Learner’s guide on currency futures in India

What is a currency future?

Currency Futures refers to a standardized foreign exchange derivative contract traded on a recognized stock exchange to buy or sell one currency against another on a specified future date

 

How can one trade on currency future?

 (i) Currency futures are to be permitted in US Dollar – Indian Rupee presently.

(ii) The contract size is USD 1000.

(iii) The maximum maturity of contracts would be 12 months

(iv) The contracts would be quoted and settled in Indian Rupees

(v) Only ‘persons resident in India’ may purchase / sell currency futures to hedge an exposure to foreign exchange rate risk or otherwise.

 

Any safety mechanisms / policy measures which have been deployed by the RBI?

An important control introduced by RBI is the quantum of open position that any person / bank accessing the exchange market can hold.  This will therefore enable the steady growth of the market.

 

How lucrative will it be for a customer to trade on currency future?

The OTC Forex market is a fairly commoditized and liquid market.  Hence, the price discovery benefits may not be substantial. Like we said earlier, the more important benefit will be that this will for the first time allow individuals/business entities to take on Fx risk whether as a proactive risk management measure or with a view to profiting from currency movements.

 

How do you propose to educate the customers on this?

RBI and SEBI guidelines are already available for generic references. However, ICICI Bank will also undertake online and other educational programme to enable customers to better understand the market. Besides the intricacies of dealing through this forum, the other important understanding the customer will need to have will be the fundamental and other reasons of currency movement. For this purpose, we will disseminate research on the Forex market.

 

What are the benefits of trading on currency future and how will it benefit the individual customer?

An Indian resident may purchase / sell currency futures to hedge an exposure to foreign exchange rate risk or otherwise.  Currently, FC trading was restricted to persons (largely business entities) who had either a trade exposure or liability exposure to foreign currency. While currency futures is an important step, the implicit change in allowing for individuals/ business entities to proactively take a foreign currency exposure /risk is an exceedingly big step for the eventual aim of rupee convertibility

 

Would you like to mention the impediments of trading on currency future?

There are certain shortcomings of futures when compared to OTC market. The major disadvantages are:

 

How does the entire system work?

Client will open an account with one of brokers (trading bank) and provide margin for trades. He will then place an order on the exchange through the broker. As the order gets executed, client will continue funding margins till the order gets executed or squared off.

 

Apart from ICICI Bank does any one else offer this?

Any AD Category-I Banks are permitted to offer currency futures through exchanges provided the following requirements are fulfilled. 

 

What are the unique features offered by ICICI Bank?

ICICI Bank intends to be a liquidity provider in this market by providing buy-sell quotes for all the available tenors. This will help the market to be vibrant from the start. As one of the biggest bank in the country with a significant Forex turnover, we will be in a position to dissipate risk in a better way than most other banks.  More importantly, we have a dedicated Treasury Research Team, which has been closely tracking the currency movements, and hence we will be able to support our clients with good quality research to enable them to take their views.

 

What kind of response do you foresee from the customers (adaptation)?

There is a large segment of SME customers who have not yet accessed the OTC markets for Forex hedging for a variety of reasons. This segment as well as individuals would comprise the initial segment of users. As and when liquidity picks up, larger corporates could also look at this market as an alternate avenue for hedging.

 

What is the market you plan to focus on?

Presently, both large corporate and SMEs are active in OTC Forex markets through ICICI Bank and the futures product would enhance the product suite available to the Bank’s customer segments. Further, HNIs and resident individuals in India could be interested in tapping opportunities in this market.

 

Do you think the market is right to introduce this?

With Equity, Commodities and Debt Markets getting more mature in our fast growing economy, introduction of currency futures is another step towards liberalization of the Indian financial sector.

 

Can you give us your perspective on the structure of currency forward market in India?

Currently, the forex market in India exists entirely as an Over The Counter (OTC) market – that is to say, it exists in a form where it is transacted bilaterally between 2 parties, one of which would necessarily be a bank authorized by the RBI to deal in forex. Transactions are largely customized to the customer and the price discovery is fairly good as the market itself is a liquid one.

 

The most significant aspect of the market is that from a regulatory perspective it is essential to have an underlying transaction where there is a forex risk (either in the form of an underlying trade transaction or in the form of an underlying liability which results in foreign currency being payable / receivable in the future).

 

What is the difference you find between currency forward and exchange traded currency futures?

Exchange Traded Currency Future is a standardized foreign exchange derivative contract traded on a recognized stock exchange to buy or sell one currency against another on a specified future date. Both OTC & exchange have their own advantages. The OTC market enables more customized access to market. For instance: If an exporter wants to hedge his position for a specified amount and for value a specified date, he can do so on the OTC market. However, the exchange traded market will enable dealing through the exchange for a standard lot only and such contract would also be for a certain standard date, both of which may differ from the exporter’s specific requirement.

 

Further, in the OTC market, banks largely enable customers to undertake these contracts without the need for margining. This is because they take a credit exposure to the client on account of the contract. However, in case of exchange-traded futures, customers are required to post margin for their trades and this will help in eliminating counter party risk, as all trades are with the exchange.

 

The third significant difference will be from a regulation perspective. In the current forwards market, customer may take exposure only to the extent of their underlying while in the case of exchange traded market; there is no requirement to submit proof of underlying. However, there is a limit on the extent of open position that can be held.

 

‘Exchange traded currency futures is a worth investment product’. Yes or no? Why? Or is it best suited only for corporations?

So far, the OTC forward market was enabling risk management (largely offloading or transforming existing currency risk of a customer). With the change in regulation in relation to the underlying, exchange-traded currency futures will enable resident Indians and businesses to prospectively take a view on the forex market. Hence it can be used not only as a risk offloading tool but it can also be an alternative investment within the prescribed limit. Its scope is now extended beyond corporates, to SMEs and individuals as well and in that sense will be a far-reaching change on the path of rupee convertibility.

 

Can you give your perspective of the structure of currency futures market in foreign countries like US and Japan?

In countries where currencies are convertible, the exchange-traded market is a small percentage of the overall market, as the liquidity and price discovery in the OTC market is also fairly good and, more importantly, there is no regulatory differentiation between the OTC and exchange market.

 

Do you think the presence of the exchange-traded currency futures would have mitigated losses incurred by small and large companies, which got exposure to currency derivatives?

It is pertinent to note that exchange traded currency futures is merely changing the methodology of dealing i.e. through an exchange in a standardized form, instead of a bilateral form as is the norm in the OTC market.  It does not change the fact that once a customer has taken a view on the market he can either profit from it (if his view goes right) or lose from it (if the view goes contrary). In that sense, what would remain material is the ability to understand the market, to monitor the positions that have been taken and to respond to subsequent market movements. Indeed, in the exchange traded market the customer will additionally have to put up cash margin to support any adverse market movement that happens.