RBI's Draft Framework on Foreign Exchange Operations by Authorised Persons

Overview of the Draft Guidelines

The Reserve Bank of India has released a comprehensive draft framework governing foreign exchange operations conducted by authorised persons. This framework finds its legal foundation in the Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 dated May 03, 2000. The draft directions establish clear parameters for various categories of market participants engaging in foreign exchange transactions, derivative contracts, and related financial instruments.

Hedging Provisions for Foreign Institutional Investors

Scope of Forward Contracts for Registered FIIs

A Registered Foreign Institutional Investor (FII) possesses the authority to enter into forward contracts where the Indian Rupee constitutes one of the currency pairs. Such contracts must be executed with an authorised dealer operating within Indian jurisdiction, specifically for the purpose of hedging the FII's exposure arising from investments in India.

Mandatory Conditions for FII Hedging Operations

The framework stipulates several stringent conditions that must be satisfied for such hedging arrangements:

Limitation on Debt Investment Hedging

The hedging value must not surpass the prevailing market value pertaining to the FII's holdings in debt instruments. This ensures that the hedge remains proportionate to the actual exposure.

Equity Investment Hedging Ceiling

For equity investments, the hedge value cannot exceed 15% of the equity portfolio's market value as recorded at the close of business on 31st March 1999. This baseline calculation uses the conversion rate of US $ 1 = Rs.42.43. Subsequently, any appreciation in market value or fresh inflows received after 31st March 1999 may be added to this base amount. However, an important safeguard requires that once established, forward cover may continue only insofar as it remains within the boundaries of the underlying investment's value.

Restrictions on Contract Cancellation and Rebooking

The guidelines impose a prohibition on rebooking forward contracts once they have been cancelled. Nevertheless, market participants retain the flexibility to roll over existing contracts on or before their scheduled maturity dates, providing operational continuity while preventing speculative practices.

Funding Requirements for Hedging Costs

All costs associated with hedging operations must be financed exclusively through repatriable funds and/or inward remittances channeled through established banking channels. This requirement ensures transparency and regulatory oversight.

Tax Compliance for Outward Remittances

Any outward remittances connected to hedging activities must be net of all applicable Indian taxes, ensuring full compliance with domestic tax regulations.

Forward Contract Provisions for Non-Resident Indians and OCBs

Eligible Hedging Scenarios

Non-resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) enjoy specific privileges to enter into forward contracts with the Indian Rupee as one of the currency pairs, transacting with authorised dealers in India for hedging purposes.

Permitted Hedging Categories

Dividend-Related Hedging

NRIs and OCBs may hedge the dividend amounts due to them from shares held in Indian companies, providing protection against currency fluctuations affecting dividend repatriation.

Account Balance Hedging

Such entities can hedge balances maintained in Foreign Currency Non-Resident (FCNR) accounts or Non-Resident External Rupee (NRE) accounts, safeguarding their deposits from exchange rate volatility.

Portfolio Investment Hedging