im Allgemeinen entspannt, bevor sie für andere Marktteilnehmer entspannt werden. 2.14 Ungeachtet der Tatsache, dass aufsichtsrechtliche Vorschriften als integraler Bestandteil der Gesamtrisikomanagementstrategie betrachtet werden, unterscheiden sich die Landpraktiken in dieser Hinsicht stark. Eine wichtige aufsichtsrechtliche Maßnahme ist die Fixierung von offenen Positionsspaltgrenzen der Banken. Diese Vorgabe variiert auch von Land zu Land, abgesehen davon, dass diese Gren - zen die Kapitalanforderung in mehreren Ländern nicht anziehen. Die aufsichtsrechtlichen Sicherungsmaßnahmen werden auch in Form von Beschränkungen von Kapitalverkehrsgeschäften verschiedener Arten einschließlich der Anleihen von Gebietsfremden auf dem lokalen Devisenmarkt, von Devisenbeständen von inländischen Gebietsansässigen und Währungseinlagen von Gebietsfremden usw. offenbart. 2.15 Mehrere Länder Erlauben es Herstellern und Herstellern, ihre Rohstoff-Exposure an internationalen Rohstoffbörsen abzusichern, ungeachtet der Tatsache, dass eine Reihe von ihnen auch lokale Rohstoffbörsen haben. Der Zugang zu internationalen Rohstoffbörsen ist grundsätzlich nur zum Zwecke der Absicherung. Spekulationsbeschränkungen gibt es in einigen Ländern wie Australien, Südafrika, China und Japan. 2.16 Eine wichtige Lehre ist, dass ähnlich wie der Missbrauch von Derivaten, der zu einer Annahme des Fremdkapitals führt, eine systemische Bedrohung vorliegt, wenn Fremdwährungsverbindlichkeiten nicht gesichert sind. Die operative Freiheit im Umgang mit Risikomanagementinstrumenten muss mit einem ordnungsgemäßen internen Risikocontrolling und effizienten Aufsichts - und Aufsichtssystemen einhergehen. In letzter Zeit wurde ein beträchtlicher Schwerpunkt auf die internen Risikomanagementsysteme und die Notwendigkeit einer klar definierten Risikomanagementpolitik und angemessenen Sicherungsmaßnahmen gelegt, um sicherzustellen, dass die akzeptierte Politik wahrheitsgemäß umgesetzt wird. Die Aufsichtsbehörden müssen mit ihren Informationsüberwachungs-, Regulierungs - und Aufsichtssystemen bereit sein, um sicherzustellen, dass die Marktteilnehmer die aufsichtsrechtlichen Risikomanagement-Normen einhalten und übermäßige Risikobereitschaft vermeiden. Vorschläge der Marktteilnehmer für eine weitere Liberalisierung, zusammen mit ihren Implikationen. 3.1. Während des Jahrzehnts, das seit dem Bericht der Expertengruppe für die Devisenmärkte in Indien vergangen ist, ist der Devisenmarkt stark gewachsen und ausge - reift. Aufgrund der Volatilität der Wechselkurse und der Zinssätze wurde ein Bedarf an mehr Dynamik zur Absicherung von Forderungen geäußert. Mit der schrittweisen Integration der indischen Wirtschaft mit der Weltwirtschaft und der Senkung der Zolltarife ist die Notwendigkeit, das Preisrisiko auf im Inland erworbenen Rohstoffen abzusichern, gewachsen. Eine Nachfrage hat sich herausgestellt, um unseren Unternehmen die gleiche Flexibilität zu bieten, wie sie ihren Konkurrenten im Ausland zur Verfügung steht, damit sie in der globalen Arena konkurrenzfähig sind. Die verschiedenen Anregungen und die diesbezüglichen Ansichten der Gruppe werden in den folgenden Absätzen erörtert. Gleichzeitig befürwortete die Gruppe nachdrücklich die Notwendigkeit, ein kompetentes Umfeld für weitere Reformen im Devisenmarkt zu schaffen. In diesem Zusammenhang wird auf Punkt I.42 des Anhangs I verwiesen, der sich ausführlich mit der Angelegenheit befasst. Die Gruppe war der Auffassung, dass die Sequenzierung im Hinblick auf die Umsetzung aller für die Umsetzung empfohlenen Reformen unverändert die Voraussetzungen für weitere Fortschritte auf dem Weg zur Kapitalkonvertierung, die Liberalisierung in anderen Sektoren der Wirtschaft sowie die Entwicklung der Gesamtbilanz berücksichtigen müssen Zahlungen. Anregungen zur Flexibilität von Unternehmen zur dynamischen Absicherung ihrer Engagements 3.2. Forward-Kontrakte Alle von Gebietsansässigen gebuchten Termingeschäfte für Devisentermingeschäfte, die innerhalb eines Jahres fällig werden, können storniert und umgebucht werden, vorbehaltlich der Vorlage von Einzelheiten der Einfuhr - und Nichthandelszah - lungsforderungen durch die Konstituenten an ihre autorisierten Händler ( ADs) auf jährlicher Basis. Ausfuhrvereinbarungen mit Tenor über einem Jahr dürfen auch frei storniert und umgebucht werden. Um den Einwohnern eine größere Flexibilität bei der dynamischen Steuerung ihrer Engagements zu bieten, die Weiterentwicklung des Marktsegments voranzutreiben und eine Vereinheitlichung in Bezug auf die Buchung dieser Verträge herbeizuführen, empfiehlt es sich, alle Terminkontrakte sowie Währungsswaps zur Absicherung zu buchen Kann ein zugrunde liegendes Fremdwährungsrisiko, das von Gebietsansässigen gebucht wird, ungeachtet des Tenors, gestrichen und umgebucht werden. 3.3. Absicherung abgeleiteter Forderungen Ein abgeleitetes Fremdwährungsrisiko entsteht auf dem indischen Markt, wenn ein Kunde, der eine Rupienexposition hat, ihn durch einen Rupien-Devisentermingeschäft in ein Fremdwährungsrisiko umwandelt. So, zum Beispiel, wenn ein Kunde von einer festen Rupien-Haftung in eine schwimmende japanische Yen-Haftung tauscht, ist sie den folgenden zwei Risiken ausgesetzt: 1. Abschreibung von Rupie vs Yen dh Aufwertung von Yen vs Dollar oder Aufwertung von Dollar vs Rupie oder beides 2. Aufwärtsbewegung in Yen LIBOR-Zinssätzen während des Laufzeitvertrags Nach den geltenden Vorschriften kann der Kunde diese Risiken nicht absichern, da diese Forderungen abgeleitet sind. Die einzige Option ist, die gesamte Transaktion abzuwickeln, die dann nicht umgebucht werden kann. Die Gruppe hat die vorgenannten Argumente geprüft und ist zu dem Schluss gelangt, dass es genügend Berechtigung gibt, die Absicherung von Zinsänderungsrisiken wie auch Fremdwährungsrisiken für Währungspaare zu vereinfachen, die nicht Rupie sind (zB ein Unternehmen, das von einer Rupienexposition gegenüber Yen - Zur Absicherung des Dollar-Yen-Währungsrisikos), die sich aus solchen abgeleiteten Forderungen ergeben. Das Argument, das abgeleitete Exposure in Fremdwährung mit einer tatsächlichen Kreditaufnahme in Fremdwährung gleichzusetzen, muss im gegenwärtigen Entwicklungsstadium des Marktes mit Vorsicht akzeptiert werden. Zwar gibt es gut festgelegte Regeln für den Zugang zu Fremdwährungskrediten, die abgeleitete oder synthetische Exposition hat jedoch ganz andere Konnotationen. Eine kostenlose Stornierung und Umbuchung solcher Forderungen wäre gleichbedeutend mit der Freiheit, den Devisenmarkt ohne eine zugrundeliegende Forex-Exposition frei zugänglich zu machen. Dies hat größere Auswirkungen und müsste erst in einem späteren Stadium berücksichtigt werden, wenn das Land näher an der Kapitalkonvertierbarkeit ist. Der Konzern empfiehlt daher, dass die Corporates, die Devisentermingeschäfte abgeleitet haben, vorerst nur das Zinsänderungsrisiko und das Cross Currency Exposure absichern dürfen. Rupien-Devisentermingeschäfte, wie oben, können nicht bei Stornierung umgebucht werden. 3.4 Absicherung von Wettbewerbspositionen. Es gibt drei Arten von Wechselkursrisiken, die ein Unternehmen ausführt: (i) Transaktionsrisiko (ii) Vertragsposition und (iii) Wettbewerbsexposition Der wesentliche Unterscheidungsfaktor für die drei Arten von Expositionen ist der Zeithorizont, über den die Exposition erfolgt Entsteht. Das Transaktionsrisiko ist das Ausmaß, in dem der Wert der bereits eingegangenen Geschäfte durch das Wechselkursrisiko beeinflusst wird. Bei den vertraglichen Engagements handelt es sich um etwas längerfristige Forderungen, zum Beispiel um vier Quartale. Dabei handelt es sich um Forderungen, die nicht mit gebuchten Geschäften verbunden sind. Der Exporteur hat vertragliche Vereinbarungen implizit oder explizit, die ihre Exposition in diesem Horizont beeinflussen. Die Exposition bei langen Horizonten ist bekannt als Wettbewerbsexposition. Zum Beispiel, die Exposition der Cash-Flow in drei Jahren ab jetzt. Ein wettbewerbswidriges Exposure gegenüber einem Exporteur entsteht, wenn sowohl der Auslandsverkauf als auch der Preis pro Einheit durch Wechselkursänderungen beeinflusst werden. Diese Exposition ist so bekannt, weil die Exporteure8217 Wettbewerbsposition 8211 und nicht nur die Rentabilität der laufenden Operationen - durch Wechselkursänderungen verändert wird. Das Wettbewerbsengagement ist ein komplexes Phänomen und hängt von den Märkten ab, in denen der Exporteur tätig ist. Gegenwärtige Transaktionen und vertragliche Engagements sind abgesichert. Transaktionsrisiken sind auf der Grundlage von Belegen und bis zur Höhe der zugrunde liegenden Forderung abgesichert. Die vertraglichen Engagements sind bis zum Umfang des Vorjahresumsatzes oder dem Durchschnitt der vorangegangenen drei Jahre8217 Umsatz, je nachdem, welcher Wert höher ist, abgesichert. Dokumente sind bei Fälligkeit des Vertrages vorzulegen. Im Hinblick auf das wettbewerbliche Engagement der Exporteure in den überseeischen Märkten schlägt die internationale Erfahrung Folgendes vor: (i) Messung der Wettbewerbsexposition ist eine ungenaue Wissenschaft (ii) Da sich die Wettbewerbsexposition über einen längeren Zeithorizont entwickelt, muss die Reaktion strategischer Natur sein , Je nach der besonderen Situation, mit der der Exporteur konfrontiert wird. Dies schließt Änderungen in Technologie, Produktmix, Eingangsquellen, Marketingansatz, Verlagerung der Produktionsbasis usw. ein. (Iii) Die Absicherung von Wettbewerbsexpositionen durch Wechselkursverträge ist nicht alltäglich, zumal, wie bereits erwähnt, der Risikofaktor besteht Im Wettbewerbsexposure ist der reale Wechselkurs und nicht der nominale Wechselkurs. Dementsprechend ist die Gruppe der Auffassung, dass die Exporteure gegenwärtig nicht in der Lage sein dürfen, ihre wettbewerbsrechtlichen Forderungen abzusichern, kann diese Anforderung zum Zeitpunkt der Einleitung der Kapitalkonvertierbarkeit am besten angegangen werden. 3.5 Fremdwährungs-Rupien-Optionen Liberalisierung Im Devisen-Rupie-Optionsmarkt können Unternehmen Unter - nehmensanleihen und - pakete erwerben, da sie auch Verpackungsprodukte einbeziehen, die Kostensenkungsstrukturen beinhalten, sofern die Struktur das zugrundeliegende Risiko nicht erhöht und keine Nettozahlungen beinhaltet Erhalt der Prämie. Als Optionen sind komplexe Produkte, die Volumina in Devisen-Rupie-Optionen-Markt hat erwartet sediert, wird aber erwartet, dass sich als Wissen und damit Komfort über das Produkt wächst. Es gibt nur wenige Marktmacher, die sich auch in den Metros konzentrieren. Kunden-Appetit war vor allem für Null-Cost-Strukturen. Die Liquidität war nicht sehr gut, was zu breiten Angebotsspreads führte. Einer der Gründe ist, dass Kunden nicht Optionen verkaufen können. Daher ist der Markt im Wesentlichen in zwei Lager aufgeteilt: Market-Maker, die Schutz verkaufen können und Unternehmen, die Schutz kaufen können. (Selbstverständlich erlauben die zulässigen Kostensenkungsstrukturen den Kunden eine geringfügige Volatilität.) Das daraus resultierende Risiko muss unter den Banken selbst gelagert werden, da Unternehmen keine Nettoempfänger von Prämien sein können. Wenn es einem Exporteur erlaubt ist, eine Forderung gegen seinen Basiswert zu verkaufen, wird er es ihr ermöglichen, ihre Ansicht auf dem Markt auszudrücken und eine Prämie für das gleiche zu verdienen, ohne ein erhöhtes Risiko hinzuzufügen. Der Markt wird auch von der zusätzlichen Liquidität und der Tatsache profitieren, dass Risiken zwischen den Marktmachern und den Endbenutzern geteilt werden können. Die Angebotspreise würden sich verringern, was wiederum zu einer größeren Allround-Beteiligung führt. Angesichts dessen empfiehlt der Konzern grundsätzlich, dass Unternehmen, die einschlägigen Risikomanagementsystemen unterliegen, erlaubt sind, abgedeckte Anrufe zu veräußern und umzusetzen. Es ist jedoch zwingend erforderlich, dass notwendige Rechnungslegungsstandards und angemessene Offenlegungsnormen für die Corporates vorhanden sind, bevor diese Anlage zugelassen wird. 3.6. Einführung von strukturierten Produkten Der optimale regulatorische Ansatz, der es Unternehmen ermöglicht, auf einfache und komplexe Derivatgeschäfte in Devisen (sowohl USRupee als auch Cross Währung) zu reagieren, um Veränderungen in ihrem Risikoprofil herbeizuführen, besteht darin, die Mikrospezifikation der Produkte zu vermeiden Und was nicht getan werden kann. Stattdessen sollte die Diskretion bei den Banken liegen. Drei integrierte Faktoren im Rahmen dieses Ansatzes würden sicherstellen, dass Unternehmen nicht über ein übermäßiges Risiko, das Derivate ergreift, hingeben: (i) Produkte, die die Risiken von Corporates erhöhen, würden die Banken dem Kreditrisiko aussetzen, dessen Quantität unter anderem davon abhängt, Die Größe und die Risikofaktoren der betroffenen Ware. Dies würde sich im Preis des Produktes widerspiegeln. Wenn die Banken die ordnungsgemäße Kreditrisikosteuerungsdisziplin, wie die Errichtung einer Kreditlinie und die Entsendung von Sicherheiten, beachten, wäre die Fähigkeit der Unternehmen, in Derivate einzutreten, auf ihre Risikotragfähigkeit beschränkt. (Ii) Ordnungsgemäße Rechnungslegungsstandards für Derivate, die ihre periodische Bewertung zum Zwecke der Erfassung derselben in der PL-Anweisung oder unter einem Eigenkapitalgeber erfordern, würden sicherstellen, dass es keinen Anreiz für Unternehmen gibt, sich an dem so genannten 8216-Cost-Saldo8217-Derivat zu beteiligen Transaktionen durch Verstecken des damit verbundenen Risikos. (Iii) Umsetzung einer Politik der Kundeneignung und Angemessenheit durch alle Banken. Diese Politik würde zwangsläufig bedeuten, dass die Bank die Raffinesse - und Risikomanagement-Richtlinien und - Kapazitäten des Kunden berücksichtigt, um die angebotene Derivat-Transaktion einzugehen und ob er die Ziele des Kunden erfüllt. Es wird berichtet, dass einige Banken tiefe Out-of-the-money Swaps von einigen Unternehmen zu Off-Market-Preisen umstrukturiert haben, damit sie ihre Verluste zu verbergen. ICAI ist noch dabei, geeignete Rechnungslegungsstandards zu erstellen, und nicht alle Banken haben eine Politik der Kundeneignung und Angemessenheit umgesetzt. Die meisten der gut dokumentierten Derivat-Debakel wurden aufgrund von Lücken in den Rechnungslegungsvorschriften, die ein paar Personen erlaubte, ein scheinbar rosiges Bild in Bezug auf ihre finanzielle Leistung, die weit von der Realität war zu präsentieren. Sie waren in der Lage, Verluste auf Derivatgeschäften für einen Zeitraum zu verbergen, der ausreicht, um der betroffenen Institution schwere Schäden zuzufügen. Dafür war es letztlich die Aktionäre, die implizierte, die regulatorische Infrastruktur wurde auch in Verruf gebracht. Die Gruppe war der Auffassung, dass die Sequenzierung so erfolgen sollte, dass die Einführung komplexer Strukturen erst dann erfolgt, wenn die ICAI robuste Rechnungslegungsrichtlinien wie IAS 39 in Bezug auf die Derivativgeschäfte einführt, die unter anderem alle Unternehmen, die in solchen Produkten tätig sind, die MTM widerspiegeln Strukturen in ihrer PL AC und Bilanz. Transparenz und Offenlegung sind unerlässlich. Dementsprechend empfiehlt die Gruppe, dass die Zeit für die Einführung komplexer Strukturen noch nicht reif ist. Diese können nach Einführung geeigneter Rechnungslegungsrichtlinien zur Einführung herangezogen werden und die rechtliche Unklarheit in Bezug auf OTC-Derivate wird angesprochen. Vorschläge für Banken 3.7. Sicherstellung der Eignung und Angemessenheit der Kunden Eine stärkere Liberalisierung erfordert eine stärkere Kontrolle und Diskretion bei den Banken, die sie mit Verantwortung zu handeln haben, und das Vertrauen der Unternehmen, die für Derivatgeschäfte tätig sind, zu entwickeln. Die 8220appropriateness-Norm8221 stellt sicher, dass die Banken die gleichen Grundsätze für Kreditentscheidungen für Derivatgeschäfte verwenden, wie dies bei nicht-derivativen Geschäften der Fall ist. Die Bank würde den Zweck der Derivatgeschäfte bewerten und eine Bewertung abgeben, ob sie dem Bedarf des Kunden und dem Grad der Raffinesse angemessen ist. Während mehrere Banken bereits eine Angemessenheit Politik im Ort, haben viele Banken nicht. Es wird empfohlen, dass alle Banken unverzüglich eine Eignungs - und Angemessenheitspolitik des Kunden einführen. Ein Beispiel dafür ist der Quanto-Swap, den mehrere Corporates, Finanzinstitute und sogar die Banken selbst eingegangen sind, ohne das Risiko in vollem Umfang zu würdigen oder das damit verbundene Risiko durch die marktbildenden Banken nicht angemessen bewusst zu machen. Ein Quantoswap ist ein Zinsswap, der die Zahlung oder den Erhalt der Differenz zwischen den Geldmarktzinssätzen in zwei verschiedenen Währungen beinhaltet. Der Kunde weist auf einen ausländischen Zinssatz ohne Berücksichtigung des Wechselkursrisikos hin. Angenommen, ein Kunde hat sich verpflichtet, US LIBOR zu bezahlen und einen festen Zinssatz in INR zu erhalten, ist sie dem Risiko ausgesetzt, dass der LIBOR um mehr als das, was prognostiziert wird, steigt. A related issue is that ADs should ensure that the Board of Directors of the corporate has drawn up a risk management policy, laid down clear guidelines for concluding the transactions and institutionalised the arrangements for a periodic review of operations and annual audit of transactions to verify compliance with the regulations. The periodic review reports and annual audit reports should be obtained from the corporate concerned by the ADs. While this guideline is already in place, it is reported that banks find it difficult to implement it in the face of certain other banks not insisting on such a policy. All ADs should ensure compliance to this regulation, and refrain from offering derivative structures to those corporates which do not submit the requisite information. 3.8. The closing time for inter-bank foreign exchange market in India. The Forex Association of India (FAI) has requested Reserve Bank to grant a grace period of half an hour (i. e. up to 4.30PM) for concluding trades like end of day position adjustments, correction of wrong reporting, late reporting of branches and cover operations for customer transactions concluded close to 4.00PM. It is reported that FIIs also access the market for varying amounts close to 4PM further, vostro account funding operations also take place after the official trading hours. The Group has examined the issue and accepts the validity of the request. It is suggested that the closing time for inter-bank foreign exchange market in India be extended by one hour from 4PM to 5PM. Accordingly, the trading hours for the inter-bank foreign exchange market would be from 9.00AM to 5.00PM. 3.9. Capital charge for open position Banks should ideally maintain capital on their actual overnight open exchange position rather than on the limit available. The current requirement to maintain capital on the limit available is on account of the practical difficulties in computing the amount of capital to be maintained by each bank. However, as on date, banks are required to report online to Foreign Exchange Department (FED) their overnight open position maintained on each day by the close of business on the following working day. The proposal to maintain capital on the actual open position (rather on the limit approved by Reserve Bank) is, accordingly, recommended for implementation. The modalities for actually computing the capital charge may be worked out based on, say, monthly averages. 3.10. Monitoring of interest rate risk using the VaR The current method of computation of interest rate risk uses the gap method. Aggregate Gaps takes into account only the sum of the monthly mismatches and does not adequately address issues regarding the period of the exposure and attendant interest rate risk. The ceiling on Aggregate Gap Limit (AGL) is fixed at 6 times the net owned funds. Further, on account of the rolling month basis for determining the buckets, the aggregate gap maintained may exhibit a rise despite no transactions having taken place. With rise in business volumes, several banks have found it difficult to stay within the prescribed AGL. It is recommended that the current method be discontinued and a Value at Risk (VaR) method be introduced for monitoring of gaps. The issue regarding capital charge on the VaR maintained by banks is required to be addressed, though. Further, with rise in derivatives market activity, many banks have gaps in the 1-3, 3-5 and 5year sectors, which the model also needs to address. An appropriate model may be suggested by FEDAI in consultation with Reserve Bank. The VaR number can be released by FEDAI for each bucket and followed uniformly by all banks. Ultimately the system should move towards the adoption of a VaR model for interest rate risk on the entire portfolio (including that on the rupee book). 3.11. Overseas borrowing limit In developed markets, while Covered Interest Rate Parity Principle invariably holds, in India it does not. Permitting banks to borrow a greater amount of foreign currency (FC), though a necessary condition, is not a sufficient one for the above principle to hold. In case the overriding feeling in the market is that of continued rupee appreciation, corporates could borrow in foreign currency and sell it to generate rupee for working capital purposes. Reserve Bank would have to mop up the excess supply. The tendency of the banks would be to go in for more and more BuySell swaps to generate FC for lending as also to meet FC payment requirements. Premia would move into discount. Only if entities that are naturally long in FC were permitted access to the market, would they do sellbuy swaps to avail of the arbitrage advantage which would ensure that covered interest parity prevails. However, this would have capital account convertibility implications. Accordingly, it is recommended that this suggestion may be examined for implementation at a later date. 3.12 Crystallization of unpaid export bills Authorised Dealers (ADs) are currently required to crystallize the liability of their customers in rupees in respect of unpaid export bills. The rule framed by FEDAI in this regard states that ADs should take into account the exchange risk inherent in an unpaid exchange bill negotiated purchased discounted and transfer the exchange risk to the exporter by crystallizing the foreign currency liability into rupee liability on the 30th day after notional due date in case of an unpaid export bill. For crystallization into rupee liability, the ADs are required to apply the ready TT selling rate of exchange ruling on the date of crystallization or the original bill buying rate, whichever is higher. This means that while losses on crystallization are passed on to the customers the gains were not. The rule was formulated in 1984 when the foreign exchange market was in its infancy, with low trading volumes and very few products and, therefore, risk-taking by banks was minimal. Further, the country had low foreign exchange reserves and speedier realization of exports was a priority. Today the situation is very different. For quite some time, exporters have been complaining that the crystallization rule is unfair and asymmetrical, maintaining that the crystallized amount should be as per the ruling selling rate, regardless of whether it is higher or lower than the original rate at which the bill was bought 8211 i. e. the gains on crystallization of an export bill should be passed on to them just as the losses are recovered from them. The argument in favour of the above rule was that since the need for crystallization arises on account of a default situation i. e. failure on the part of the exporter to realize the export bill on the due date, there is no need to part with the exchange gains realized on account of crystallization. The arguments against the rule underscore the asymmetry and the logic that the ADs should not gain on account of default by their customers. Further, compared to the early 1980s, when this rule came into force, the foreign exchange market now is more liberalized and, among other things, the risk control systems being followed by ADs are much more developed and robust. ADs now manage fairly substantial open positions and are exposed to a variety of exposures much larger than that arising from unpaid export bills. Also, as per available information, such an asymmetric rule for treatment of exchange gain and loss on crystallization of export bills is not being followed in developed markets. The Group examined the matter and recommends that the spirit of the current rule, namely, compulsory crystallization of unpaid export bills should be preserved. However, both the exchange loss and gain on crystallization should to be passed on to the exporters in a symmetrical manner. Further, the mandatory period of 30 days for crystallization of export bills should be done away with and ADs be given the freedom to decide on the period for crystallization which may be linked to factors, like the time lag in receiving information about realization of export bills, credit risk perception of different types of exporter clients etc. However, the internal norms to be devised and followed by banks in this regard should be transparently disseminated to all concerned. Suggestions relating to hedging of commodity and related exposures 3.13. Permission to specific ADs for approving commodity hedging applications At present, applications from firms for commodity hedging are to be forwarded by their ADs to Reserve Bank along with their recommendations. Certain details are called for: 8226 A brief description of the hedging strategy proposed such as nature of risk, instruments proposed to be used to hedge the risk, names of commodity exchanges and brokers to be used for the purpose, average tenuresize of exposure along with expected peak positions 8226 A copy of the risk management policy covering risk identification, measurement, guidelines to be followed for revaluation and monitoring of positions and namesdesignations of officials authorised to undertake transactions and limits assigned. A one-time approval is granted by Reserve Bank and the responsibility of monitoring transactions in this regard thereafter becomes that of the AD. All forex flows pass through one AD only. Monitoring of operations is thus facilitated, since all flows and reporting is to one single AD only. Firms would have to apply to their AD detailing clearly their risk management policy, guidelines to be followed in the matter of price-fix hedging (what percentage of their total anticipated exposure they plan to hedge), internal risk management procedures and operational controls. A certificate from statutory auditors would have to be submitted by the firm on an annual basis to the AD. The certificate should confirm that the prescribed terms and conditions have been complied with and that the firms internal controls are satisfactory. These certificates may be kept on record for internal auditinspection. The Group recommends that the practice of one-time permission by Reserve Bank be dispensed with. The corporates8217 bankers could adopt the same methodology as has been practiced by Reserve Bank while screening applications from corporates, as well as improve upon it. On account of having banking relationship with the corporates, the ADs would in fact be better placed to appreciate and process the corporate8217s application. Since all permission to corporates to hedge their commodity price risk overseas and monitoring thereafter would be done by ADs, it is essential that the AD has relevant expertise domain knowledge in the area. The Group suggests that relevant criteria be fixed by Reserve Bank for the purpose of authorising ADs to approve commodity hedging applications and monitor transactions thereafter. Apart from financial strength and expertise, it would be essential for the AD to have put in place a customer suitability and appropriateness policy. A suitable reporting format may be designed for reporting to Reserve Bank the participants, volumes and other relevant aspects. As is the practice currently, permission would be given to corporates to hedge their commodity price risk through one AD of their choice only. However, since gold and silver fall under policy prescriptions different from other commodities, hedging the price risk of these commodities will not fall under these delegated powers. Further, while granting permission for hedging overseas, ADs may indicate that it would be advisable to use exchange-traded derivatives as far as possible. With increase in the number of corporates seeking to hedge their exposure to commodity price risk in the international as well as the domestic exchanges through OTC contracts, it is necessary that suitable hedge accounting norms in this regard be put in place for adoption by corporates. The Group suggests that the ICAI should come up with accounting rules in respect of commodity derivatives in line with international standards. 3.14. Permission to hedge freight risk The tanker and dry bulk shipping businesses primarily provide services for the carriage of commodities. The rates and realisations on them are closely linked to the commodities markets. The volatility in the freight rates is therefore of a very high level. For instance, it is reported that in 2004, the freight rate on the VLCC (Very Large Crude Carrier) route from the Arabian Gulf to the Far East saw a high of US 45 per ton and a low of US 9 per ton. For trades involving low value 8211 heavy weight commodities, managing shipping costs becomes even more important 8211 it is observed that shipping iron ore costs more than the cost of the iron ore, while the shipping cost of coal is around 60 per cent of the cost of the coal. For a shipping company, managing the freight volatility assumes a great deal of importance. Forward Freight Agreements (FFAs) are widely used internationally to hedge the risks ship owners and their clients are exposed to. FFAs are contracts bought or sold on a specified Baltic route at an agreed rate for a specified quantity and specific period in the future, and then settled in cash against the appropriate Baltic indexroute at the end of each agreed period. The Baltic Exchange declares the indicesrates for several vessel types and routes, both tankers and dry bulk. FFAs are quoted in terms of freight (rate per ton) or as a time-charter rate. The FFA is essentially an OTC market, where settlement is made between the two parties to the contract and not through an Exchange. Counterparties are exposed to mutual credit risk exposure. Keeping in view the freight risk incurred by the ship owners and their clients, it is recommended that both parties may be permitted to hedge themselves to the extent of their actual physical exposure, based on underlying. 3.15. Hedging of Inventories. It is observed that several oil companies carry considerable inventory at all times, necessitated by oil and oil products being a sensitive commodity. This is in order to ensure that no shortages occur at any time. Oil companies are, therefore, 8216long8217 and hence exposed to the risk of a decline in prices. The Group recommends that oil companies may be permitted to hedge inventories based on balance sheet to the extent of the inventory during the previous year. Public sector oil companies may obtain requisite Government clearance before operationalising their hedging strategies. 3.16. Hedging of economic exposure arising out of commodity price risk Under extant regulations, residents in India engaged in import and export trade, may hedge the price risk of all commodities in the international commodity exchanges markets. All standard exchange-traded futures and options (purchases only) are permitted. If the risk profile of the resident entity warrants, it is also permitted to use OTC contracts. It may also use a combination of option strategies involving a simultaneous purchase and sale of options as long as there is no net inflow of premium. The focus is on risk containment. Only off-set hedges are permitted. This implies that the resident entity should have a firm underlying before it hedges its risk in the international market by buying futures and options contracts in the commodity exchanges or OTC contracts. No price-fix hedge is permitted. A price-fix hedge enables an importerexporter to lock into a future price for a commodity she plans to importexport without actually having a crystallised physical exposure to the commodity. The advantage of a price-fix is that it allows a firm to lock into a price when it is attractive, leading to better planning and raw material management. It is well accepted that giving freedom to hedge against price risks is an integral part of the process of economic reform and liberalisation. Accordingly, the Group recommends that corporates may be permitted to hedge their commodity price risk by entering into price fix hedges to the extent of the average quantity of commodity boughtsold during the previous three years, or during the previous year, whichever is higher. This would be applicable both to commodities imported exported and procured domestically. Wherever necessary, Government clearance may be obtained by public sector companies before operationalising their hedging strategies. For producersconsumers of commodities, the risk of fallrise in prices may be on the entire produceamount consumed. Accordingly, they may be permitted to hedge their commodity price risk by entering into price fix hedges to the extent of the average quantity of commodity producedconsumed during the previous three years, or during the previous year, whichever is higher. Alternatively, there may be situations where producersconsumers may run a price risk not on the gross amount, but on the net amount only. They may be permitted to hedge the price risk on the net amount, since a part of the input price risk is offset by the output price risk. Illustratively, consumers of commodities may buy raw material, process the same and sell finished goods, in which case they run a commodity price risk on the net amount only. 3.17. FCNR (B) deposits in more currencies The Group recommends that FCNR (B) deposits may also be accepted in CAD, AUD and NZD so as to encourage flows from these countries. This would enable non-resident Indians (NRIs) in these countries to avail FCNR(B) facility without having to incur any exchange rate risk. 3.18. Deregulation of PCFC interest rate The existing regulations which stipulate that that Pre-shipment Credit in Foreign Currency shall be extended to exporters at not more than LIBOR 75 basis points is observed more in the breach. Banks frequently add a 8220service charge8221 to the LIBOR 75 basis points cap. This is not objected to by exporters also since they are still able to obtain funding at cheaper levels as compared to rupee credit objecting to getting PCFC at this enhanced rate may actually result in the exporter not getting PCFC at all. In such a situation, the stipulation on the interest rate on PCFC may be dispensed with. It is recommended that Reserve Bank may write to the Government of India suggesting deregulation of PCFC interest rate. 3.19. Release of data on derivatives Release of data to the market improves transparency and enables participants to gauge the volumes being transacted. This suggestion is recommended for implementation. Reserve Bank may design a suitable format in consultation with FEDAI. 3.20. Introduction of USINR currency futures. As per current regulations, only those market participants who have an exposure to exchange rate risk are allowed to hedge the risk using various products available, such as spot and forward contracts, swaps and options. Once currency futures are introduced, it would no longer be possible to ensure that the entity buying selling a futures contract has an underlying. As such, participants having purely a speculative interest would be enabled to enact their views using futures. Therefore the Group is not in favour of introduction of this product for the present. 3.21. Regulatory and accounting convergence in respect of derivatives. There is regulatory divergence in the permissible structures of rupee and forex derivatives. These restrictions have been put in place on account of prudential considerations and the fact that India is not fully convertible on the capital account. The Group recommends that till such time as capital account restrictions are in place, it would be desirable to maintain differential regulations with respect to rupee interest rate derivatives and forex derivatives. There should be full convergence between the accounting treatment of all types of derivatives (Rupee as well as foreign exchange). and also amongst banks and corporates. The objective here is to eliminate all incentives to drive any wedge between on-balance sheet and off8211balance sheet items. Moreover, there is need to put in place objective conditions to determine whether a derivative is in the nature of a hedge or not. Wherever the derivative is in the form of a hedge, the accounting treatment should be the same as that for the underlying. The Group recommends that derivatives accounting norms on the lines of IAS 39 be introduced for adoption by banks and corporates alike. However, in the case of banks, a somewhat stricter and conservative accounting norms may be necessary on prudential considerations, in view of the pivotal position of banks in the country8217s financial and payments systems. Para I.40 of Annex I may be seen for a more detailed analysis. 3.21 Implications of further liberalisation Safeguards The implications of liberalisation measures recommended by the Group for the overall forex market and its two major constituents 8211 users and banks 8211 are as follows: Forex market Going by international experience, more freedom on outflows would cause more inflows, particularly when the outlook on the rupee is bullish. Thus, further liberalisation would possibly lead to increased supply and more volume and liquidity in the spot and derivatives segments of the forex market. Market users With increase in the international trade volumes, greater access to international funds by way of borrowings and enlargement in scope for investments overseas, it is imperative that Indian corporates have the necessary systems to manage their foreign exchange risk. The proposed liberalisation measures would offer more flexibility to corporates to manage their risks dynamically and lead to more efficient reallocation of risks. The competitive position of Indian entities engaged in international trade will be enhanced as a result of the suggested measures. Liberalisation measures pertaining to hedging of commodity price risk would ensure that corporates dealing in commodities whose prices are linked to international prices would be able to compete effectively with their competitors. Banks Authorised dealers will benefit from the larger array of products and higher volumes. Banks as users will also benefit in the same way as all other users in better management of their market risks. Safeguards Phased implementation The recommendations need to be implemented in a phased manner so as to allow time to all categories of participants to adequately prepare for the new productsactivities that will ensue. Monitoring of user activities - Information Enhanced flexibility to users should go hand in hand with availability of critical information for monitoring purposes. At present, there is a substantial information gap as regards what the market-users are doing. This is important for market monitoring purposes, particularly since forex activities of the treasuries of large corporates are increasingly becoming profit-seeking. Large corporates often use more than one authorised dealer for forex operations. Hence, it would be a good idea to designate one authorised dealer for each large customer to collect and collate information in respect of their forex operations. Transparency From a systemic perspective, guaranteed settlement of forex transactions, particularly of the derivatives, provides a fair degree of stability. Also, it becomes easier for authorities to monitor and regulate activities in the derivative markets if all information is concentrated on the clearingsettlement mechanism. CCIL has been offering clearing and guaranteed settlement of spot USINR transactions. Guaranteed settlement of USINR forward transactions from trade date is likely to commence soon. Centralised clearing and settlement for derivatives by CCIL would rid banks of their concerns regarding credit risk on account of the derivative positions of the counterparty banks dissemination of information by CCIL would bring about more transparency. Disclosure Further liberalisation requires better transparency and ready availability of information. It would therefore be essential to put in place a comprehensive reporting system for all derivatives transactions. The reports should be such that they bring into focus not only the volumes transacted but also the quantum of risk faced by banks on account of their derivative positions. Chapter 4 Summary of recommendations for implementation in the short-term. The following measures are proposed for implementation in the short-term: Resident Entities 1. To provide greater flexibility to resident entities in dynamically managing their exposures, to further the development of the forward segment of the market and to bring about uniformity with respect to booking of such contracts, all forward contracts booked by residents, regardless of tenor, may be allowed to be cancelled and rebooked freely. Foreign currency-rupee swaps booked to hedge genuine foreign currency exposures may also be permitted to be rebookedreinstated on cancellation. Currency swaps enabling a corporate to move from a rupee exposure to a foreign currency exposure, one cancelled, cannot be rebooked. 2. Corporates who have derived foreign exchange exposures arising from rupee-foreign currency swaps may be permitted hedge the interest rate risk and cross currency exposures (not involving the rupee). 3. Corporates may be permitted to sellwrite covered call and put options subject to adequate accounting standards and risk management systems being in place, Banks 1. Greater liberalisation requires greater control and discretion with banks. Banks need to evaluate the purpose of the derivative transaction being offered to their customers and make an assessment as to whether it is appropriate to the needs and level of sophistication of the customers. All banks may be required to put in place a customer suitability and appropriateness policy. 2. Banks may be permitted to provide capital on the actual overnight open exchange position maintained by them, rather than on their open position limits. 3. Banks may be given the freedom to decide on the period of crystallization of unpaid export bills. The exchange gain and loss on crystallization shall be passed on to exporters symmetrically. 4. Banks having expertise in managing commodity price risk and hence specifically authorised by Reserve Bank in this regard, may be allowed to approve commodity hedging proposals from their corporate customers. 5. The closing time for inter-bank foreign exchange market in India may be extended by one hour from 4.00 PM to 5.00 PM. 6. Forex data, including traded volumes for derivatives such as foreign currency-rupee options, may be made available to the market on a regular basis. Non resident entities 1. FCNR (B) deposits may also be accepted in Canadian dollar (CAD), Australian dollar (AUD) and New Zealand dollar (NZD), apart from US dollar (US), Pound sterling (GBP). Euro and Japanese yen (JPY), as at present. Perspective on the Indian Forex Market. I.1 The wide-ranging structural reforms in the 1990s in response to the unprecedented external payment crisis of 1990-91 led to strength and resilience in the external sector of the economy. With the country moving to a market determined exchange rate regime and becoming fully convertible on current account transactions, the risk-bearing capacity of banks increased and trading volumes started rising. The first major initiative toward further developing the forex market along modern lines in the early years of reform was the appointment of an Expert Group in November 1994 to study, in-depth, the shortcomings of the foreign exchange market and to recommend measures for its efficient and orderly growth, including the introduction of new derivative products. The Expert Group, popularly known as the Sodhani Committee, made 33 major recommendations. Reserve Bank accepted these for implementation and the period starting from January 1996 saw wide-ranging reforms in the Indian foreign exchange market. Certain measures, such as permission to Foreign Institutional Investors (FIIs) to hedge their investments in India, which were not found suitable for implementation initially, were also implemented subsequently. I.2 The Indian forex market is made up of banks authorised to deal in foreign exchange, known as Authorised Dealers (ADs), foreign exchange brokers, money changers and customers - both resident and non-resident, who are exposed to currency risk. It is predominantly a transaction-based market with the existence of underlying forex exposure generally being an essential requirement for market users. The entire gamut of regulations on hedging of currency exposures is predicated on the fact that the entity accessing the forex market should have an underlying. Foreign Exchange Dealers8217 Association of India (FEDAI) plays a special role in the foreign exchange market as a Developmental Agency for smooth and speedy growth of the forex market in all its aspects. All ADs are required to become members of FEDAI and to execute an undertaking to the effect that they would abide by the terms and conditions stipulated by FEDAI for transacting forex business. FEDAI is also the accrediting authority for the forex brokers in the interbank forex market. I.3 AD licences are issued to banks, on their request, under Section 10(1) of the Foreign Exchange Management Act, 1999. The AD licences are co-terminus with the banking licences and allow ADs to undertake the entire range of foreign exchange activities. All merchant transactions are required to be undertaken through ADs. ADs are freely allowed to buysellswap foreign exchange and enter into forward and derivative contracts with other banks. Currently, there are 88 ADs operating in India out of which two are Urban Co-operative banks (UCBs) and one is a State Co-operative Bank. Some UCBs have been granted Full Fledged Money Changer8217s licence, which allows them to buy foreign currency and sell foreign currency for private and business visits. A few of them have also been granted permission by Reserve Bank to maintain NRENRO deposits. Some financial institutions, which have large volumes of foreign exchange transactions and wish to run their own treasuries, have been granted restricted authorised person8217s licence. Under this licence, their foreign exchange transactions have to be restricted to those listed out in their licence. While they are allowed to hedge their underlying forex risk, they are generally not permitted to trade initiate positions. I.4 As mentioned above, AD licences are granted to banks co-terminus with their banking licences. However, it is well acknowledged that managing forex risk requires expertise, both in terms of human resources and systems, on an ongoing basis. It, therefore, bears examination as to whether one should consider issuing an AD licence initially for a period of, say, three years. During this period, the bank8217s forex operations would be monitored and only if the systems and procedures adopted are found to be satisfactory, would the licence be renewed. If any major violation of guidelines is detected warranting discontinuation of the AD licence, the same would not be renewed. AD licence would not be granted or if granted, would be withdrawn, in case of banks whose balance sheets are weak, and which could possibly face a difficult financial situation. I.5 Primary Dealers (PDs), who primarily deal in government securities, have evinced interest in obtaining AD licences. Their specific interest appears to be in acting as market makers in derivative products. However, as dealers in Indian securities, they are not exposed to foreign exchange risk. In addition, PDs are financial intermediaries mandated to perform a specialised role in Government Securities Market their role as market - makers in foreign exchange has not been envisaged, and may, in fact, come in the way of effective discharge of their responsibilities as primary dealers. As such, PDs may not be granted AD licences for the present. The request of PDs for permission to invest in overseas securities is currently under consideration. In case such investments are approved, PDs would be exposed to exchange risk insofar as their overseas investments are concerned and would be permitted access to the domestic forex market as users, through their ADs. 1.6. All merchant transactions in the forex market have to be necessarily undertaken directly through authorised dealers. However, to provide depth and liquidity to the interbank segment, ADs have been permitted to utilise the services of brokers for better price discovery in their interbank transactions. Inter-bank contracts can be concluded between ADs through direct negotiations over the telephone or through an electronic negotiated dealing system where the counterparties directly contact each other over an electronic dealing platform and negotiate the terms of the contract. Alternatively, such deals can be put through a voice broker over telephone or through an electronic order matching system, where counterparties leave their bid offer quotes on an electronic system which are displayed to the market participants. The Sodhani Committee had seconded the proposal of Reserve Bank for setting up of a clearing house for forex transactions, considering the substantial benefits which would accrue to banks such as reduction in the cost of settlement, reduction in counterparty risk due to the settlement guarantee offered by the Clearing House, better utilisation of counterparty limits on account of netting, etc. Accordingly the Clearing Corporation of India Ltd. (CCIL) was set up in 2001 and has been undertaking guaranteed settlement of interbank USINR spot and forward contracts since November, 2002. Forward deals are guaranteed for setlement from the S-2 day the proposal for guaranteed settlement of forward deals from trade date is currently under examination. Subsequently, CCIL has been undertaking guaranteed settlement of cash (value same day) and tom (value next working day) contracts also. The settlement is undertaken on a multilateral net basis, through a process of novation, and all trades accepted are guaranteed for settlement. To take care of the risks associated with guaranteed settlement, CCIL has set up a robust risk management mechanism by setting exposure limits for its members and also putting in place a sound allocation mechanism. CCIL has recently been granted pemission for aggregation of cross currency deals of ADs through the Continuous Linked Settlement (CLS) process by becoming a third party user in the CLS system. CLS settlement is however not a guaranteed settlement and only ensures that settlement takes place on a Payment Versus Payment basis. Once the CLS facility is operational, the feasibility of extending it to banks in our neighbouring countries (such as those under the Asian Clearing Union mechanism) needs to be explored. I.7 General permission has been given to ADs to openclose rupee accounts of their overseas branches or non-resident banks with whom correspondent relationship is established. No interest is payable on the balances in these accounts. Funding of the vostro accounts can be done only on up to spot basis, for which ADs are permitted to quote only the bid side. ADs are not permitted to make two way or forward quotes to overseas banks. I.8 Reserve Bank issued guidelines to banks in November 2002 for opening and maintenance of Off-shore Banking Units (OBUs) at the Special Economic Zones set up at the behest of the Ministry of Commerce, Government of India. The OBUs are expected to provide world class facilities and funds at global rates to the export oriented units situated in these zones. OBUs are not permitted to deal in rupees at all except for their day to day expenses. There has to be a clear fire wall between their activities and the domestic forex and money markets. To this end, they have been prohibited from lending to their parentsbranches in India. They are also permitted to lend only 25 per cent of their total liabilities as on the previous working day to units in the Domestic Tariff Area (DTA). While OBUs are permitted to invest overseas, they are not permitted to lend outside India. Several banks operating OBUs have requested for expansion of the activities conducted by OBUs. They have represented that lending to units in the SEZs does not generate sufficient business and they should be allowed further facilities such as lending to banks in India, to Export Oriented Units in the Domestic Tariff Area and to overseas entities. To prevent off shore funds from contributing to credit expansion and increase in prospects of liquidity, forex and credit risks, it is necessary to insulate the DTA from credit flows from the OBUs. Therefore, the first two activities cannot be considered. However, allowing OBUs to lend outside India and take part in international syndications consortiums at par with the foreign branchesoffices of Indian banks may be considered favourably. This would enable OBUs to shift focus from the domestic canvas to an international one and help them develop expertise in the international sphere. At the same time, this would ensure that dealings of offshore banks with residents would reduce as a percentage of their total business, which really was the intention when OBUs were established. I.9 The Indian forex market has grown manifold over the last several years. While the number of banks authorised to deal in foreign exchange has shown a modest increase from 84 to 88 and the number of forex brokers from 40 to 47, turnover has grown substantially, as reflected in the table below. The top 30 banks in India account for approximately 90 per cent of the overall turnover in the market. (Amount in US billion, without adjusting for double-counting) Jul 96-Jun 97 Jul 03-Jun 04 Total turnover 915.98 2429.81 (2.6 times) Avg. daily Merchant turnover 0.60 2.24 (3.7 times) Avg. daily Inter-bank turnover 3.07 7.47 (2.4 times) Avg. daily total turnover 3.67 9.71 Inter-bank to Merchant ratio 5.12 3.33 Spot to as a percentage of total to 52.92 49.38 Forward to as percent of total to 11.65 13.36 Swap to as percent of total to 35.43 37.26 There are two significant features in the above data. The first is that inter-bank to merchant turnover ratio has declined from 5.12 to 3.33. This is on account of the fact that the merchant turnover has grown at a much faster pace than the interbank turnover. The second is that Inter-bank FCFC (foreign currencyforeign currency) turnover as a percent of total Inter-bank turnover declined from 42 per cent in 96-97 to 24 per cent in 2003-04. This was on account of substantial increase in Inter-bank FCINR turnover. I.10 The sector-wise distribution of the turnover figures (as a proportion of the total turnover for the respective year) is given below: (In per cent) 1996-97 2003-04 Banks Merchant Interbank Total Merchant Interbank Total Public Sector 8 21 29 9 32 41 Private Sector 2 10 12 5 13 18 Foreign 7 52 59 9 32 41 Total 17 83 100 23 77 100 The table indicates that the share of the public sector banks in the total turnover has increased from 29 per cent in 1996-97 to 41 per cent in 2003-04 equaling that of foreign banks, whose share has declined from 59 per cent to 41 per cent during the same period. The share of private sector banks has also gone up from 12 per cent to 18 per cent during the same period. Some of the new private sector banks have shown significant growth in their turnover over this period. The major growth for the public sector banks has been in their interbank segment, indicating an increase in their trading transactions. On the other hand, the foreign banks have seen a sharp decline in their interbank volumes from 52 per cent in 1996-97 to 32 per cent in 2003-04, while their merchant volumes have grown from 7 per cent to 9 per cent. The merchant turnover of a few foreign banks has shown a significant increase during the period. I.11 The market trades freely in spot and forward exchange contracts, and to a limited extent in derivatives. Corporates are not permitted to undertake foreign exchange swap transactions. The efficiencyliquidity of the market is often gauged in terms of bidoffer spreads. Wider spreads are a sure indication of an illiquid or a one-way market. In India, the normal spot market quote has a spread of 0.50 to 1 paise while swap quotes are available at 1 to 2 paise spread. The forward market is very liquid up to one year. I.12 While the market has grown tremendously, it is fledgling compared to the global market. As per the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by BIS in April 2004, and in which Reserve Bank also participated, average daily turnover in the international market has risen to US1.9trillion in 2004 as against US1.2trillion in 2001.This represents an increase of 57 per cent at current exchange rates and 36 per cent at constant exchange rates. Regarding the currency composition of turnover, DollarEuro is by far the most frequently traded currency pair with 28 per cent of global turnover, followed by DollarYen (17 per cent) and DollarSterling (14 per cent). Percentage share of average daily turnover indicates that US dollar holds 88.72 per cent share, followed by Euro(37.2 per cent), Japanese yen(20.3 per cent) and Pound sterling (16.9 per cent). (Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200 per cent instead of 100 per cent) The Indian rupee has just a 0.3 per cent share. It is also worth mentioning that the growth in forex turnover in India has been more than in the global markets. The reason may be attributed to the substantial increase in the volume of forex flows into the country. I.13 The above survey also indicated that the derivatives market activity has shown tremendous growth as well. Turnover in nominal or notional principal amounts (in US million) during the month of April 2004, which may be considered as representative of average monthly turnover, is as follows: (Amounts in US million) Forward Rate Agreements Of which INR FRAs 2242 698 Interest Rate Swaps Of which INR IRS 17102 11437 Cross Currency Swaps Of which FCINR swaps 3028 2096 OTC Options (FCINR Cross cy) Of which FCINR 2836 1365 However, average daily OTC derivatives turnover in India forms around 0.1 per cent of the US1.26 trillion average daily global turnover (excluding outright forwards and foreign exchange swaps). I.14 Non - Deliverable Forwards: An interesting development has been the establishment of a non-deliverable forward (NDF) market in USINR offshore, largely concentrated in Singapore, but also traded out of London and New York (on a smaller scale, though). While reliable statistics on the volumes traded are hard to come by, a recent BIS report puts the average daily turnover, as measured by an Emerging Markets Traders Association (EMTA) survey in early 2003, at US38 million. This is quite small compared to a daily turnover of US9.71 billion (US7 billion excluding double-counting) in the onshore market, although reportedly NDF volumes have grown since then. The daily turnover in US million per day for the other commonly traded Asian currency NDFs are 1,350, 250, 150, 65 and 38 for Korean won, New Taiwan dollar, Chinese renminbi, Indonesian rupiah and Philippines peso, respectively. NDFs in offshore locations are synthetic foreign currency forward contracts on non-convertible or restricted currencies traded over the counter outside the direct jurisdiction of the authorities of the corresponding currencies. These are generally settled in US dollar. The demand for NDFs arises principally out of regulatory and liquidity issues of the underlying currencies. These derivatives allow multinational corporations, portfolio investors, hedge funds and proprietary foreign exchange accounts of commercial and investment banks to hedge or take speculative positions in local currencies. The pricing of NDF is quite different from that of regular outright forward contracts. The prices are determined by a combination of interest rate differential between the two currencies, supply and demand, future spot expectation and local currency forex regime central bank policies. Thus, NDFs are derivative instruments for investors speculators who are interested in hedging speculating on a currency without a forward market, or a forward market with restrictions for non-residents. The settlement of the transaction is not by delivering the underlying pair of currencies, but by making a net payment in a convertible currency proportional to the difference between the agreed forward exchange rate and the subsequently realised spot fixing. It is observed that the average turnover in Asian NDF currencies, which amount to around 70 per cent of the emerging market NDF turnover globally, has risen over the years however, turnover fluctuates a good deal from day to day. Volatility is typically larger than the spot counterpart, owing possibly to intervention in the spot market. Asian NDFs tend to correlate more positively with each other than do their spot counterparts. The wide spreads between onshore interest rates and NDF-implied offshore interest rates suggest segmentation of onshore and offshore markets in Asia, with the exception of South Korea. In the case of India, the relationship between the two rates also seems to reflect the swings in the underlying market pressure in the rupee. In the wake of the Asian crisis, offshore implied interest rates were higher than onshore rates, reflecting ongoing depreciation pressure in the offshore trading at the time. Since 2003, however, offshore expectation of further rupee appreciation has driven offshore implied interest rates below onshore rates. Thus, for example, the onshoreonshore interest rate spreads swung from a negative 400 to 1000 basis points in 1999-2001 to positive 300-600 basis points by late 2003. Current spreads continue to reflect offshore expectations of further rupee appreciation. Policy initiatives to develop the forex market (A) Relaxations for banks: I.15 Overnight Open Position Limit (OPL) The Sodhani Committee recognised that a vibrant forex market would have to allow banks to make two way quotes and take larger open positions. Until 1994, ADs were not permitted to take any view on currency movements and were required to maintain square or near square positions. Subsequently in May 1994, all banks were uniformly allowed an overnight open position limit of Rs 15 crore. As per the Sodhani Committee recommendation, banks were given the freedom to fix their own open exchange position limit and seek approval of Reserve Bank in this regard. The revised limits became operative from January, 1996. Obviously the limits should have a reasonable relation to the trading volumes, merchant turnover and the capital structure of the banks. It has been observed that as the banks8217 sophistication and volumes have grown, they have gradually sought to increase their OPL. The combined OPL of the banking system today is several times the OPL that was prevailing in 1996. I.16 Aggregate Gap Limit AGL) Depending upon the asset-liability profile, dealing expertise and such other relevant factors, ADs have been accorded freedom to fix their own gap limits for more efficient management of their assets and liabilities, subject to Reserve Bank approval. The ceiling on AGL is fixed at 6 times the net owned funds of the AD. AGL seeks to control an AD8217s liquidity or mismatched maturity risk. Such risks occur when liabilities and contracts to sell in a given currency mature earlierlater than assets and contracts to purchase in that currency. The maturity mismatch is basically a problem of excess or shortage of funds on any given day generally, banks are more concerned about a negative gap than a positive gap since it could imply having to fund such shortage at higher than anticipated interest costs (in case of borrowing) or swap costs (in case the currency is purchased to match the shortage and re-sold for another date). The current method of capturing the risk associated with asset-liability maturity mismatch of the forex book of ADs through an indicator (AGL), which is the aggregate of the monthly mismatches, is not very accurate. Banks which are permitted higher Aggregate Gap Limits are required to mark-to-market their gaps on a daily basis using value-at-risk (VaR) models. A VaR methodology is better than the current methodology for estimating the risk associated with gaps. While ADs have sought to increase their AGL in tune with their business volumes, the utilisation of AGL for accommodating maturity mismatches on account of derivative transactions has also increased. I.17 Initiating cross currency position in the overseas markets: With globalisation and significant increase in cross border capital flows, banks commenced taking views on cross currency movements also. The banks which had put in place adequate risk management systems, on approval of Reserve Bank, were permitted to trade in the overseas markets, subject to observance of the overall positiongap discipline. Currently, banks do not need prior approval of Reserve Bank for initiating cross-currency trading positions overseas. I.18 Asset - liability management by banks: Once the foreign currency balance-sheet of the banks started swelling on account of liberalisation, banks were permitted to use interest rate swaps, currency swaps and FRAs for their own asset liability management, subject to a proper risk management policy being approved by their top management. They can also purchase call or put options to hedge their cross currency proprietary trading positions. I.19 Removal of statutory pre-emptions on inter-bank borrowings Among other things, the Sodhani Committee went into the issue of the absence of a term-money market in rupee and the consequential imperfection of the yield curve at that time. To address this, it recommended that statutory pre-emption on inter-bank borrowings be abolished. Accordingly, in April 1997, Reserve Bank exempted cash reserve requirements on inter-bank borrowings. An inter-bank term money market is yet to develop, and the closest proxy to a rupee yield curve is the MIFOR curve. MIFOR is an acronym for Mumbai Inter-bank Forward Offered Rate. MIFOR curve is a swap curve which is fairly liquid up to five years, although quotes extending to ten years are usually available. Use of MIFOR swap as a derivative instrument for management of interest rate and currency risks has been increasingly resorted to by banks, non-bank financial institutions and corporates alike over the last few years. The evolution of MIFOR swaps can be traced to the facility extended by the Reserve Bank in April, 2000 for the use of 8216interest rates implied in the foreign exchange forward market8217 for pricing of rupee interest rate derivatives. At present, daily trading volumes in the MIFOR swap market are estimated to be in the region of INR350-450 crore. The MIFOR is a benchmark denoting the cost of rupee funds implied by the US dollar interest rate (LIBOR) and USINR forward premia. A MIFOR swap is a plain vanilla (FixedFloating) interest rate swap with the floating leg tied to the MIFOR. For swaps of tenor more than 12 months, the floating rate is six-month MIFOR. For swaps of shorter tenor, the floating rate is three-month MIFOR. There is no exchange of principal and interest payments are settled on a net basis. There are established market conventions for computation of six - and three-month MIFOR on all working days. By construction, hedging of MIFOR swaps necessarily involves a transaction in the USRupee forward market. For example, hedging of a 8216Received8217 position (Receive Fixed 8211 Pay Floating) in a MIFOR swap of five-year tenor would involve the following: (i) Borrow rupee funds (equal to the principal amount) for six months (ii) Use this fund to do a USINR Buy-Sell swap for six months (iii) Invest the US dollars in a six-month deposit (iv) Repeat these steps every six months. Conversely, hedging a 8216Paid8217 position (Pay Fixed 8211 Receive Floating) in a MIFOR swap of five-year tenor would involve the following: (i) Borrow US funds for six months (ii) Use this fund to do a USINR Sell-Buy swap for six months (iii) Invest the rupee fund in a six-month deposit (iv)Repeat these steps every six months. The above characteristics of MIFOR swap render it a tool for coupon-only currency swaps as well. Those with medium to longer term borrowing in US dollars at floating rates can lock in a fixed rupee rate for interest payments through MIFOR swaps. Despite its ingenuity and popularity, MIFOR swap mechanism raises a few issues: (i) The MIFOR swap rates cannot be arrived at analytically. In other words, pricing of MIFOR swaps do not follow the no-arbitrage principle. MIFOR swap rates are determined by forces of demand and supply. In this respect, it is exactly similar to the USINR forward premia, which usually do not reflect the interest rate differential (arbitrage-free level) and are determined solely by forces of demand and supply. (ii) The six-month MIFOR is a rupee interest that should prevail if the USINR six-month forward premium is equal to the interest rate differential for a similar tenor. To the extent that the USINR forward premia reflect market8217s expectation about future movement of the spot USINR, MIFOR rates embody an exchange rate expectation. This is equally true about the longer-term MIFOR swap rates as well. In economic terms, MIFOR swap rates can be better explained with reference to the principle of 8216Uncovered Parity8217. Thus, MIFOR swap rates are derived rupee interest rates, given the expectation about the movement of the spot USINR rate and US dollar interest rates for similar tenors. I.20 Permission for overseas borrowings and investments One of the major shortcomings of the Indian foreign exchange market is that the forward price of the rupee is not determined by the interest rate differentials alone, but is influenced in a major way by (a) supply of and demand for forward dollars, (b) interest differentials and expectations of future interest rates, and (c) expectations of future USINR rate. This would indeed be the case in all countries that still have exchange and capital controls. To initiate the process of integration between the two markets, Reserve Bank has permitted limited access to banks to borrow from and invest in the overseas markets. Presently, banks are permitted to borrow overseas up to 25 per cent of their Tier I capital or US10 million, whichever is higher. However, overseas borrowings of banks for funding export credit are not included in this limit. The interest and exchange rate scenario, prevailing over the last two years has led to increased demand by exporters for foreign currency denominated loans leading to manifold increase in the overseas borrowings of banks to fund these loan assets. In March 2004, rationalization of the various avenues for foreign currency borrowings of banks was undertaken and a system of monthly reporting was introduced. Current data indicates that the banking system8217s overseas borrowing is quite close to the overall ceiling and if borrowings for funding of export credit are also included, the total overseas borrowings are significantly higher. A reference is also drawn to the Report of the Internal Group on External Liabilities of Scheduled Commercial Banks constituted by Reserve Bank. In its report dated May 24, 2004, the Group had stated as follows: 8220International liabilities of banks are now nearly double of their international assets which is an issue of serious concern.8221 There has been some thought on whether a cap should be placed on the total overseas borrowings of banks at, say, 50 per cent of each bank8217s Tier-I capital. The concern about residents borrowing in foreign currency is that it might lead to a ballooning of unhedged exposures which may have adverse implications for the stability of the foreign exchange market as well as the quality of loan assets in the books of banks. However, foreign currency loans for funding export credit cannot be considered to be unhedged since exporters have a natural hedge in terms of their export proceeds. The only apprehension would then be if exporters were to sell their foreign currency proceeds forward and repay the foreign currency loans out of rupee resources. One point of view is that with the withdrawal of quotas for many manufactured goods, Indian exports are set to take off and this may not be the right time to restrict the availability of foreign currency funds to the exporters and therefore, no limit should be placed on banks8217 borrowings for funding export credit. Another issue for examination is whether smaller banks, for whom US10 million is higher than 25 per cent of their Tier-I capital, should be permitted to borrow only up to the 25 per cent limit. This could be justified in the sense that being a smaller bank, its risk-taking appetite would also be smaller and the prudential limit of 25 per cent would be an appropriate ceiling. On the other hand, such small banks are few in number they have limited merchant base and restricting their borrowing would further starve them of opportunities in the market. ADs are free to undertake overseas investments up to the limits approved by their respective Boards. Such investments may be made in deposits with banks or money marketdebt instruments of approved rating with residual maturity up to one year. Investments in fixed income securities of longer tenor are permitted for undeployed FCNR (B) funds subject to the condition that the maturity of the securities does not exceed the maturity of the underlying deposits. I.21 Hedging of capital by banks Foreign banks are allowed to hedge the Tier-I capital held by them to manage the translation risk on their global balance sheet on account of their operations in India, subject to the condition that the forward contracts should be for tenors of one year or more and that the capital funds should be available in India to meet local regulatory and CRAR requirements. Rebooking of cancelled hedge will require prior approval of Reserve Bank. (B) Relaxations for the users I.22 Starting from 1992, corporates have been permitted increasing access to foreign currency funds. While exchange earners in select categories such as Export Oriented Units (EOU) are permitted to retain 100 per cent of their export earnings, others are permitted to retain 50 per cent of their forex receipts in EEFC accounts. On account of these factors, corporates were accorded greater freedom to undertake active hedging. Recognising this, Reserve Bank permitted the following facilities in stages: I.23 With effect from December 2001, exporters and importers have been permitted to book forward contracts on the basis of past performance (without production of any underlying document evidencing transactions at the time of booking the contract). Eligible limits were gradually raised to enable corporates greater flexibility. Initially, forward contracts booked, in the aggregate, could not exceed the average of the previous three financial years8217 turnover. This was subject to the condition that at any point of time forward contracts so booked and outstanding could not exceed 25 per cent of the eligible limit, within a cap of US100 million. The eligible limit itself was amended to mean the average of the previous three years8217 turnover or the previous year8217s turnover, whichever was higher. The US100 million cap was then done away with and the cap of 25 per cent gradually increased such that today contracts booked and outstanding can be 100 per cent of the eligible limit. The limits are computed separately for export and import contracts. Documents are required to be furnished at the time of maturity of the contract. Contracts booked in excess of 25 per cent of the eligible limit have to be necessarily delivered. This relaxation has proved very useful to exporters of software and other services since their projects are executed on the basis of master agreements with overseas buyers which usually do not indicate the volumes and tenor of the exports. I.24 Corporates have been given freedom to choose the currency of hedge irrespective of the currency of the exposure. I.25 When cross currency options were introduced in 1994, it being a new product, it was stipulated that an option once cancelled could not be rebooked. In other words, once a corporate chose to exit from the option, this product was not available to hedge the exposure again. This restriction was removed in 1996 and corporates were given complete freedom on par with forward contracts to book and cancel cross currency option contracts. I.26 Use of derivatives to manage the risk of external commercial borrowings required prior permission of Government of India till August 1996. This requirement was withdrawn subsequently and the banks given full freedom to offer any derivative product or combination thereof to the corporates subject to the condition that there was no net receipt of premium nor was the structure a leveraged one. I.27 In many businesses, contracts are denominated in foreign currency but settled in Indian Rupees. Recognizing the exposure of corporates with this invoice pattern, Reserve Bank allowed residents to enter into forward contracts with ADs to hedge such transactions. The hedge contracts are required to be held till maturity and cash settlement to be made on the maturity date by cancellation of the contracts. I.28 In 1998, residents in India, engaged in exportimport trade, were permitted to hedge the attendant commodity price risk in international commodity exchanges markets using exchange traded as well as OTC contracts. The onus of ensuring that the hedge undertaken by these entities is in the nature of an offset hedge and not a price-fix hedge lies on the AD who is also required to ensure that every contract is backed by an underlying. The oil sector was initially excluded necessary permission was accorded with Government concurrence in 2000. Given the fact that domestic prices are inextricably linked to the international prices of oil which are volatile, and since there is a time lag between procurement of crude oil and sale of petroleum products, oil refining companies were permitted to hedge their refining margins too. A refining margin allows refineries to lock in the differential between refinery input and output prices, and profit or protect against changes in that value. This approval allows refineries to hedge their margins against both export and domestic sales of all petroleum products produced out of imported crude. A major oil producer has even been permitted to hedge the price risk on crude oil, natural gas and other petroleum products producedsold by it in India. I.29 External Commercial Borrowings (ECBs) have been a source of funds for many Indian corporates. General permission has been given to ADs for approving ECBs of their customers up to a limit of US 500 million, subject to post facto reporting to Reserve Bank. This has been a major step towards freeing of capital controls. However, there are restrictions on the end-use of such funds - for example, they cannot be utilised towards rupee working capital purposes or for replacing existing rupee debt. Financial intermediaries have to seek prior approval of Reserve Bank for availing ECBs. Freedom has also been given to borrowers for prepayment of ECBs under certain terms and conditions. I.30 Once banks were permitted to lend in foreign currency to resident corporates from their pool of non-resident deposits, corporates availed of this facility in good measure. During the last couple of years, there was large demand from corporates, both big and small, for loans denominated in foreign currency. It is understood that many banks had lent out their entire corpus of foreign currency deposit liabilities and were generating additional foreign currency funds through swaps in the foreign exchange market to meet the demands of their customers. Foreign currency exposures assumed in this way were left largely unhedged by many corporates in the belief that rupee would continue to appreciate and LIBOR would remain low. This had systemic implications and Reserve Bank had to draw attention of the banks to the need for hedging foreign currency exposures. Non-residents Non-Resident Indians I.31 Non-resident Indians are permitted to place deposits in foreign currency with ADs where the exchange rate risk is borne by the banks. Earlier, the foreign currency funds thus mobilised remained invested overseas to a large extent. Subsequently, banks were permitted to lend in foreign currency to resident corporates from out of this pool of non-resident deposits. I.32 ADs are permitted to enter into forward contracts with rupee as one leg with NRIs to hedge the amount of dividend due to them on shares held in Indian companies, balances held in FCNR (B) and NRE accounts, as also the amount of investment made under Portfolio Investment Scheme. With regard to balances in FCNR (B) accounts, cross currency (not involving the rupee) forward contracts are also allowed to be booked to convert the balances in one foreign currency to another foreign currency in which FCNR (B) deposits are permitted to be maintained. Foreign Direct Investments I.33 ADs are permitted to enter into forward contracts with residents outside India to hedge their investments made in India since January 1, 1993, subject to verification of the exposure in India, as also the dividend receivable on their investments. I.34 Residents outside India are permitted to enter into forward sale contracts with ADs to hedge the currency risk arising out of their proposed foreign direct investment in India. Such contracts, if cancelled, are not eligible to be rebooked for the same inflows and exchange gains, if any, on cancellation, are not allowed to be passed on to the overseas investor. Foreign Institutional Investors I.35 Foreign Institutional Investors (FIIs) have been permitted to hedge the market value of their entire investment in equity andor in debt in India. While there is no absolute limit on the amounts that FIIs can invest in equity subject to sectoral caps, FIIs, as a whole, can invest only up to US 1.75 billion in Government securities and Treasury Bills and US 500 million in corporate debt. Holding of Government securities by non-residents beyond a reasonable limit is neither feasible nor advisable in the present situation. The reason is that if all controls on portfolio debt flows are removed there should be convergence between domestic and foreign interest rates, subject to a country risk premium. Convergence of interest rates would happen only if there is a convergence between domestic inflation and foreign inflation, currently in the range of 2-3. Achieving this kind of low inflation in India would be incompatible with the medium - term target growth rate of 7-8 per annum. In other words, interest rate in India will continue to be much higher than in the developed countries and this would attract huge capital flows if restrictions on portfolio debt flows are removed. Upward bias in interest rate is also caused by high fiscal deficit and buoyant private sector demand for borrowing. Further opening up of the Government securities market to non-residents would, therefore, be contingent upon significant reduction in fiscal deficit on a sustainable basis. Further, on account of the clear arbitrage avenues available at the short-end, it bears examination whether non-resident investment in Government securities could be severely restricted in the short-end. There is a view that investment could be restricted to the medium and long end of the yield curve. Similarly, opening of the corporate debt market to non-residents may also not be advisable from the point of view of financial stability and considerable sensitivity to higher interest rate volatility. (C) Derivative Products I.36 One of the recommendations of the Sodhani Committee was that ADs should be permitted to offer all types of derivative products, subject to their putting in place comprehensive risk management systems on the basis of Reserve Bank guidelines. It was also recommended that an association of professionals or FEDAI should put in place uniform documentation and market practices for derivative products. The following products are currently transacted by Indian banks: I.37 Forward contracts Forward contracts have been in use in India for a very long time. While booking of forward contracts is only possible based on underlying genuine exposures, corporates were given complete freedom in 1992 to actively hedge their exposures by freely booking and cancelling forward contracts. When a forward contract is cancelled, the difference is cash-settled. It thus has elements of an NDF contract. The important difference is that, while booking a forward contract, the existence of an underlying is a pre-requisite, whereas the same is not required when booking an NDF contract. In other words, freedom to book and cancel forward contracts has elements of an NDF contract ex-post, whereas ex-ante the two are not comparable. In the wake of the SE Asian crisis, it was observed that the freedom to freely cancel and rebook forward contracts was being misused. This facility was, therefore, withdrawn except for export transactions. The facility has since been restored in respect of all transactions of residents with a residual maturity upto one year. Export contracts beyond one year can also be freely cancelled and rebooked. However, forward contracts entered into by non-residents, once cancelled, cannot be re-booked. While the forward market is very liquid up to one year, the volume of long term forward contracts has also increased over the years. I.38 Foreign Currency Options Banks in India were allowed to write cross-currency options on fully covered back-to-back basis from 1994. In 1996, banks were accorded freedom to offer cost reduction strategies, such as range forwards and ratio range forwards, subject to the important condition that corporates do not receive premium on a net basis. As part of developing the derivative market in India and adding to the spectrum of hedge products available to residents for hedging currency exposures, foreign currencyrupee options were introduced in July 2003. The product complements the spot and forward FX markets to provide the complete universe of hedging products to market participants. The product allows the user to hedge her currency risk without sacrificing the up side of the currency movement. For this right, an upfront premium has to be paid by her to the AD. All ADs having a minimum CRAR of 9 per cent are allowed to sell rupee options to their customers on back-to-back basis. Select ADs satisfying specified financial criteria and having the necessary expertise and systems, are permitted to be market makers and run a foreign currencyrupee option book after obtaining a one-time approval of Reserve Bank. To begin with, 11 banks were given such permissions. Currently, there are 14 banks acting as market makers for foreign currencyrupee options. Only plain vanilla European options or combinations thereof are permitted to be used. End users are not permitted to be net receivers of premium. The volumes are not much and bid-offer spreads are quite wide, indicating that the market is not very liquid yet. However, it is only to be expected that a non-linear product such as the option would have a sedate start. Most of the interest has been for zero cost structures, involving simultaneous purchase and sale of options in such a way that corporates are not net receivers of premium. Most of the corporates using foreign-currency rupee options are located in metros. Many corporates in non-metros are not adequately comfortable with the product yet. FEDAI and the market-makers themselves have organised seminars and training programmes to disseminate knowledge about the product. One of the main constraints hindering the development of the options market is stated to be the fact that corporates are not permitted to writesell options. If corporates with underlying exposures are permitted to writesell covered options, this would lead to increase in market volume and liquidity. Further, no public sector bank is a market maker in the product. For the product to be available to the SME sector, it is imperative that public sector banks should develop the necessary infrastructure and expertise to run option books. I.39 Swaps A person resident in India who has borrowed in foreign currency is permitted to enter into an interest rate swap, currency swap, coupon swap, cross currency option, interest rate cap or collar purchase or forward rate agreement (FRA) with an AD or with a branch outside India of an AD or with an OBU for hedging her loan exposure and unwinding from such hedges. These products were permitted so long as they did not have rupee as one of the currencies. A beginning for rupee based derivatives was made in India when in April 1997 Reserve Bank permitted banks to offer foreign currencyrupee swaps to corporates wishing to actively manage their foreign exchange exposures. Once this was permitted, the market has seen contracts even up to 7-10 years, whereas earlier a price beyond 6 months was virtually unheard of. The product also became popular among rupee borrowers who opted to acquire foreign currency liability when the US dollar interest rates started moving down and the rupee depicted an appreciating trend against the US currency. Currently, no limits are placed on ADs for undertaking swaps to facilitate corporates to hedge their foreign exchange exposures a limit of US50 million per AD is, however, fixed for net supply in the market on account of swaps enabling corporates to move from rupee to foreign currency liability. It may be noted that this is the only foreign exchange derivative product which is allowed to be used by entities with no foreign currency exposures to begin with. There are currently 15 ADs actively managing foreign currencyrupee swap books. The notional principal amount of swaps undertaken during the month of April 2004 (information collected as part of the BIS Triennial Survey) was US 2096 million. Current regulations do not permit rebooking of cancelled swaps nor can exposures arising on account of swaps enabling a corporate to move from rupee to foreign currency liability (derived exposures) be hedged. I.40 Regulatory and accounting convergence in respect of derivatives The derivatives mentioned above and combinations thereof are permitted to be transacted in the Indian forex market. Interest rate swaps, forward rate agreements and exchange-traded interest rate futures are currently available for hedging the rupee interest rate risk in the books of banks and corporates. There are regulatory disparities in the permissible structures of rupee and forex derivatives. For instance, a limit of US 50 million per AD is placed for net supply in the market on account of foreign currencyrupee swaps whereas there are no such limits in place for rupeerupee swaps. Further, there is a limit of 25 of Tier I capital (or US10 million) up to which banks are permitted to borrow overseas. The current regulatory approach toward derivatives involving foreign currencyrupee has been shaped by the considerations of (i) existing restrictions on capital account (ii) impact on the local forex market (iii) encouraging use of derivatives for risk reduction or hedging, etc. While optionality is permitted to be built into the pricing of foreign currencyrupee swaps (so long there is no increase in risk or net receipt of premium), structures having option elements, such as caps and collars, are not permitted in the case of rupee interest rate swaps. On the other hand, while foreign currencyrupee swaps cannot be rebooked on cancellation, there is no such restriction for rupee interest rate swaps. The restriction on foreign currencyrupee swaps has been placed to ensure that excessive cancellation and rebooking does not add to the volatility of the rupee. These restrictions have been put in place on account of prudential considerations and the fact that India is not convertible on the capital account. Till such time as capital account restrictions are in place, it would be desirable to maintain differential regulations with respect to rupee interest rate derivatives and forex derivatives. In respect of structured products, the regulation needs to be so framed in order to ensure that residents are not able to circumvent the applicable restrictions on accessing the 8216underlying cash8217 market abroad through derivatives. In other words, regulation should examine the permissibility of all the individual elements comprising any structured product. Further, while derivatives involving at least one foreign currency have a clear legal standing under FEMA, there is some legal ambiguity in regard to OTC rupee derivatives. As regards the accounting treatment for derivatives, there should be full convergence between all types of derivatives and also amongst banks and corporates. The objective here is to stop all incentives to drive any wedge between on-balance sheet and off8211balance sheet items. Moreover, there is a need to put in place objective conditions to determine whether a derivative is in the nature of a hedge or not. Wherever the derivative is in the form of a hedge, the accounting treatment should be the same as for the underlying. Consequently, the Group has recommended that derivatives accounting norms on the lines of IAS 39 should be introduced for adoption by banks and corporates alike. Recommendations of the Sodhani Committee8211 Status. I.41 Most of the recommendations, including the setting up of the Clearing Corporation of India Ltd. which conducts inter-bank forex clearing and settlement operations, among other activities, have been implemented and have had a beneficial impact on the market. Recommendations which have not been implemented chiefly relate to accounting of derivative transactions and disclosure norms. The ICAI is still in the process of formulating them. Second, laws relating to withholding tax are still not unambiguous. Third, the recommendation that all market participants should put in place risk management policies and internal control systems before being allowed to transact in forex and interest rate derivative products, has not been followed in practice. Few corporates have an appropriate risk management policy and systems in place. Banks frequently report that they find it very difficult to obtain these policies. Further, even from corporates that have such policies in place, they find it difficult to obtain a review report and annual audit report, as required under the extant regulations. I.42 Enabling Environment for Reforms in the Forex Market The approach towards financial sector reforms in India has been cautious with appropriate sequencing of reform measures, mutually reinforcing norms, complementary reforms across sectors (e. g. monetary, fiscal and external sector), and development of financial institutions and markets. In order to embark upon further deregulation of the foreign exchange market, including relaxation of capital controls, an enabling environment is needed for the reforms to proceed on a sustainable basis. It is in this context that liberalisation of various sectors has to proceed in tandem to derive synergies of the reforms encompassing multiple sectors. The Indian approach to opening the external sector and developing the foreign exchange market in a phased manner from current account convertibility to the ongoing process of capital account liberalisation is perhaps the most striking success relative to other emerging market economies. The move towards a market-based exchange rate regime in 1993 and the subsequent adoption of current account convertibility were the key measures in reforming the Indian foreign exchange market. Reforms in the foreign exchange market focused on market development with prudential safeguards without destabilising the market. Authorised Dealers of foreign exchange have been allowed to carry on a large range of activities. Banks have been given large autonomy to undertake foreign exchange operations. In order to deepen the foreign exchange market, a large number of products have been introduced and entry of newer players has been allowed in the market. Full convertibility on the current account and extensive liberalisation of the capital account transactions have facilitated not only transactions in foreign currency, these have enabled the corporates to hedge various types of risks associated with foreign currency transactions. A comparative analysis of the crucial reforms pending in various sectors provides an idea of the complementary sectoral reforms required for the success of external sector reforms. The foremost challenge to the external sector reforms arise from the persistence of large fiscal deficit and debt. Large fiscal deficit has the potential of making the foreign exchange market vulnerable in a liberalised capital account regime. A conducive environment for further reduction in capital account restrictions, thus, necessitates reduction of fiscal deficit and debt stock to more sustainable levels as the first order condition. The banking sector is still vulnerable to the possibility of rise in non-performing assets (NPAs), though the magnitude of such NPAs has come down significantly in recent years. More particularly, the financial institutions still carry large burden of NPAs. The pace of enduring liberalisation of foreign exchange market is determined by the robustness of the banking system. Further, the liberalisation of foreign exchange transactions is to be aligned with price alignments in the form of tariff structure, which are still higher in India vis--vis the East Asian countries. The enabling environment also encompasses harmonisation of reforms in the financial sector with the real sector, where the issues relating to reforms in labour market, de-reservation for SSIs and liberalisation of sectoral caps on FDI remain to be resolved. Importantly, large gaps exist in demand-supply of infrastructure services such as transportation, electricity, ports etc. where regulatory and procedural hurdles, pricing and user charges are crucial for attracting foreign investment and ensuring export competitiveness of the Indian industry. It needs to be emphasised that sound macroeconomic policies and a competitive domestic sector improve the capacity of the economy to absorb higher capital inflows, reduce the cost of capital, translate external inflows into higher investment levels and provide cushion against unexpected shocks in more liberalised external markets. Table: Important Sectoral Reforms Sector Current Status Fiscal Sector Gross fiscal deficit of the combined Government sector in India amounted to 9.4 per cent of GDP, which puts India in the category of high fiscal deficit countries. Combined Debt of Central and State Governments has risen to 76.7 per cent of GDP at end-March 2004 from 61.7 per cent at end-March 1991. Banking Sector Although the Gross Non Performing Assets (NPA) as ratio to gross advances for scheduled commercial banks has come down from 11.4 per cent at end-March 2001 to 7.2 per cent at end-March 2004, it still remains a concern from the viewpoint of financial stability. Net NPAs are still around 6 per cent. NPA levels for financial institutions (term lending financial institutions) continue to be relatively high. Technological intensity is one area where significant catching up is required, notwithstanding the rapid strides made over the last few years. Improving recovery-management is an area requiring expeditious and effective actions in legal, institutional and judicial processes. Interest Rate Interest rate differentials between India and major developed countries are positive and this will continue to remain so in the foreseeable future, given higher inflation rate and high fiscal deficit of the country. This leaves open the scope for large and volatile capital inflows. Debt Market The private corporate debt market, in the absence of a well functioning secondary market, remains illiquid. Tariffs Liberalisation of foreign exchange transactions is to be aligned with price alignments in the form of tariff structure. Peak tariff level for India is presently at 20 per cent, which is much higher than that of 5 per cent for the East Asian countries. Industrial Sector Continued reservation for small-scale industry conflicts with the objective of efficiency and the higher competitive pressures. Entryexit restrictions continue to exist. Foreign Direct Investment (FDI) in various sectorsindustries is guided by sectoral caps. Labour laws such as Contract Labour Act are not in synchronization with the objective of inculcating flexibility in labour market to maximize efficiency and promote growth. Infrastructure Sector Large gaps exist in demand-supply of infrastructure services such as transportation, electricity, ports etc. Regulatory and procedural hurdles, pricinguser charges and cross subsidy in infrastructure sector ultimately impact on competitiveness of Indian manufacturing. Annex II Cross-country Experiences in Development of Foreign Exchange Markets II.1 The decade of the 1990s was characterised by remarkable developments in emerging market economies (EMEs) towards shift to flexible exchange rate regime, opening up of capital account and integration of their domestic financial markets with the global system. This was a reflection of conscious efforts in this direction either as an integral part of the overall process of liberalisation or was prompted by an adjustment mechanism initiated in the wake of financial crises. Despite a series of crisis that marred the EMEs in the decade bygone, the private capital flows to these countries resumed, their currency markets recovered quickly and investors8217 confidence regained as the adjustment process progressed. Alongside there has also been a perceptible policy shift towards reorientation of their financial markets in terms of availability of a wide range of new products and instruments, development of institutional and market infrastructure, and realignment of regulatory structure consistent with liberalised operational framework. Reflecting the impact of increasing integration with the global system, the domestic foreign exchange markets of these economies have started to play an important role in transmission of global financial market developments to other segments of domestic financial markets. The changing contours of foreign exchange markets are mirrored in a rapid expansion in terms of participants, innovation in products, rising transaction volumes and reduction in transaction costs and more efficient mechanism of risk transfer. II.2 At the global level, the policy measures relating to development and liberalisation of foreign exchange markets particularly in EMEs are to be seen from the perspective of their bringing about market efficiency while providing adequate safeguards from the point of view of market and financial stability issues. It is held that a floating and market-determined exchange rate system facilitates efficient functioning of foreign exchange markets by adding depth and providing liquidity to these markets. This, by itself, may not be sufficient until and unless operational and regulatory environment is aligned suitably. The process of foreign exchange market liberalisation generally speeds up with an increasing move towards the capital account liberalisation and the resultant shift to a more liberal approach towards investment flows. However, the regulators prefer to tread carefully in providing freedom to market players in the use of risk management instruments particularly derivatives. The cautious stance is in view of the role played by the excessive use or misuse of derivatives in exacerbating the financial crises in a number of EMEs including Mexico, Russia, Brazil and East Asian countries. II.3 Derivatives have in-built features to provide leverage to both hedgers and speculators. This leverage not only reduces the cost of capital for taking positions but also the cost of taking on price exposure and in the process encourages greater speculation. This tendency can be quite destabilising for financial markets in times of external shocks. The empirical evidence shows that the use of derivatives is considered more risky from the point of view of their potential for increasing credit risk. Apart from these considerations, the regulators seem to be even more concerned on account of the fact that derivatives appear to have been used to manipulate accounting rules and financial reporting requirements, and to circumvent prudential market regulations in several counties. Empirical evidence also corroborates the view that derivatives allow financial institutions to change the shape of financial instruments in such a way as to circumvent financial regulations in a fully legal way (Steinherr 1998). The task of regulators becomes even more difficult as the increasing use of derivatives makes the full disclosure of relevant information, or at least the full interpretation of the disclosed information, even more difficult (Stiglitz, 1998). From the viewpoint of transparency, the precise measurement of risk exposure itself becomes intricate as the risk shifts to off-balance sheets of players with the use of derivatives (Randall Dodd, 2003). II.4 In the Indian context, the foreign exchange market development and liberalisation measures have been implemented in a phased manner. These measures have broadly been in line with the pace of liberalisation in other segments of financial markets. The emphasis has no doubt been on the simplification of rules and operational guidelines and dismantling the regulations that impede operational efficiency. The initiatives towards enhancing market transparency have also been equally significant. This entire process implemented in an orderly manner has, of course, contributed significantly to an increasing integration of domestic financial markets on the one hand, and the integration of domestic financial markets with the global financial system on the other. II.5 Against the above backdrop, an analysis of some important issues that emerge for future development of Indian foreign exchange market keeping in view the experiences of other EMEs. The selection of these issues has also been guided by the responses of market participants in their interaction with the RBI. As a prelude, Section II sets out the background in terms of development of foreign exchange markets the world over in the 1990s. Section III provides a summary of exchange rate regimes prevailing in various countries including the emerging market and developing countries. Section IV deals with the regulatory requirements including the need for documentation for carrying out the forex transactions, particularly the derivative transactions, open foreign exchange position of banks and regulatory restrictions on non-resident holding of deposit accounts, resident holding of foreign currency accounts and borrowings by non-resident entities in domestic markets. Country practices regarding hedging of commodity exposures are outlined in Section V. Market structure issues, such as, Over-the-Counter (OTC) versus exchange-traded derivatives, features of derivative exchanges in Mexico, Brazil and Russia, and country practices in respect of on-shoreoff-shore non-deliverable forwards (NDFs), are analysed in Section VI. Section VII provides the concluding observations and specific inferences that can be drawn from the country experiences. Section II: Foreign Exchange Markets at the Global Level II.6 Aided by technological breakthroughs, the rapid growth in investment funds and financial flows, daily trading volume in foreign exchange markets at the global level more than doubled to US 2,408 billion in 2004 from US 1,076 billion in 1992. It is estimated that less than a small percentage of all foreign exchange transactions is directly related to the needs of importers and exporters while the remaining involve financial flows related to investments and profit-seeking transactions. Adjusted for local and cross-border double counting, the global foreign exchange market turnover increased from a daily average of US 820 billion in 1992 to US 1,880 billion in 2004. Within the traditional foreign exchange transactions, the share of spot turnover continued to decline steadily till 2001, before showing a reversal in 2004 while the share of foreign exchange swaps remained significantly higher vis--vis outright forwards (Table II.1). Table II.1 Global Foreign Exchange Market Turnover Daily averages in April, in billions of US dollars Instrument 1989 1992 1995 1998 2001 2004 Spot transactions 317 394 494 568 387 621 Outright forwards 27 58 97 128 131 208 Foreign exchange swaps 190 324 546 734 656 944 Estimated gaps in reporting 56 44 53 60 26 107 Total 8216traditional8217 turnover 590 820 1,190 1,490 1,200 1,880 Source: BIS, Triennial Central Bank Survey, 2004 II.7 Details of geographical distribution of reported foreign exchange turnover along with instrument-wise details for 2004 are set out in Tables II.2 and II.3. II.8 Geographical distribution of foreign exchange turnover by instruments reveals that foreign exchange swaps account for more than 50 per cent of total turnover Table II. 2:Geographical Distribution of Reported Foreign Exchange Market Turnover Daily averages in April, in billions of US dollars 1992 1995 1998 2001 2004 Country Amount Share () Amount Share () Amount Share () Amount Share () Amount Share () UK 291 27 464 29.5 637 32.5 504 31.2 753 31.3 USA 167 15.5 244 15.5 351 17.9 254 15.7 461 19.2 Japan 120 11.2 161 10.2 136 6.9 147 9.1 199 8.3 Singapore 74 6.9 105 6.7 139 7.1 101 6.2 125 5.2 Germany 55 5.1 76 4.8 94 4.8 88 5.5 118 4.9 Hong Kong 60 5.6 90 5.7 79 4.0 67 4.1 102 4.2 Australia 29 2.7 40 2.5 47 2.4 52 3.2 81 3.4 Switzerland 66 6.1 87 5.5 82 4.2 71 4.4 79 3.3 France 33 3.1 58 3.7 72 3.7 48 3.0 64 2.7 Canada 22 2.0 30 1.9 37 1.9 42 2.6 54 2.2 Russia - - - - 7 0.4 10 0.6 30 1.2 Korea - - - - 4 0.2 10 0.6 20 0.8 Luxembourg 13 1.2 19 1.2 22 1.1 13 0.8 14 0.6 Mexico - - - - 9 0.5 9 0.5 15 0.6 South Africa 3 0.3 5 0.3 9 0.5 10 0.6 10 0.4 India - - - - 2 0.1 3 0.2 7 0.3 Taiwan - - - - 5 0.3 4 0.3 8 0.3 Brazil - - - - 5 0.3 5 0.3 3 0.1 Chile - - - - 1 0.1 2 0.1 2 0.1 Indonesia - - - - 2 0.1 4 0.2 2 0.1 Malaysia - - - - 1 0.1 1 0.1 2 0.1 Thailand - - - - 3 0.2 2 0.1 3 0.1 Argentina - - - - 2 0.1 - - 1 0 China - - - - 0 0 0 0 1 0 Philippines - - - - 1 0.1 1 0.1 1 0 Total 1,076 100 1,572 100 1,969 100 1,618 100 2,408 100 Source: BIS, Triennial Central Bank Survey, 2004 Table II. 3:Geographical Distribution of Reported Foreign Exchange Market Turnover Daily averages in April, in billions of US dollars, April 2004 Country Total foreign exchange turnover Spot foreign exchange turnover Outright foreign exchange turnover Foreign exchange swap turnover UK 753 223 103 428 USA 461 217 61 183 Japan 199 53 21 125 Singapore 125 43 11 72 Germany 118 36 12 70 Hong Kong 102 36 5 61 Australia 81 26 5 50 Switzerland 79 23 7 49 France 64 13 5 46 Canada 54 18 4 32 Russia 30 24 0 5 Korea 20 10 4 6 Luxembourg 14 3 2 10 Mexico 15 11 1 3 South Africa 10 2 0 8 India 7 3 1 2 Taiwan 8 5 1 2 Brazil 3 3 0 0 Chile 2 2 1 0 Indonesia 2 1 0 1 Malaysia 2 1 0 0 Thailand 3 1 0 1 Argentina 1 1 8230 8230 China 1 1 8230 8230 Philippines 1 0 0 0 Total 2,408 829 260 1,318 Source: BIS, Triennial Central Bank Survey, 2004 Section III: Exchange Rate Regimes II.9 Foreign exchange market development and liberalisation measures have generally coincided with a shift to more flexible exchange rate regimes in several EMEs in the 1990s. In the East Asian countries (Thailand, South Korea, Philippines, Indonesia), it is the financial crisis-driven situation that made them abandon fixedintermediate (crawling bands) exchange rate regimes and experiment with intermediatefree floating exchange rate regimes with varied degree of flexibility. Mexico and Brazil also moved over from intermediate to free float exchange rate system in similar circumstances. Russia showed a transition from a pegged exchange rate system to an intermediate regime in 1998. The Philippines switched over to an intermediate regime under crisis-driven situation in 1997 but its move to free float in 2000 was voluntary. Out of 187 IMF member countries in 2004, 84 had either managed floating or independently floating exchange rate regimes (Table II.4). Available data show that foreign exchange market turnover grew in EMEs that adopted more flexible exchange rate regimes (IMF, 2004). Table II.4: Exchange Rate Arrangements Exchange Rate Arrangement Name of country No. of Countries 1. Exchange arrangement with no separate legal tender Ecuador El Salvador Kiribati Marshall islands Micronesia Palau Panama San Marino Timor-Leste Antigua and Barbuda Dominica Grenada St Kitts Nevis St. Lucia St Vincent Benin Burkina Faso Cote dIvoire Guinea Bissau Mali Niger Senegal Togo Cameroon Central African Republic Chad Congo Gabon Austria Belgium Finland France Germany Greece Ireland Italy Luxembourg Netherlands Portugal Spain 41 2. Currency board arrangements Bosnia and Herzegovina Brunei Bulgaria China-Hong-Kong SAR Djibouti Estonia Lithuania 7 3. Other conventional fixed peg arrangement Aruba Bahamas Bahrain Barbados Belize Bhutan Cape Verde China PR Comoros Eritrea Guinea Jordan Kuwait Lebanon Lesotho Macedonia Malaysia Maldives Namibia Nepal Netherlands Oman Qatar Saudi Arabia Suriname Swaziland Syria Turkmenistan Ukraine UAE Venezuela Zimbabwe Botswana Fiji Latvia Libya Malta Morocco Samoa Seychelles Vanuatu 41 4. Pegged exchange rate within horizontal bands Denmark Cyprus Hungary Tonga 4 5. Crawling Pegs Bolivia Costa Rica Nicaragua Solomon Islands Tunisia 5 6. Exchange Rates within crawling bands Belarus Honduras Israel Romania Slovenia 5 7. Managed floating with no pre announced path for the exchange rate Bangladesh Cambodia Egypt Ghana Guyana Indonesia Iran Jamaica Mauritius Sudan Zambia Czech Rep. Peru Thailand Argentina Azerbaijan Croatia Ethiopia Georgia Haiti Kenya Kyrgyz Rep. Lao Moldova Mongolia Mozambique Pakistan Rwanda Serbia and Montenegro Tajikistan Vietnam Afghanistan Algeria Angola Burundi Dominican Rep. Gambia India Iraq Kazakhstan Mauritania Myanmar Nigeria Paraguay Russian Federation Sao Tome Singapore Slovak Rep. Trinidad and Tobago Uzbekistan 50 8. Independently Floating Malawi Sierra Leone Sri Lanka Uruguay Yemen Australia Brazil Canada Chile Colombia Guatemala Iceland Korea Mexico New Zealand Norway Philippines Poland South Africa Sweden Turkey UK Albania Armenia Congo Dem Madagascar Tanzania Uganda Japan Liberia Papua New Guinea Somalia Switzerland USA 34 Source: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, 2004 Section IV: Regulatory Requirements II.10 The exchange rate flexibility exposes market participants to risks arising as a result of exchange rate fluctuations. The market risk assumes significance in globally integrated foreign exchange markets encouraging market participants to use risk management instruments. These instruments allow market participants to hedge their currency risks related to currency mismatches between assets and liabilities in an environment of exchange rate uncertainty. Availability of these instruments as also the freedom to use them depends on the existing exchange controlregulation environment in a country. The countries that have allowed their currencies to be convertible on current and capital accounts are liberal in terms of stipulation of operational guidelines although the monitoring aspects still remain crucial from the regulatory angle. Following the same analogy, the operational environment is relatively more flexible in countries with current account convertibility and open capital accounts. The exchange rate regimes do influence the regulatory framework when it comes to the issue of providing operational freedom to market participants in respect of their foreign exchange market operations. These issues are discussed in detail in the following sub-sections. 1. Documentation and Other Related Regulatory Requirements II.11 The EMEs differ among themselves in terms of exchange rate regimes, degree of convertibility of their currencies and adoption of capital account convertibility. While there has been a distinct move towards greater exchange rate flexibility and financial sector liberalisation, many of them still have restrictive exchange control regimes and continue to tinker with the micro level aspects of foreign exchange market operations. A gradual liberalisation approach is generally preferred to keep it in line with the strengthening of policy framework and tightening of prudential norms against the risk of foreign exchange exposure. While the use of risk management instruments is encouraged for hedging of genuine exposure linked to real and financial flows, speculation is not acceptable in this framework. Foreign participation in local derivatives markets is more closely monitored and even restricted. The discipline in the market in countries with non-deliverable domestic currencies is generally sought to be achieved through the stipulation of documentation requirements for the use of risk management instruments. At the same time, some countries allow limited flexibility through fixation of minimum foreign exchange limit up to which documentation requirement is waived. Hong Kong and Singapore, with deliverable currencies, are even more liberal in allowing both onshore and offshore entities to access forex and derivative markets. South Korea and Chile also have fairly liberal operational regimes. Table II.5 provides details of documentary requirements in select EMEs. Table II.5: Documentation and Other Regulatory Requirements for ResidentsNon-Residents Country DocumentationOther Regulatory Requirements Brazil No documentation requirements, but for deliverable transactions, it is mandatory. Legally allowed derivative transactions are only simple debt and equity instruments and options in the case of more complicated and over-the-counter products, prior negotiation with the financial authorities may be necessary in order to ensure registration. Derivative transactions are registered with the Brazilian Central Bank if these are used for hedging of international assets and liabilities. Foreign investors have access to domestic derivative markets. Chile All derivative products including NDFs are available onshore. Banks cannot offer currency options directly to their customers. Pension funds are important providers of foreign exchange hedging in the domestic market. Commercial banks can hedge their net positions offshore, if required. China Onshore entities can access the local forward market to cover current account transactions (subject to documentary proof such as invoices or trade agreements) and to hedge foreign currency loans borrowed from banksan offshore entity or any other transaction approved by State Administration of Foreign Exchange (SAFE). Currency options are not available. Purchase, sale or issue of derivatives or other instruments by non-residents is not allowed. Residents are also not allowed to issue financial derivatives abroad. Financial institutions approved by the People8217s Bank of China who can engage in derivatives business include foreign banks mainland branches, mainland banks, trust and investment companies, financing companies, financial leasing companies and auto financing companies. They may purchase or sell derivative instruments for hedging purposes or for providing trading services to clients as a dealer or a market maker. However, they can purchase foreign financial derivatives and other instruments for hedging after having passed the inspection of qualification and exposure of foreign exchange position. Non-financial institutions may engage in such activities through financial institutions as part of their approved operations without prior approval. Prior SAFE approval is required if these transactions are made with foreign institutions. Hong Kong The HKD is freely tradable and convertible. Onshore spot, forward and currency option markets are available to onshore and offshore entities. Indonesia Onshore entities are free to access the local spot and forward markets and access the derivatives market without supporting documents for transaction value of up to IDR 100 million. Documentation verification is the responsibility of remitting banks and not of receiving banks. Onshore banks may have derivative transactions with non-residents in foreign currencies against the IDR up to a maximum notional amount of USD 3 million (or its equivalent) for each bank per day (cumulative limit) without any proof of the underlying economic activity. This restriction does not apply when currency exchange transactions are for investment activities in Indonesia. All IDR-related FX deals must be transacted with onshore banks. Malaysia Forward foreign exchange contracts with residents are for the purpose of any paymentsreceipts related to importexport of goods and services, and income (based on firm commitment or anticipatory basis), hedging the foreign currency exposure of permitted overseas investment including extension of credit facilities to non-residents, and any committed capital inflowsoutflows including drawdownrepayment (within 24 months) of permitted foreign currency credit facilities. Forward salespurchases by residents of any foreign currency receivablespayment can be undertaken up to the tenor of the underlying transaction. Interest rate swap transactions of residents are required to be supported by firm underlying commitment. Currency options are not available. On-shore licensed banks can enter into short-term currency swaps or forward MYR sales with non-residents to cover payment for share purchases on the Malaysian exchange (subject to firm commitment). The contracts are limited to maturity of up to 3 working days with no rollover option. Mexico Controls apply to Mexican financial institutions with respect to types of transactions they can enter into and amounts related thereto when it comes to purchasessales abroad of derivatives. However, there are no documentation requirements for non-bank residents viz. individuals and corporates. Philippines Banks, non-banks with quasi banking functions (NBQBs) and their subsidiariesaffiliates authorised by the BSP enter into derivative contracts where either party to the transaction is hedging only eligible exposure. They can also engage in derivative transactions as end-users. Forward sale of forex is allowed to cover obligations (deliverable and non-deliverable) arising on account of trade and non-trade (foreign currency loans owed to non-residents or Authorised Agent Banks (AABs) wherein the maturity portion of the outstanding eligible obligation is covered by a deliverable forward and the outstanding eligible obligation is covered by a non-deliverable forward subject to the documentary requirements) and inward foreign investments (outstanding amount of salematurity proceeds due for repatriation to non-resident investors pertaining to BSP registered investments). AABs are authorised to sell foreign exchange to residents every 20-calendar days for any non-trade purpose other than that related to foreign currency loaninvestment without the need of appropriate documentation up to US 5,000. Registration for foreign currency investments is required if the foreign currency needed to service repatriation of capital or remittance of dividend and profits is to be sourced from the domestic banking system. Purchase of foreign exchange from local banks by residents for settlement of derivatives abroad is not permitted. FX Swap transactions viz. FX sale (first leg)forward FX purchase (second leg) with non-bank counterparties are subject to the minimum documentary requirements for sale of FX for non-trade and trade transactions. For FX purchase (first leg)forward FX sale (second leg) with non-bank counterparties, the first leg of the swap is subject to the institution8217s 8220Know Your Customer8221 policy and the AMLA guidelines and requires the conversion of foreign currency to pesos. The second leg of the swap transaction will be subject to the swap contract between the counterparties. The tenormaturity of FX forwards (whether deliverable or non-deliverable) and swaps shall not be longer than the maturity of the underlying FX obligation or the approximate due date or settlement of the FX exposure, while the tenor of the deliverable FX forward in the case of foreign currency loans shall be co-terminus with the maturity of the underlying obligation. Swap contracts involving the sale of foreign exchange by non-residents to banks as a first leg require BSP approval. Derivatives involving forward purchases of foreign exchange by non-residents are not allowed except for BSP registered foreign investments under certain conditions. Russia The purchase of hard currency by residents for any payments outside the country is on the basis of documentary proof. Purchase of derivatives abroad by residents is also permitted with prior Bank of Russia (BOR) authorisation. Purchase of derivatives with foreign exchange by non-residents requires prior BOR authorisation. Singapore There are no restrictions in transacting Singapore dollar (SGD) spot, forward, asset swaps, foreign exchange options, cross-currency swaps, and repos in Singapore for residents. Banks are permitted to freely transact in Singapore dollar. However, they are required to submit monthly reports detailing all interest rate derivative transactions in excess of SGD 5 million with non-Singapore counterparties. Non-resident financial entities are also allowed to transact freely in asset swaps, cross-currency swaps, and cross-currency repos, lend any amount of SGD-denominated securities in exchange for both SGD and foreign currency denominated collateral, transact freely in SGD foreign exchange options with non-resident entities (documentary proof was earlier required to show that SGD foreign exchange option transactions with non-resident entities were for hedging purposes). South Korea There are no documentation requirements for non-bank residents and non-financial foreign customers for underlying forex exposure. Forward and derivative transactions are no longer based on the 8216real demand principle8217. Non-bank financial institutions viz. securities, investment trust and insurance companies, etc. also participate in the inter-bank forex market. Financial institutions (other than banks and merchant banking corporations), firms and individuals are allowed to trade derivative products only with banks and merchant banking corporations, except in the case of certain demand-backed derivative transactions. Instruments traded in the market include forwards, foreign exchange swaps, futures, options and credit derivatives. Transactions in financial futures are also allowed on internationally recognised financial futures exchanges. Residents8217 participation in international exchange-traded derivatives markets is required to be through foreign exchange banks, merchant banking corporations or licensed futures brokerage firms. Foreign investors have access to onshore spot and forward markets provided that forex transactions are linked to actual investment in securities or bonds. No ceiling applies to sale of foreign exchange to a national resident. However, sale of foreign exchange to a non-resident is subject to the ceiling of foreign exchange sold by him since his last entrance date, or USD 10,000 (in case there is no evidence of sale of foreign exchange). Amounts exceeding these limits require declaration to the BOK. Non-residents8217 sale of foreign exchange over USD 20,000 without documentation details relating to acquisition requires declaration to the BOK. Taiwan Documentary proof is required for forex transactions onshore where the amount is equal to or more than USD 1 million. Prior approval is required for initiating a new foreign exchange derivative product, NTD exchange rate and domestic risk related products. Select banks are also allowed to offer structured products. Forward market was completely opened up in December 1996. In addition to forwards, futures, swaps and options are traded. Thailand There are no restrictions in the spot market. However, the Bank of Thailand only allows transactional exposures to be hedged. Proofs of foreign currency obligations are required for different transactions relating to trade, service fees, interestloan repayment, profitroyalty repatriation, travel and education expenses. Thai state enterprises are allowed to freely hedge foreign currency debts regardless of maturity. Non-residents are allowed to sell USD forward with a tenor exceeding three months without any restriction. Transactions with a tenor of less than three months without any underlying transaction are subject to the limit of THB 50 million for borrowing by resident banks from non-residents. Source: Asian Bond online (Asian Development Bank), HSBC and Central Bank websites of these countries. II.12 Another operational issue relates to flexibility in establishment and lifting of hedges (booking, cancellation and re-booking of derivative contracts). Reversal of transactions along with netting is permitted in Mexico, Russia and Brazil. Thailand allows this flexibility as long as the underlying exposures are covered. In South Korea, there are no restrictions on residents so long as they trade with onshore banks. II.13 Country practices also differ in respect of permission given to authorised banks (ABs)authorised dealers (ADs) to engage in local currencyforeign currency derivative transactions with non-resident banks and non-banks. Mexico imposes no restrictions while Brazil allows foreign investors to trade any instrument that is available to residents (with the exception of investment in real estate, energy companies airlines). South Korea permits it for all instruments except credit and commodity related products. In Russia, there are no formal limitations for conducting derivative transactions but the regulatory framework in respect of certain products like NDF contracts is perceived to be inadequate. Thailand allows such transactions only to the extent of underlying exposure. 2. Open Foreign Exchange Position of Banks II.14 Central banks use the fixationapproval of net open foreign exchange position limits of banks as a prudential tool to contain the scope for their being used for assuming undue foreign exchange risks. The practice of imposition of limits on individual currency positions (and even differential limits depending on the currency) has been on the decline while limits on banks8217 overall open positions either in absolute terms or linked to their capital base exist in several EMEs. In addition, the supervisory authorities have also started stipulating capital requirements against foreign exchange risk measured by the overall open positions or by the total foreign exchange risk based on the bank8217s internal risk model. The Basel Committee defined the size of a single currency position as the sum total of the net spot and the net forward position, guaranteesother instruments (certain to be called and likely to be irrecoverable) and net future incomeexpenses not yet accrued but already fully hedged (at the discretion of reporting bank). The overall foreign currency position, as per traditional measures of foreign exchange risk, is taken as the 8216gross aggregate position8217 (i. e. the sum of all net short and all net long positions), or the 8216net aggregate position8217 (i. e. the absolute value of all short positions less all long positions, or the 8216shorthand position8217 (i. e. the greater of the sum of the short positions and the sum of the long positions). In some countries, distinction is also made between banks8217 overall long and overall short foreign exchange positions. These traditional measures are subject to the limitation that the correlation in movements between the various currencies is not fully taken into account. Further, foreign exchange risk is taken independently of other risks faced by banks. Given these limitations, the use of VaR models to estimate foreign exchange risk is gaining prominence. II.15 IMF data reveals that in a sample of 41 countries for 2001, 23 imposed limits on overall positions and 13 on single currency positions. While 14 countries stipulated capital requirements against these limits, 13 had other types of measures. Further, overall open position limits ranged from 10 to 60 per cent of banks8217 capital. The limits relate to either overnightend-weekend-month positions or need to be maintained continuously (and therefore more stringent). The limits assume significance in countries having non-deliverable currencies where the foreign exchange exposure of banks is subjected to prudential norms. In several countries, there are reporting rules on positions prescribed by the regulatorssupervisors. In addition, banks are required by regulation to prepare a policy on internal controls, get it approved by their boards and have a monitoring mechanism to determine the effectiveness of internal controls on a regular basis through auditinspection process. Capital requirements against open positions have also been stipulated by developed as well as EMEs. Singapore does not restrict open positions but imposes capital requirement against these positions measured in terms of 8216shorthand position8217. This practice is seen in other developed countries e. g. in Spain and the Netherlands. In the US, the foreign exchange positions of banks, whether overall or individual currency, are not subject to quantitative limitations but banks are subject to prudential oversight. In addition, large foreign exchange market participants are required to report their holdings of five major currencies and dollars weekly, monthly, or quarterly basis. The details of restrictions on open positions in various EMEs are set out in Table II.6 Table II.6: Open Foreign Exchange Position Limits Country Open Limits Brazil Banks that are authorised to conduct foreign exchange operations may hold long positions up to the equivalent of US 6 million, including all currencies and all of each banks branches. Amounts exceeding this ceiling have to be deposited with the Central Bank of Brazil in dollars. The ceiling on bank8217s short exchange position is unlimited, provided that the total amount of combined exposure in gold, assets, and liabilities in foreign exchange does not exceed 30 per cent of bank8217s base capital. Banks must increase capital by their open position over 5 per cent of capital. For licensed dealers, the ceiling on long exchange position is the equivalent of US 500,000 but no short exchange position is allowed. Chile The limit (net aggregate position) is 20 per cent of Tier I and Tier II capital and reserves. This limit includes derivative and spot instruments, foreign investment, and assets and liabilities issued abroad or denominated in foreign exchange. China, People8217s Republic For financial institutions trading foreign exchange on their own behalf, the daily total amount traded i. e. total open foreign exchange position should not exceed 20 per cent of the foreign exchange working capital. Financial institutions trading foreign exchange on their own behalf may retain a small amount of overnight open position, but this should not exceed 1 per cent of the foreign exchange working capital or foreign exchange operating funds. Hong Kong SAR The aggregate net overnight open position i. e. sum of net longshort position of individual currencies should not normally exceed 5 per cent (and, in any event, not more than 15 per cent) of the capital base of any institution, and the net 8216overnight position8217 in any individual currency should not exceed 10 per cent of the capital base. Indonesia At the end of each business day, the total daily consolidated net open position (net aggregate position), including on and off balance sheet items and both onshore and offshore branches must not exceed 20 per cent of a bank8217s capital Malaysia Banks are subject to the net open position limit depending on bank capital and management. Mexico The Bank of Mexico allows short or long foreign exchange risk positions, which, both jointly and for each foreign currency at the end of each day, do not exceed 15 per cent of bank8217s net capital base. Total liabilities of commercial banks, denominated in or referred to foreign currency (excluding cash and highly liquid assets) must not exceed an amount equal to 183 per cent of the capital stock of the respective bank. Further, for all foreign currency liabilities with a maturity of up to 60 days, banks must maintain liquid assets. Philippines All depository banks within the foreign currency deposit system are required to maintain at all times 100 per cent asset cover for their foreign currency liabilities, of which 30 per cent must be liquid. For foreign currency deposit units (FCDU) of commercial banks and commercial banks with expanded derivatives authority, at least 70 per cent of the cover must be maintained in the same currency as the liability and 30 per cent in other acceptable foreign currencies. FCDUs of thrift banks must maintain foreign currency cover in the same currency as that of the corresponding foreign currency deposit liability. From March 13, 2003, the limit on a banks long (overbought) foreign exchange position is 2.5 per cent of its unimpaired capital or equivalent of US 5 million, whichever is lower. Any excess must be settled daily. No limit applies on short (oversold) foreign exchange positions. Russian Federation The limit for commercial banks is 20 per cent of capital for all currencies and 10 per cent of capital for an individual currency or precious metal. Singapore The Monetary Authority of Singapore sets no limits, but it reviews the internal control systems of banks to ensure that adequate limits and controls are established for treasury activities. South Korea The overall net position (i. e. shorthand position) measured by the sum of the net short positions or the sum of the net long positions, whichever is greater, is limited to 20 per cent of the total equity capital at the end of the previous month. In addition, any over-bought (over-sold) foreign exchange position is restricted to 20 per cent of equity capital on the basis of the sum of the over-bought (over-sold) amounts in each foreign currency. Taiwan Authorised banks determine their own overbought and oversold positions subject to the approval of Bank of China from July 1996 onwards. Thailand The regulation on net foreign exchange exposure limits allows commercial banks to maintain positions in terms of their first-tier capital of no more than 15 per cent oversold or overbought. Thai commercial banks are required to include the foreign exchange positions of their foreign branches in the calculation of the open position. Foreign currency loans classified as doubtful of loss are to be included in the foreign exchange position net of provisions. Financial institutions must include irrevocable guarantees in foreign currency denominations that are within 3 months of maturity if the counter party has a loan account classified as doubtful, doubtful of loss or loss. They should not include loan accounts denominated in foreign currency and classified as doubtful of loss in the calculation of the net open position. The BOT allows financial institutions that have a high degree of system proficiency to use the present value method to calculate their forward positions with prior approval. Source: IMF, Annual Report on Exchange Arrangements Exchange Restrictions, 2004. 3. Deposits and Borrowings by Non-residents and Foreign Currency Deposits by Residents II.16 Restrictions on each one of these have an impact on the foreign exchange markets. There is a policy preference to restrict local currency borrowing by non-residents as a precaution against domestic currency speculation. During the Asian Crisis of 1997-98, the facility to borrow in local currency, and offshore domestic currency markets were used to short-sell domestic currencies of Thailand, Malaysia and Indonesia. In Thailand, the non-resident baht accounts (NRBAs) were used as a means of speculative transactions during the first half of 1997. In view of the same, Thailand restricted short-term borrowing up to 3 months by non-residents without an underlying trade or investment transactions to THB 50 million per entity and imposed a limit on the outstanding amount of NRBAs at the end of the day of 300 million baht for each non-resident. Malaysia also restricts lending to, and forward and swap transactions with non-residents in the light of pressure that had been created on the ringgit in mid-1997. In Singapore, banks can lend to non-residents for investment purposes, and to fund offshore activities as long as the Singapore dollar (SGD) proceeds are swapped into foreign currency for use abroad. There is a maximum limit of SGD 5 million on lending of SGD to non-resident financial institutions. For SGD proceeds used outside Singapore exceeding this amount, banks are required to swap or convert the proceeds upon drawdown. This restriction is part of the policy of non-internationalisation of the SGD. However, for non-resident, non-financial issuers of SGD bonds, the restriction relating to swapconversion of the SGD proceeds into foreign currency before remitting abroad has been withdrawn. South Korea limits non-resident won funding and regulates local currency denominated bond issuances with maturity of less than one year. In Brazil, credits granted to non-residents are required to be registered with the central bank. Domestic currency accounts held by non-residents in some countries are subject to an upper limit on the amount that can be held by an individual depositor. II.17 In Brazil, banks are prohibited from granting foreign currency loans within the country. However, this restriction does not apply to on lending of external foreign currency loans. In Mexico, borrowing abroad by commercial banks is subject to the limits on their liabilities denominated in foreign currency, and open foreign exchange positions (Table II.7). Table II.7: Restrictions on Borrowings and Deposits by Non-Residents and Forex Deposits by Residents Country Borrowings by Non-Residents in Domestic Currency Deposits Accounts by Non-Residents Foreign Currency Deposits by Residents China No. However, international financial institutions have been permitted to raise funds in renminbi for use offshore in 2004. Yes (RMB accounts held by non-resident individuals without restriction). Foreign Direct Investors can hold both foreign exchange and RMB accounts. Yes (both domestic and abroad). Approved domesticforeign funded enterprises that have managed rights or earn foreign exchange from current transactions can open these accounts. Natural persons are allowed to open accounts with ABs. Domestic companies also allowed to retain their foreign currency revenue in FC accounts. Indonesia No (prohibits onshore banks to lend in IDR or foreign currencies. Local banks prohibited from purchasing securities issued in IDR by non-residents). Non-residents are not allowed to issue local currency denominated money market securities. Yes (both IDR and foreign currency accounts with some restrictions on cheque facility). Yes (both in Indonesia and abroad, allowed to transfer foreign currency funds abroad subject to restrictions). Malaysia Yes (both foreign currency and MYR credit facilities in the range of MYR 10,000-200 million depending on whether the lenderborrower is individualstockbroker custodian bank. Resident, bank or non-bank, is also allowed to extend credit facility up to a maximum of three immovable property loans in ringgit. Multilateral development banks and foreign multinational corporations are allowed to issue MYR-denominated bonds . Yes (foreign currency accounts with licensed banks without restrictions, MYR accounts with no overnight or withdrawal limits but with some restrictions on sources of funds for credit into these accounts, and their use). Yes (both domestically and abroad). Corporate residents can maintain FC accounts abroad up to the amount of their foreign currency receipts other than those arising from exports. Resident individuals (without funds abroad) can open FC accounts for meeting expenditure towards education and employment overseas, subject to limits. Mexico - Accounts in domestic currency convertible to foreign currency are not permitted. Yes (bank accounts may not be denominated in foreign currency except in a few cases for residents in border areas, embassies, consulates and international organisations, firms resident in Mexico and other firms (for payments abroad). Philippines Banks are prohibited from extending peso loans to non-residents. Prior approval or license requirement to issue all peso-denominated instruments in international capital markets. Yes (foreign currency account and PHP accounts provided the latter are funded by inward remittances of foreign currency and by PHP income of non-residents). Yes (both domestic and abroad). Russia - Yes (bank accounts denominated in foreign currency and RUB accounts viz. 8216K8217 accounts - funds are convertible into foreign currency with no repatriation requirements N8217 accounts - funds are convertible into foreign currency over a year after a currency purchase order has been presented 8216F8217 accounts freely opened by non-resident natural persons and freely convertible into foreign currency, and 8216S8217 accounts - used for transactions in Russian securities denominated in RUB and repatriable only after being kept in a non-interest bearing transit account for a fixed period). Yes (domestically with ABs without restriction, and abroad subject to BoR approval except for deposits in OECD or FATF countries by resident natural persons provided these are not used for commercial purposes) Singapore Yes (Banks may arrange SGD bond issues for non-resident financial institutions). Yes (SGD or foreign currency accounts with a bank without authorisation) - South Korea Yes (KRW 1 billion ceiling on KWR-denominated loans to non-residents by banks and institutional investors ). Issue of local currency-denominated bonds by foreign issuers requires notification to the Ministry of Finance Economy (MOFE) and permission required if the maturity period is less than one year. Yes (Restriction on deposits denominated in KRW with maturities of less than one year withdrawn). Non-residents hold domestic currency accounts (subject to the restriction of notification to the BOK for overseas remittance of funds withdrawn from these accounts) and 8216free won8217 accounts (to be used for all won denominated funds allowed by law to be paid abroad and without any restriction on their conversion and repatriation abroad). Individuals and corporate residents can hold unlimited amounts, and Korean firms can maintain foreign currency accounts abroad. Thailand Yes (Non-residents may borrow either directly or through FX Swap transactions in local currency from commercial banks to finance their underlying activities without underlying a maximum of Baht 50 million). This limit does not apply to transactions with contract maturity above 3 months. Local Thai Baht borrowing is also allowed against foreign currency held locally by non-residents. Yes (FC accounts if funds originate from abroad and THB accounts to be credited with proceeds from the sale of foreign currencies and other payments received from residents). FIs are required to curb the outstanding amount of Non-resident Baht Accounts (NRBAs) at the end of the day to the limit of 300 million baht for each NR. Yes (subject to evidence of underlying transactions e. g. with funds originating from abroad or with borrowing proceeds from licensed Bangkok International Banking Facilities and other BOT restrictions). Foreign currency deposits are allowed for obligations becoming due in 6 months. For foreign currency accounts held abroad, approval is required if funds are of domestic origin. Source: IMF, Annual Report on Exchange Arrangements Exchange Restrictions, 2004. Section V: Commodity Exposure: Hedging Practices in Select Countries II.18 The era of derivatives contracts started with the introduction of an agricultural contract at the Chicago Board of Trade in 1859. Over the years, financial derivatives have become more important than commodity derivatives although the latter continue to play a significant role against the backdrop of globalisation of commodity markets and liberalisation of agricultural markets in several EMEs. In the recent past, the upsurge in global commodity prices has been widespread across a number of metals and minerals besides crude oil and petroleum products. There has been an increasing tendency to hedge commodity price risk on the international commodity exchanges by market participants viz. commodity producers, commodity users and traders (both importers and exporters) with the objective of protecting against volatility in commodity prices and to ensure stable cash flows. The international commodity markets are also reported to have attracted a new class of players including banks, hedge funds and even pension and mutual funds that are looking for higher returns and avenues for diversification. There is also an element of uncertainty relating to persistence of the upward trend in commodity prices in the near future that generates an interest in use of price risk management instruments by commodity users. The commodities being traded at the international commodity exchanges include oil, electric power, natural gas, coal, nuclear power, pharmaceuticals, metals and agricultural products. Of these, crude oil and petroleum products predominate in terms of their share in all commodity swaps. Commodity hedging instruments are traded at the exchanges and are also available in OTC markets. The documentation procedure in respect of commodity hedging instruments is highly standardised. II.19 The commodity risk management instruments are different from financial derivatives to the extent that a weak relationship between spot and forward prices of commodities may account for poor hedging effectiveness of commodity futures contracts (Chatrath, 2002). There is an in-built element of credit risk that is specific to the use of commodity price risk management instruments. The providers of the risk management instruments generally face this risk when they extend credit lines to buyers of commodity options. On organised exchanges, brokers extend this facility to counterparties but it is mostly backed by bank letters of credit to safeguard against credit risk. Over-the-counter commodity price risk management instruments play a credit-enhancing role to the extent that upfront cash payments by clients may not be substantial (UNCTAD, 1994). In any case, the transactions remain confined to parties of good repute and standing as there is a tendency on the part of trade houses and banks to minimise the risk of counterparty default in such deals. The safeguards are also provided by way of upfront premiums, posting of collaterals and margin payments that reduce the credit risk exposure inherent in any risk management transaction. International banks and trading houses have their own systems of determining counterparty and country limits which restrict the access of domestic participants to international commodity exchanges. II.20 Country practices reveal that several countries allow commodity producers and traders to hedge their commodity price risk exposure on international commodity exchanges like London Metals Exchange, Chicago Board of Trade, New York Mercantile Exchange, etc. This is regardless of the fact that a number of these countries also have local commodity exchanges. The local exchanges are not considered as substitutes to international commodity exchanges. In general, the access to international commodity exchanges that provides benefits of market depth, liquidity and diversity of instruments (and therefore competitive advantage) is allowed only for the purpose of hedging. Restrictions on speculation are in place in a number of countries e. g. in Australia, South Africa, China and Japan. Commodity hedging practices in select countries are set out in Table II.8. Table II.8: Commodity Hedging Practices in Select Countries Country Overseas Commodity Hedging Local Commodity Exchange Other Features Australia 61654 Restrictions on speculation continue. Hedging is done mostly through overseas commodity exchanges. Most Australian companies are quite sophisticated in their approach towards hedging. Regulations apply to firms providing brokerage services on recognised futures exchange anywhere in the world. This is controlled by the Australian Securities and Investment Commission. Even foreign brokerage firms are required to be regulated by the Commission, if they are offering exchange-traded instruments to Australian clients. China had a highly regulated commodities market until mid-1990s and most of the Chinese companies, who wanted to hedge, were doing it through their overseas subsidiaries. The local companies were later allowed to hedge in a regulated way in late 1990s. Hedging is allowed, subject to licenses provided by local regulators. China Securities Regulatory Commission (CSRC) issues licenses to companies authorizing them to trade on specified foreign futures exchanges. Once authorised, the companies have aggregate limits approved for trading as well as acknowledgement that specified brokers have been approved. Once active, both the clients and brokers are required to send reports on a monthly basis to the CSRC, outlining the client8217s activity and open positions. Brokers send these directly to the CSRC, to avoid any interference by the client. In addition to controls outlined by CSRC, all Chinese companies are required to register with SAFE for approval of foreign exchange activities. State owned enterprises require the approval in advance for overseas commodity future transactions. These arrangements imply the existence of a two-tier structure of controls. Regulated companies are theoretically watched closely, with various checks and balances in place. However, many firms avoid the regulations by trading through offshore entities, which remain completely unregulated. Japan 61654 61654 Local commodity exchanges trade yen denominated contracts. Although there is free market, restrictions on speculation exist. Malaysia 61654 61654 Banks offering commodity products must obtain the central bank approval. Local banks cannot trade commodity derivatives. They provide only hedging solutions to their clients. Pakistan 61654 No With permission from the central bank. South Africa 61654 61654 Domestic players are allowed to hedge overseas provided they have a genuine commodity price risk by way of direct commodity exposure, i. e. those importing or exporting. However, clients wishing to hedge indirect commodity exposure must gain approval from the central bank. Speculation is not permitted. South Korea 61654 61654 Korean Laws permit domestic players to hedge overseas as long as they go through local counterparties. The market is less regulated in terms of corporates, although foreign brokerage firms can only execute futures business for Korean companies through a local (Korean) introducing broker (IB). These IBs are regulated by the Financial Supervisory Service (FSS). The local brokers are monitored for activity as well as for financial performance. Overseas brokers are not required to lodge any reports to the FSS directly or on behalf of their Korean counterparts. Thailand 61654 No Bank of Thailand allows only vanilla hedges (swaps, forwards, simple options) and clients need to have underlying commodity exposure. Local commercial banks are currently not permitted to engage in trading operations8211they provide only back to back cover transactions for their clients. UK 61654 61654 The Financial Services Authority (FSA) regulates all brokers, exchanges and anyone using exchanges. It centralises all regulation from retail to corporate and market counterparts. Source: UNCTAD. Section VI: Market Structure II.21 According to the BIS Triennial Survey for 2004, the average daily turnover in OTC derivatives market at the global level increased sharply to US 3,509 billion in April 2004 from US 2,168 billion in April 2001. Adjusted for local and cross-border double counting, daily turnover of the OTC derivatives markets nearly doubled from US 1,385 billion in April 2001 to US 2,410 billion in April 2004. Of the total adjusted turnover (net-net), foreign exchange turnover instruments accounted for US 1,292 billion while the share of interest rate turnover was US 1,025 billion. The interest rate options recorded a six-fold increase from US 29 billion to US 171 billion. Despite a rise in turnover that has been associated with an increasing exchange rate flexibility and greater forex market development, the share of EMEs in global OTC derivatives turnover has remained insignificant. II.22 Average daily turnover of exchange traded derivatives is estimated at US 23 billion for currency instruments and US 4,634 billion for interest rate instruments in April 2004 as against US 10 billion and US 2,170 billion, respectively in April 2001. It is evident that trading volume in currency instruments at exchanges is much smaller than that for OTC (Table II.9). Table II.9: Geographical distribution of reported OTC derivatives market activity Daily averages in April, in billions of US dollars Country Total Foreign exchange Interest rate April 2001 April 2004 April 2001 April 2004 April 2001 April 2004 United Kingdom 628 1,176 390 613 238 563 United States 285 599 169 281 116 317 France 106 205 41 54 65 151 Germany 158 127 65 85 94 43 Italy 36 53 12 15 24 38 Japan 132 185 116 154 16 31 Belgium 22 45 8 14 14 31 Netherlands 49 61 25 42 24 19 Australia 8 23 4 9 4 14 Canada 43 53 33 41 10 12 Switzerland 63 74 53 62 10 12 Singapore 73 100 69 91 3 9 Austria 8 23 4 9 4 14 Hong Kong SAR 52 82 49 70 3 11 Taiwan, China 2 6 2 5 0 2 Brazil 2 2 2 1 0 1 India 2 4 2 3 0 1 Korea 4 11 4 10 0 1 Mexico 5 6 4 5 0 1 Chile. 1 1 1 1 0 0 Malaysia 1 1 1 1 0 0 Philippines 1 0 1 0 0 0 Thailand 1 2 1 2 0 0 Total 1,862 3,089 1,186 1,758 676 1,331 Source: BIS, Triennial Central Bank Survey, 2004 1. OTC versus Exchange-traded Derivatives II.23 OTC markets still predominate in terms of the currency derivatives trading taking place the world over. According to the BIS Triennial Survey, In terms of outstanding positions, global notional amount outstanding of OTC contracts at end-June 2004 was US 220 trillion (US 119 trillion at end-June 2001) as against US 49 trillion of exchange-traded positions (US 17 trillion at end-June 2001). The notional amounts in the exchange rate segment accounted for 14.3 per cent of global notional amounts in OTC derivatives market at end-June 2004. This is notwithstanding the fact that the Asian crisis brought about increased awareness of credit risks and encouraged investors to relocate their derivatives business onto exchange-listed derivatives. In terms of daily turnover in interest rate instruments, the exchange-traded derivatives, however, were far ahead of the OTC derivatives market with a turnover of US 4,521 billion (US 1,026 billion in OTC derivatives market) in 2004. The rapid growth of both OTC and exchange-traded derivatives market turnover seems to be unrelated to genuine commercial trade or hedging purpose transactions. They do contain a large element of synthetic transactions. II.24 OTC derivatives markets provide the facility of customised products but they attract the criticism of not being transparent and therefore more prone to information and action-based manipulation and also to illiquidity problems (Randall Dodd, 2003 ). Another shortcoming arises on account of difficulty in enforceability of these contracts on some occasions due to possible ambiguity in legal documentation requirements. Because of these limitations, they do not provide a clear picture of concentration risk being embedded in their operations. While exchange-traded derivatives require upfront initial margin in order to enter the contract, OTC derivatives sometimes have no initial collateral requirement - collateral is posted only after the position has lost money above a certain threshold. Given this practice, trading in OTC derivatives market may at times be riskier vis--vis exchanges. These markets also attract the criticism of not being subject to proper regulation. 2. Important Features of Currency Derivative Exchanges in Emerging Markets II.25 Of the select EMEs whose forex market development and liberalisation measures have been studied, Brazil, Mexico and Russia have derivatives exchanges of international repute. Trading at these exchanges extends beyond forex and interest rate instruments. The development of market infrastructure and operational rulespractices at these exchanges in a gradual manner provides a clear idea of the advantages to market participants while also facilitating the task of regulation and supervision. The derivatives exchanges provide for adequate safeguards against systemic risks through guarantee settlement fund. They also reduce the risk linked to 8216concentration8217 of trading among a handful of market players by acting as a central counterparty to all the exchange transactions. Further, it is easier for regulatory authorities to monitor and regulate activities in the derivative markets due to centralisation of information. (1) Brazil II.26 Brazilian Mercantile and Futures Exchange (BMF) was founded in July 1985 and commenced its operations in January 1986. In 1991, the Sao Paulo Commodities Exchange (BMSP) merged with BMF. The exchange has three clearinghouses separately for derivatives, foreign exchange and securities. The BMF8217s Foreign Exchange Clearing House has been in operation since April 22, 2002. In August 2002, it launched the Brazilian Commodities Exchange that started trading in October 2002. II.27 A wide variety of futures, forwards, swaps and options on interest rates, exchange rates, stock indexes, gold, foreign currency spreads, and sovereign debt instruments, and a number of commodities are traded at BMF. It also facilitates OTC trades. The clearing and settlement system is operated by the exchange itself. In the spot market, DVP is observed while in the derivatives market, the clearing house processes daily margin calls based on mark to market principle for the collateral and applies haircut according to credit and liquidity risk of each asset. The BMF Derivatives Clearinghouse imposes intraday risk limits, market concentration limits, and collateral requirements on clearing members, brokerage houses, and customers. Most of the OTC contracts registered with the BMF are guaranteed by the exchange. In view of the importance assigned to liquidity aspect, the exchange does not allow risk offsets between different products. II.28 The foreign exchange interbank operations were earlier performed exclusively over-the-counter with mandatory registration at the Central Bank. However, the volatility of the Brazilian real in 1999 when it was made floating encouraged the use of hedging instruments. While the government regulations inhibited the growth of OTC market, the BMFs aggressive marketing strategy was quite successful in attracting investors to currency derivatives traded at the exchange. BMF accounts for a significant part of trading in currency derivatives in the country. BMF runs both open outcry and electronic trading. II.29 In 2003, BMF traded 21 million currency option contracts (IDMA Derivatives Market Survey, 2003). In terms of futures trading volumes, Futures Industry Association (FIA) rated BMF as the sixth largest global futures exchange and the 12th largest exchange in terms of global futures and options volume in 2003. The interest rate swap market is more liquid in Brazil than is the underlying cash market. Hence, it has become the chief price discovery mechanism. Further, trading volume in currency derivatives is much higher than in the cash market. II.30 The exchanges liquidity is concentrated in three areas: the foreign currency futures (dominated by the US50,000 cash-settled US dollar contract) the stock index futures and the interest-rate futures. The contracts that dominate trading at the exchange include DI Futures (based on one-day interbank deposit futures contract and used for hedging or taking position on local interest rate risk), US dollar futures for maturities of one year or less, Ibovespa Index Futures (based on the Brazilian stock market index) and Cupom Cambial Futures (based on the spread between the local interest rate on interbank deposits, and the exchange rate variation during the life of the contract that amounts to onshore US dollar interest rate). Most of the derivatives contracts traded at the exchange are 8220non-deliverable8221. (2) Mexico II.31 The efforts to create an exchange-listed derivatives market in Mexico began in 1994. The preferred approach was in favour of a gradual opening of the Mexican markets to derivatives products in anticipation that excessive speculation might pose threats to the financial system. The Mexican Derivatives Exchange (MexDer) began operations in December 1998. It deals in currency futures, stock index futures and interest rate futures, and option contracts (stock index and individual stock options) but not commodities. The Electronic Trading, Transaction, Registry and Allocation System was introduced in September 1999 to reduce the operation cost, facilitate the activities of monitoring of the market and to bring about transparency in the process of price making. II.32 MexDer is an organized derivatives market that offers advantages of liquidity, transparency and a diverse array of instruments for investment to the participants in the exchange. The exchange along with a clearinghouse functions on the principle of self-regulation. The Ministry of Finance and Public Credit, the National Banking and Securities Commission, and the Central Bank jointly regulate it. II.33 Mexico is in the same time zone as Chicago and the derivatives exchanges of Chicago offer a number of derivative products based on Mexican underlying assets that restricts the level of turnover on MexDer. Notwithstanding this, trading volume totalled 173.8 million contracts in 2003 (84.27 million contracts in 2002), showing an increase of 106 per cent. Open interest showed a rise from 5.4 million contracts in 2002 to 20.5 million in 2003. MexDer emerged as the fastest growing market for interest rate derivatives and the sixth in terms of futures trading volumes in the world in 2003 (International Options Market Association, Derivatives Market Survey 2003, May, 2004). The FIA Annual Survey for 2003 also revealed that it was the interest rate contracts that led to a sharp rise in MexDer8217s growth, shifting it to the list of ten largest exchanges. Foreign investors are also allowed to trade on MexDer. (3) Russia II.34 The Moscow Interbank Currency Exchange (MICEX) was formed in January 1992 to organise interbank trading in currency and other financial instruments. It began trading in governmental short-term non-coupon bonds (GKO) in 1993. In addition to MICEX, there are seven regional currency exchanges. II.35 With the introduction of a new electronic trading and depository complex in 1994, the exchange started trading in new financial instruments of stock and derivatives market. In September 1996, the exchange initiated derivatives exchange market (futures for US dollar and GKOs). As the exchange was emerging as the leading market of derivatives in Russia in terms of open position volumes, it introduced futures on government securities (OFZ-PK), equities and MICEX Composite Index. Option is an interbank market whose operators are banks and companies hedging their currency positions but is much less developed. Dealers operating on the forward market usually quote options only on the 15th of each month for a period of one to 12 months. II.36 In 1997, the System of Electronic Lot Trading (SELT) was introduced which led to integration of regional currency exchanges with MICEX. This system is used to hold inter-bank and inter-regional currency tenders. Traded currencies include the US dollar and the Euro. The volume of inter-bank currency tenders held on the MICEX reached US 350 billion in 2004. II.37 The MICEX Group comprising the MICEX Stock Exchange, the MICEX Settlement House, the National Depository Centre, regional exchanges and others is the largest exchange in Russia, the CIS and Eastern Europe. Its total trade turnover in 2004 was US 548 billion with the average daily volume of transactions of about 2 billion dollars. Annual trading volume in currency market segment of MICEX stood at 10051,89 billion roubles in 2004, up from 3512,13 billion roubles in 2000. Derivatives section (confined to futures on the US dollar and the Euro) trading turnover at MICEX increased from 57 billion roubles to 1307 billion roubles during the same period. II.38 The legislative framework, particularly for OTC derivatives, is not considered perfect. Regulation of derivatives recently became simpler in Russia because of the creation of a single derivatives regulator, in the form of the Federal Service for Financial Markets instead of three different regulators 8211 foreign exchange, equities and commodities derivatives. Forwards are understood only as deliverable forwards. Netting is also effectively impossible in Russia. Only matured obligations in the same currency are allowed to be offset against each other. 3. On-shoreOff-shore Non-Deliverable Forwards II.39 Trading in offshore NDF contracts arises on account of restrictions on the use of hedging instruments by non-residents in the onshore market. Mostly foreign investors use offshore NDF contracts for emerging market currencies, and these generally trade at a premium to local markets. The post-Asian crisis period has been marked by the imposition of various restrictions on onshore-offshore transactions by several Asian EMEs to contain speculative pressures that arise on account of offshore markets. The existence of an offshore market in domestic currency is also perceived to interfere with the monetary policy objectives of regulating money supply and or maintaining stable exchange rates. Notwithstanding these restrictions. the NDF market is reported to be active in six Asian currencies viz. Korean won, New Taiwan dollar, Chinese renminbi, Indian rupee, Indonesian rupee and Philippine peso (BIS, 2004 EMTA, 2003 ). The Brazilian real, Chilean peso and the Russian rouble are other currencies that are important in terms of their share in daily NDF turnover. The derivatives linked to the Central European currencies are also often traded offshore (IMF, 2004). NDF trades are observed to be more volatile vis--vis spot and deliverable outright forward transactions. The offshore use of domestic currencies is restricted in Asia (Indonesia, Korea, Malaysia, Singapore, Thailand, China, India, the Philippines, Taiwan Province of China), Latin America (Brazil, Chile and Colombia), and Europe (Hungary and Poland) (Ishii et al, 2001). NDFs onshore are generally restricted in several countries (Table II.10). Table II.10: Non-Deliverable Forwards: Experiences of Select EMEs Country Features of NDF market Brazil Most of the derivatives contracts traded at BMF are non-deliverable. Chile Domestic corporations prefer to hedge their exposure in the onshore NDF market while leveraged foreign investors use mainly the offshore market. China NDFNDS market is available offshore. Indonesia Before the crisis, even deliverable IDR market existed offshore. However, the imposition of restrictions on domestic currency loans and transfers to non-residents in 2001 led to the replacement of offshore deliverable IDR forwards by NDFs. Malaysia Prior to the crisis in 1997, an active offshore market in ringgit had developed in Singapore that was used for cross-currency hedging of ringgit. However, the offshore trading of MYR was severely curtailed through controls on cross-border transactions after the crisis. An offshore market in USDMYR is practically not available. NDF market is technically non-existent in Labuan International Offshore Financial Centre in Malaysia. Philippines Under the Currency Rate Risk Protection Program, US dollar-Philippines Peso forward foreign exchange contracts are entered between the BSP and the commercial bank with the foreign exchange obligations of bank clients as the underlying transaction only the net difference between the contracted forward rate and the prevailing spot rate shall be settled in pesos at maturity. NDF contracts with non-residents are also allowed but the forward contract amount shall not exceed the outstanding amount of the underlying obligation during the term of the contract. Russia NDF market is mainly located offshore due to insufficiently developed regulatory base in Russia (NDF contracts are not supported by Russian court, and enforceability is questionable). Futures liquidity both offshore (CME) and on-shore (MICEX and SPICEX) is insignificant. However, before the financial crisis in 1998, the onshore NDF market was very active. The outstanding notional of the US dollar-rouble NDF contracts in the pre-crisis situation ranged from US 10 billion to US 100 billion. Singapore Singapore discourages offshore trading of its currency. However, an offshore SGD market exists in London, Hong Kong and New York. South Korea No regulation on trading NDF onshore since April 1999 although offshore market is more active. Domestic banks are allowed to participate in the offshore NDF market. NDF can be structured in tenors of up to ten years in the offshore market. The offshore NDF market in Korean won is reported to be the deepest in Asia and also globally. Taiwan NDF market exists both onshore and offshore. Thailand Onshore NDF transactions are discouraged except for rollover transactions, or for transactions that have to be terminated due to settlement failure. 4. Forex Derivatives and Financial Crisis II.40 Derivatives that are primarily supposed to be risk management instruments to be used by market participants for minimising their currency exposure and interest rate risks have often attracted criticism when they exacerbate crisis situation and lead to financial sector vulnerability. During periods of extreme financial distress, markets become one sided as firms and investors look forward to hedging their exposures. With few or no entities willing to step in on the other side of the trade, market makers are forced to hedge their exposures by short-selling the domestic currency in the spot market. Consequently, domestic currency weakens further, interest rates rise, volatility increases and corporate solvency deteriorates, posing threat to financial stability. II.41 The experiences of EMEs reveal that in several cases, the excessive use of derivatives enabled market participants to establish leveraged positions and assume risks, which could not be sustained leading thereby to crisis situations. The EMEs with fixed exchange rate arrangements were more vulnerable to such situations although Hong Kong with flexible exchange regime could also not avoid speculative attack on its currency by highly leveraged players. The use of specific derivative instruments e. g. total return swaps in East Asia with the underlying objective of gaining from the carry trade or carry business on account of interest rate differential of borrowing and lending under fixed exchange rates came under severe criticism in the context of their role in deepening the financial crises (Randall Dodd, 2000). II.42 OTC options on emerging market debt particularly of Brazil, Mexico, Argentina, Venezuela and Poland also generated an element of volatility arising as a result of their use for speculation. It is the use of structured products, which combine the features of conventional financial instruments with callsoptions that is reported to have caused volatility in foreign exchange markets during the Mexican and Asian crises. In Mexico and Brazil, there were also instances of circumvention of prudential regulations by market participants with the shifting of on-balance sheet exposures to off-balance sheets that subsequently turned destabilising. There have been several cases of commodity price manipulation through the use of derivatives, which affected severely a number of primary products exporting developing countries. II.43 An important lesson to be drawn from the country experiences is that large positions in OTC derivatives markets by investors were generally financed through credit lines provided by commercial banks (e. g. LTCM case, attack on Hong Kong dollar). Consequently, the excessive derivatives exposure got linked to credit risk faced by the banking system in a number of countries. The restrictions on domestic currency lending to non-residents can limit the scope for short-selling the currency and reduce the scope for speculative attacks. Section VII: Conclusions II.44 Country experiences indicate that a move to flexible exchange rate regime necessitates as also facilitates the development of foreign exchange market. A number of EMEs have adopted either managed floating or independently floating exchange rate regimes. Despite a rise in turnover that has been associated with an increasing exchange rate flexibility and greater forex market development, EMEs are still insignificant in terms of their share in global foreign exchange turnover and also in derivatives segment of the forex market. They still retain a number of foreign exchange regulations and are yet to have their currencies convertible on the capital account. The markets for underlying assetsinstruments themselves in some of these countries leave scope for development. These factors limit the size of their foreign exchange markets. II.45 The exchange rate flexibility exposes market participants to risks arising as a result of exchange rate fluctuations. The market risk assumes significance in globally integrated foreign exchange markets encouraging market participants to use risk management instruments. Availability of these instruments as also the freedom to use these instruments depends on the existing exchange controlregulation environment in a country. EMEs differ significantly among themselves in terms of their overall approach towards foreign exchange market liberalisation strategy. While the majority has been supportive of a gradual approach towards reforms, some have preferred to adopt 8216big bang8217 approach and gone in for a wide range of capital account liberalisation measures. The operational environment is relatively more flexible in countries with current account convertibility and open capital accounts. The countries with liberal exchange control regimes have now switched over to the regulatory system for capital account transactions that allows market participants to undertake a large number of transactions subject to the requirement of making notification to the regulatory authorities while the 8216negative8217 list requiring prior permission is getting pruned over time. II.46 The exchange rate regimes do influence the regulatory framework when it comes to the issue of providing operational freedom to market participants in respect of their foreign exchange market operations. While the use of risk management instruments is encouraged by EMEs for hedging genuine exposure linked to real and financial flows, their overall approach towards risk management has remained cautious with a clear emphasis on the need to safeguard against potential financial instability that could arise due to excessive speculation in the foreign exchange market even when macro-economic fundamentals are reasonably good. This has been seen even in those countries where the use of hedging instruments is not linked to the 8216real demand principle8217. II.47 Country practices in respect of permission given to banks to engage in local currencyforeign currency derivative transactions with non-residents reveal a move towards relative freedom with minor restrictions. Mexico imposes no restrictions while Brazil allows foreign investors to trade any instrument that is available to residents. Korea permits it for all instruments except credit and commodity related products. In Russia, there are no formal limitations on conducting these derivative transactions. Several countries allow flexibility in establishment and lifting of hedges. NDFs onshore are restricted in some countries while others allow flexibility in their use. Although there is no clear pattern relating to sequencing of liberalisation measures, regulations on forex transactions for individuals and companies seem to be generally eased before relaxing them for financial sector participants. In some countries, the emphasis has been placed on enhancing the real and the financial sectors8217 capacity to manage risks before undertaking large-scale liberalisation measures. In South Africa, the exchange controls on transactions of non-residents were relaxed before granting permission to corporate residents. II.48 Notwithstanding the fact that prudential regulations are considered as an integral part of the overall risk management strategy, the country practices differ widely in this regard. An important prudential measure is the fixation of open position limits of banks. This stipulation also varies from country to country besides the fact that these limits do attract capital requirement in several countries. The prudential safeguards also get manifested in the form of restrictions on capital account transactions of various types including borrowings of non-residents in the local currency market, foreign currency deposits holdings of domestic residentslocal currency deposit holding of non-residents, offshore holding of domestic currency deposit accounts, etc. II.49 Several countries allow producers and manufacturers to hedge their commodity exposure on international commodity exchanges regardless of the fact that a number of them also have local commodity exchanges. In general, access to international commodity exchanges is only for the purpose of hedging. Restrictions on speculation are in place in some countries such as Australia, South Africa, China and Japan. II.50 The experience with the extant market structure in many EMEs brings forth the fact that it may be desirable to develop exchanges for forex transactions including derivatives, which would provide benefits of decentralised risk, transparency, price discovery, faster settlement and better regulation. II.51 Country experiences highlight the fact that much like the misuse of derivatives, which leads to assumption of leveraged risk, systemic threat can be posed if foreign currency denominated liabilities are left unhedged. II.52 The operational freedom in use of risk management instruments has to go along with a proper internal risk control mechanism and efficient prudential and supervisory systems. Of late, there has been a great degree of emphasis on internal risk management systems and the need to have a well-defined risk management policy and appropriate safeguards to ensure that the accepted policy is implemented in true spirit. Supervisors have to be ready with their informationmonitoring, regulatory and supervisory systems to ensure that market participants observe the prudential risk management norms and avoid excessive risk taking in a liberalised environment. Bibliography Abrams, Richard K. and Paulina Beato, 1998, The Prudential Regulation and Management of Foreign Exchange Risk,8217 IMF Working Paper 9837 (Washington, International Monetary Fund). Ammar Siamwalla, Yos Vajragupta Pakorn Vichyanond, 1999, 8216Foreign Capital Flows to Thailand: Determinants and Impact,8217 Thailand Development Research Institute, November 1999. Asian Bonds Online, Asian Development Bank website Asian FX Regulation Handbook, 2003, HSBC. Bank for International Settlements (BIS), 2004, 8216Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 20048217, Basle, September 2004 Bank for International Settlements (BIS), 2005, 8216Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 20048217, Basle, March 2005. Bank of Thailand News, various issues Brazilian Mercantile Futures Exchange website Canales Jorge Ivan-Kriljenko, 2003, 8216Foreign Exchange Market Organization in Selected Developing and Transition Economies: Evidence from a Survey8217 IMF Working Paper 0395 (Washington, International Monetary Fund). Canales-Kriljenko, Jorge, 2003b, 8216Foreign Exchange Intervention in Developing and Transition Economies: Results of a Survey8217, IMF Working Paper 0395 (Washington, International Monetary Fund). Central Bank websites of Brazil, China Mexico, Russia, Taiwan Thailand, and The Philippines. Chatrath Arjun, 2002, 8216Futures Market Hedging and the Behaviour of Commodity Prices8217, 2002, paper presented at Economics Finance Workshop, School of Economics and Finance, The University of Hong Kong. Dodd Randall, 2000, 8216The Role of Derivatives in the East Asian Financial Crisis8217, Derivatives Study Centre, Washington. Dodd, Randall, 2002, 8216Consequences of Liberalizing Derivatives Markets8217, Financial Policy Forum, Washington. Emerging Market Traders Association, 2003, Second Quarter 2003 emerging market NDF volume survey, New York, August 2003. Eswar Prasad, Thomas Rumbaugh, and Qing Wang, 2005, 8216Putting the Cart Before the Horse Capital Account Liberalization and Exchange Rate Flexibility in China, International Monetary Fund Discussion Paper, PDP051. Guonan Ma, Corrinne Ho and Robert N. McCauley, 2004 8216The markets for non-deliverable forwards in Asian currencies8217, BIS Quarterly Review, June 2004. Hoschka Tobias C. 2005, 8216Developing the Market for Local Currency Bonds by Foreign Issuers: Lessons from Asia, ERD Working Paper Series No. 63, Asian Development Bank. IMF Survey, 2001 on 8216Foreign Exchange Market Organization8217 IMF, 2004, 8216The Role of Financial Derivatives in Emerging Markets8217, Report on Financial Stability. IMF, 2004, Learning to Float: The Experience of Emerging Market Countries since the early 1990s, World Economic Outlook, September 2004. IMF 2004 Mexico: Selected Issues Country Report No. 04250, IMF, Washington, August 2004. Ishii Shogo, Inci Otker-Robe, and Li Cui, 2001, 8216Measures to Limit the Offshore Use of Currencies: Pros and Cons8217, IMF Working Paper, WP0143, April 2001. Jorge A. Chan-Lau, 2005, 8216Hedging Foreign Exchange Risk in Chile: Markets and Instruments8217, IMF Working Paper, WP0537, (Washington, International Monetary Fund). MexDer MICEX websites Rene M. Stulz and Rohan Williamson, 1996, 8216Identifying and Quantifying Exposures8217, August 1996 Reserve Bank of India, 1995, Report of the Expert Group on Foreign Exchange Markets in India 8211, June 1995 Reserve Bank of India, 1997, Report of the Committee on Capital Account Convertibility 8211, May 1997 Reserve Bank of India, 1997, Report of the Committee on Hedging Through International Commodity Exchanges 8211, November 1997 Rupa Duttagupta, Gilda Fernandez, and Cem Karacadag, 2004, 8216From Fixed to Float: Operational Aspects of Moving Toward Exchange Rate Flexibility8217, IMF Working Paper, WP04126. Shah Ajay, 1997, 8216Derivatives in Emerging Markets8217, Media. UNCTAD, 2001, 8216Overview of the World8217s Commodity Exchanges8217, 2001 UNCTAD, 1994, 8216Report of Standing Committee on Counterpart and Sovereign Risk Obstacles to Improved Access to Risk Management Markets: Issues Involved, Problems and Possible Solutions8217, Ad Hoc Group of Experts on Risk Management in Commodity Trade8217 August 1994.A V Rajwade Quantity Available: gt 20 Item Description: 2016. Softcover. Buchzustand: New. 54 Lang:- mar, Pages 54, Print on Demand. Reprinted in 2016 with the help of original edition published long back1900. This book is Printed in black amp white, sewing binding for longer life with Matt laminated multi-Colour Soft Cover , Printed on high quality Paper, re-sized as per Current standards, professionally processed without changing its contents. As these are old books, there may be some pages which are blur or missing or black spots. If it is multi volume set, then it is only single volume. 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