The Reserve Bank of India (RBI) prescribes permitted products and operational guidelines for Over the Counter (OTC) foreign exchange derivative contracts that can be transacted by various categories of persons resident in India, for hedging different categories of foreign exchange exposures. Such derivatives include foreign exchange forward contracts, foreign currency-INR options, cross currency options and cross currency swaps.
Under the present regulatory framework, outlined in RBI’s Comprehensive Guidelines on OTC Foreign Exchange Derivatives and Overseas Hedging of Commodity Price and Freight Risks (A.P (DIR Series) circular no. 32 dated 28 December 2010), writing of options by users (Indian resident entities) on a stand-alone basis is not permitted. The users could currently enter into option strategies of simultaneous buying and selling of plain vanilla European options, provided there is no net receipt of premium.
With the view to encourage participation in the OTC currency options market and improve its liquidity, RBI through its Circular-RBI/2015-16/431 (the RBI
Circular), issued on 23 June 2016, has permitted resident exporters and
importers of goods and services to write (sell) standalone plain vanilla
European call or put option contracts against their contracted exposure, i.e.
covered call or covered put respectively, to any AD Category-I bank in India
subject to the prescribed operational guidelines, terms and conditions.
Some of the salient features of the RBI Circular are as follows:
Similar amendments have been made in the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000.
A company that writes a call or put option hasthe obligation, but not the right to sell or buy foreign currency, respectively, at the option price, on exercise of the option by the buyer. While RBI’s move is expected to improve liquidity in the OTC currency options market, companies that are proposing to write these options should carefully assess the accounting implications of these options. For instance, the European call or put options are not generally capable of being treated as hedging instruments under current accounting principles.
Also, these options will generally not qualify for hedge accounting under Indian Accounting Standard (Ind AS) 109, Financial Instruments. The covered options would generally, therefore, be recognised at their fair value with changes in fair value recognised through the statement of profit and loss by the issuing companies, under current accounting principles as well as under Ind AS.
To access the text of the RBI circular, please click here.
© 2016 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.