Foreign Exchange Dealers’ Association of India

(Registered u/s.25 of The Companies Act, 1956) CIN:U67190MH1988NPL047993

173, Maker Tower ‘F’, E-mail : mail@fedai.org.in
Cuffe Parade, Tel.: 2218 2549 / 2218 4432 Website: https://fedai.org.in
Mumbai - 400 005.

Circular Letter No.11/2020 14th July 2020

To All Member Banks

FAQs on Guidelines issued vide RBI AP (Dir.) Circular No. 29 on

Risk Management and Inter-bank Dealings – Hedging of foreign exchange risk

The ‘Risk Management and Inter-bank Dealings – Hedging of foreign exchange risk’
guidelines issued on 07 April 2020 are going to be effective from 01 Sept. 2020.
The guidelines are in line with the RBI approach of moving away from the Prescriptive to the
Principles based approach giving AD I banks considerable operational freedom. However,
this also gives rise to several interpretational issues in operationalising these guidelines.

FEDAI has compiled a list of FAQs clarifying several points referred to FEDAI by several
member banks. These FAQs are issued to serve as a guide to member banks in interpreting
the stipulations in the RBI Circular and arrive at market wide common understanding. They
are not meant to be instructions to member banks and member banks are advised to use
the FAQs judiciously in interpreting these guidelines.

Yours faithfully,

Chief Executive

Encl : FAQs
 Enclosure to FEDAI
Circular Letter No.11/2020
dated 14th July 2020

Note: • This FAQ pertains to ‘Risk Management and Inter-bank Dealings – Hedging of
foreign exchange risk’ by Reserve Bank of India [RBI/2019-20/210, A.P.(DIR Series)
Circular No. 29] issued on April 7, 2020.
• FAQs are based on queries from member banks. Usage and reference of this FAQ
document is restricted to members of the Foreign Exchange Dealers Association of
India (FEDAI)

A) User Classification and Permitted Products

Q1) All entities regulated by a financial sector regulator subject to general or special
permission of the concerned regulator have been classified as a Non-retail user for the
purposes of this guideline. Whether listed companies with a Net Worth below Rs.500 crores
will be classified as non-retail users (by virtue of them being regulated by financial sector
regulator i.e. SEBI)?

• No. Companies with net worth below Rs.500 crores will be classified as retail users.

Q2) Do we need to capture the time stamped interbank rates of forward contract in
confirmation / term sheet?

• No, these requirements need to be complied with internally only, for all forward
contracts executed. Trade confirmation would capture only client price.

Q3) For retail users entering into all other derivative contracts (i.e. excluding Forward
Contracts), how do we capture the price in the term sheet?

• On a pre-deal basis, banks need to disclose mid-market mark to the customer.

The term sheet needs to capture the mid-market mark, as well as the final execution price
(the all-in price which will include profit, credit reserve, hedging, funding, liquidity charge
etc.).

Any other charges that are levied to the client in connection with the transaction (but are not
already captured in final execution price above) shall fall under the scope of "All applicable
fees / commissions / service charges etc.", which need to be treated separately as specified
by RBI.

Q4) Do the Regulations deal with the ability to enter into foreign currency interest rate
derivatives?

• Yes. The amended FEMA definition states “Foreign exchange derivative contract”
means a financial contract which derives its value from the change in the exchange rate of
two currencies at least one of which is not Indian Rupee or which derives its value from the
change in the interest rate of a foreign currency and which is for settlement at a future date,
i.e. any date later than the spot settlement date, provided that contracts involving currencies
of Nepal and Bhutan shall not qualify under this definition”.

Foreign currency interest rate derivatives are permissible without application of stipulations
in relation to underlying exposure detailed in section 2.A.(ii) of Annex. I, and gains/ losses
may be freely settled upon cancellation.
Q5) Do the Regulations deal with the ability to enter into foreign exchange derivatives not
involving the Rupee?

• Yes. Foreign exchange derivatives not involving the Rupee may be offered to both
residents and non-residents as per their User Classification.

Foreign exchange derivatives not involving the Rupee and NDDC may be offered without
application of stipulations in relation to underlying exposure detailed in section 2.A.(ii) of
Annex. I. Further, the stipulations as detailed in the Comprehensive Guidelines on
Derivatives, including the Suitability & Appropriateness guidelines, shall also be applicable.
Gains/ losses may be freely settled upon cancellation.

Q6) Does user classification apply to all derivatives including contracts not involving INR
and NDDC transactions?

• Yes.

Q7) Can client choose his classification differently with different Banks?

• A non-retail user can choose to be classified as retail user with some banks and as
non-retail user with others.
Banks can ask eligible non-retail users (who chose to classify as retail users with them) to
disclose their user classification status with other banks.

Q8) Can group-level consolidated net worth be considered for an entity while classifying as
Retail User / Non-Retail User?

• No

Q9) A user may book a contract (while being classified as Retail User or Non-Retail User)
and may subsequently move to other classification category. What User Classification shall
be applicable for such contracts booked under prior classification?

• Authorised Dealers shall offer derivative contracts to a user as per the user’s
classification at the time of original booking. Outstanding contacts may be allowed to run till
maturity subsequent to change, from non-Retail to Retail, in user classification.

Q10) For non-retail users, can swaps / any other permissible products or combinations be
undertaken involving upfront payment of rupees (or its equivalent in another currency)?
• Subject to compliance with Comprehensive Guidelines on Derivatives vide Para 6.3
which state that "All permitted derivative transactions, including roll over, restructuring and
novation shall be contracted only at prevailing market rates".
FX trades should not be used as surrogate for financing transactions.

Q11) Are Non-Retail Users allowed to use any permissible product of their choice (or
combination thereof) to convert INR liability into FCY?
• No, Non-retail users have been permitted only Swaps to convert INR liability into
FCY.

Q12) Can retail users enter into covered options, against underlying?

• Yes. Also Non-Retail users can undertake all derivative contracts which are permitted
for Retail users.
Q13) Do the regulations permit retail users to buy vanilla interest rate caps and floors?

• Yes. Caps, Floors and spreads are permitted products for Retail Users

Q14) Directions in case of non-retail users (under ‘Eligible products’) state that “… provided
that the potential loss from the derivative transaction to the user, in any scenario, does not
exceed the loss that the user would face if he had left the position unhedged.” What are the
principles that determine eligibility of a permitted product under this definition?

• Hedging is an activity of undertaking a derivative contract to offset the impact of an

underlying exposure. By virtue of this fact, gain / loss on a derivative is expected to
partially/completely offset the loss/gain on the unhedged position. Accordingly, a derivative
transaction should not have a loss when the underlying position has a loss. Hence, we
interpret the above wordings "potential loss from the derivative transaction" to imply the
potential loss from a combination of the derivative transaction and the unhedged position
which should "not exceed the loss that the user would face if he had left the position
unhedged." This is intended to ensure that while hedging downside risk, the derivative
should not introduce further downside as a result of derivative cashflows. Any cost paid on
account of buying optionality of any kind by the user would be outside the purview of the
definition of loss.

Further, it may be noted that RBI has specifically stressed only upon the downside scenarios
i.e. "loss that the user would face if had left the position unhedged" and this condition is to
be complied with only in the scenarios that the user would have incurred a loss on the
underlying position. Upside scenarios where user would have a gain on the underlying
position, the combination of the derivative transaction + unhedged position would be worse.
However, this is acceptable as giving up potential upside by undertaking a derivative hedge
can reduce cost for the user. The focus of the above definition is on protecting downside
risk (loss scenarios on the unhedged position) and is not restrictive on giving up upside
(upside scenarios on the unhedged position).

Q15) Section 2(A)(viii) Annex I of the regulations state that “Authorized dealers, unless
permitted by Reserve Bank to run books in contracts not involving Rupee, shall offer such
contracts on a fully covered back-to-back basis.” Is this restriction applicable only to FCY-
FCY Option books as was the case under the erstwhile regulations?

• Yes

Q16) Can users enter into Par Forward contracts?

• Par Forwards are not Forward Contracts but a Structured Product and hence retail
users are not permitted to enter into Par Forwards Contracts, whereas non-retail users may
be offered any product which the AD bank can price and value independently. Accordingly,
only non-retail users may enter into Par Forward contracts.

Q17) Can non-retail users enter into Buy-Sell or Sell-Buy FX Swaps, where both the legs
have valid underlying?
• Yes. Near as well as Far leg both should be at prevailing market rates.

Q18) Can AD banks deal in forwards, swaps, options and other structured derivatives with
another AD bank, as an inter-bank transaction?

• Yes. An AD bank can deal with another AD bank, in the products permitted to be
offered to Retail and Non-retail users, as an inter-bank trade.
Q19) Can non-resident entities deal with Authorized Dealers in India for their offshore non-
INR exposures?

• Yes, subject to stipulations as applicable for contracts not involving the Rupee.

Q20) Section 2(B)(iii) Annex I states that “Authorised Dealers may deal with the non-resident
user (or its central treasury, where applicable) either directly or through the overseas bank
of such user (including overseas branches of authorised dealer) or through other overseas
entities eligible to deal in derivatives as per local regulations.”

a) Can Central Treasury and other eligible entities act as Agent as well as Principal?

• Yes, provided the Central Treasury and other eligible entity is also Non resident. For
hedging undertaken by Non-resident parent of an Indian Subsidiary or its centralised
treasury or its regional treasury outside India on behalf of Indian Subsidiary, AD Banks may
follow the guidelines A.P.(DIR Series) Circular No.41 dated March 21, 2017.

b) In cases where Central Treasury or other eligible entity is acting as Principal, can Gross
Settlement be done with Central Treasury or Group entity on whose behalf the hedge
transaction was undertaken?

• All settlements shall be with the counter party for the hedge transaction subject to
FEMA regulations pertaining to cross border remittances FX foreign exchange.

c) When AD Bank in India is dealing with overseas bank of a non-resident, does the
overseas Bank have to cover the trade on a fully back-to-back basis with AD Bank in India?

• Yes

d) While dealing through Overseas bank can the non resident user undertake transactions
upto and beyond spot?

• No, only transactions beyond Spot are permitted under these guidelines

B) Contracted/ Anticipated Exposure and USD 10 Mio facility

Q21) Can contracts booked on Anticipated Exposure basis be shifted to Contracted

Exposure, and vice versa?

• No. Contracts once booked on Anticipated Exposure basis will remain on Anticipated
Exposure basis only. And contracts once booked on Contracted Exposure basis will remain
on Contracted Exposure basis only.

Q22) Whether an onshore buyer of a commodity, pricing of which is linked to a benchmark

denominated in foreign currency, can hedge his exposure to currency risk arising out of the
commodity inventory?

• Yes, currency risk arising out of the inventory / stock of commodity pricing of which
is linked to international benchmark can be hedged.
Q23) As per RBI circular, “net gains (gains over and above losses if any) on contracts
booked to hedge an anticipated exposure shall be passed on to the eligible user only at the
time of the cash flow of the anticipated transaction. In this regard, is there any limitation on
timeline when the user can produce the cashflow? Is there any limitation on number of times
a user can rollover the contracts booked under Anticipated Exposure?

• Provided the AD Bank is satisfied about genuinity and bonafides of the exposure,
there is no limitation on timeline when the user can produce the cashflow. Further, there is
no limitation on number of times a user can rollover the contracts booked under Anticipated
Exposure.

Q24) With respect to Anticipated Exposure (AE), where RBI guidelines refer to "net gains
(gains over and above losses if any)", can AD banks permit netting of gains held under one
AE contract against losses from another contract booked under AE? In other words, whether
the concept of ‘net gains’ applies at a contract level or at portfolio level?

• Net gains will apply on a Contract basis in as much as banks are required to put in
place proper monitoring system and obtain adequate information at the time of initiating the
hedge to be able to link the subsequent hedges, cash flows to the respective hedge to be
able to net off the losses, pass the gains.

Q25) Customer has booked a transaction under Anticipated Exposure, but his underlying
transactions / cash flows are routed through another AD bank. In such cases, can the gains
be passed on cancellation basis transactions / cash flow routed through other bank?

• Yes. AD Bank needs to satisfy itself about cash flow of the transaction.

Q26) Can a customer simultaneously use the USD 10 million route and Contracted
Exposure / Anticipated Exposure route?

• Yes, this is not a separate facility. Relaxations in submitting information of underlying

exposure is provided to Clients with total outstanding notional, either under Contracted or
Anticipated exposure, below USD 10 mio.

Q27) Is the USD 10 million limit is per bank limit or is it across all banks limit?

• USD 10 million limit is a limit across all banks.

Q28) How will the USD 10 million limit be tracked under this relaxation?

• Each Bank will keep track of contracts booked with it. Monitoring of limit across Banks
will be done by AD Banks basis a declaration from the client that she is complying with the
requirements of the guideline.

Q29) What happens when the client exposure exceeds USD 10 million and client is under
this scheme?

• The client will be required to furnish information as may be required under Contracted
Exposure / Anticipated Exposure (CE / AE) for all the outstanding hedges.

All outstanding and future hedge contracts for the client shall be covered under Contracted
Exposure or Anticipated Exposure.
Q30) Post the introduction of the new guidelines will clarifications given earlier in respect of
the subject matter covered by the directions in Part A - Section I and II and Part D of the
Master Direction on Risk Management and Interbank Dealings dated July 5, 2016, as
amended from time to time be valid?

• After these new guidelines come into effect all other clarifications given earlier
through Mailbox, individual letters to Bank, Compendium of discussion at the meeting of
authorised dealers and any other document of similar nature in respect of the areas covered
by the directions in Part A - Section I and II and Part D of the Master Direction on Risk
Management and Interbank Dealings dated July 5, 2016, as amended from time to time shall
cease to be effective.

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