Financial Markets Archives

Hedging in Currency Derivatives Market: Is This End of Currency Derivatives?

Leave a Comment / Capital Markets and Securities Law / CBCL

[By Pranshu Agarwal] The author is a student of Institute of Law, Nirma University. Introduction The Exchange-Traded Currency Derivatives (“ETCD”) was introduced with the primary aim to enable traders and members to hedge their forex risk exposure, but they were using the ETCD platform for speculative trading without having any underlying contracted exposure. Although, the Reserve Bank of India (“RBI”) had stated that the Authorised Dealers (“AD”) do not need to establish the existence of any underlying contracted exposure up to $100 million yet, this led to speculative trading by the traders without having any underlying contracted exposure at all. The RBI on 5th January, 2024, issued a circular titled “Risk Management and Inter-Bank Dealings – Hedging of foreign exchange risk” (“RBI Circular”) and thereafter, the National Stock Exchange (“NSE”) issued circular to the brokers to comply with the RBI Circular by April 5th. Because of these circulars, Market experts are expecting a slump of 80-85% in the volume in the ETCD overnight that is comprised of proprietary traders, retailers and arbitragers. This article seeks to analyses the principle-based regime and RBI’s direction to establish an underlying contracted exposure for ETCD. The article explores the requirement of valid underlying contracted exposure and its implications. It also discusses the effect of the RBI Circular on the derivatives market. Underlying Exposure for ETCD: The Current Position ETCDs are financial contracts traded and regulated by the stock exchanges. These contracts are akin to the volatility in international trade and exchange rates, making such contracts exposed to transactional exposure. To ensure stability and exposure against sudden market movements, RBI required the users to have underlying exposure for taking a position in the market. Whereas, for the convenience of the users, RBI allowed them to take up a position of up to $ 10 Million in the market without having to establish the existence of any underlying exposure. Later the limit was increased to $ 100 Million combined across all exchanges. The RBI Circular, followed by the 1st April NSE’s circular specified that the users are allowed to take a position in the ETCD upto $100 Million without having to establish the underlying exposure, however they have to ensure a valid underlying contracted exposure for the same. What this entails is that before the RBI Circular, the users could trade on the ETCD up to $ 100 Million without having to show any underlying exposure and RBI did not have any authority to ask for the existence of the same. The RBI Circular has granted the RBI the power to inquire the user whether the ETCD units purchased by them have been hedged by a valid underlying contracted exposure. If the users fail to comply with the Circular by 5th April, 2024, they will be held liable for non-compliance under the Foreign Exchange Management Act, 1999 (“FEMA”). The deadline for the compliance has been extended to May 3rd, 2024 in light of numerous requests from members and traders. Analysis of the RBI’s Circular A prima facie reading this circular implies that an exemption provided to the users from having an underlying exposure in the ETCD unit upto $ 100 Million. This exemption has been curbed by the RBI Circular, prescribing the users to ensure valid underlying contracted exposure. Due to this, the traders are squaring off their current position in the ETCD market as the circular aim to eliminate speculative trading and various scams in the derivatives market. As per the SEBI report 90% of the traders make loss in the market, the circular will also ensure protection to the traders. The derivatives market is very volatile for trading purposes, which can multiply your investment or shrink it down to zero in few minutes. Using this speculative and volatile nature of the derivatives market, many traders trade without any underlying exposure. For example, one of the trader keeps on buying derivative units and another trader keeps on selling the same derivative units thereby artificially inflating the price of the derivative unit, and the situation results in significant loss or profit to either of the trader. Such a scenario is not possible in case the users establish an underlying exposure. That is why hedging is prescribed by the RBI under FEMA as it reduces risk and profitability by creating a negative position in the particular unit. On the close reading of the RBI Circular in line with the RBI’s policy for currency derivatives, it can be said that the RBI Circular does not make any real changes in the hedging requirement for the currency derivatives. The RBI’s policy has always been consistent over the years regarding the hedging requirement. Earlier, the RBI provided exemption from producing evidence of an underlying exposure, but it never intended to allow trading without any exposure. The exposure requirement was always mandatory. The users understood this exemption from producing evidence of exposure tantamounting to no exposure at all. The RBI Circular merely reiterate what was said in the earlier directions and nothing new has been introduced in the RBI Circular. End of Speculation: Would this serve the RBI’s Purpose? Speculative trading is often perceived as inherently risky, posing significant risk to traders. However, it is also necessary as it contributes to market volume. Eliminating speculative trading in the market may lead to reduction in market liquidity, issues in finding getting accurate pricing. The RBI Circular will not affect the hedgers, as they already hedge their investment, but the proprietary traders and retailers were the biggest contributors to the currency derivatives market, liable for more than 80% liquidity in the market. This circular will require these traders and investors to square off their existing positions without having underlying exposure. With all the traders and investors gone, hedgers will not find any liquidity or any counterparty to execute a contract or hedge their securities in the currency derivatives market. However, hedgers have the option to hedge their securities with future contracts through the Over-The-Counter (“OTC”) market with the banks. Still, there

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SEBI’s Take on Rumour Verification: Micromanagement or a Welcome Move?

Leave a Comment / Capital Markets and Securities Law / CBCL

[By Dharani Maddula & Anoushka Das] The authors are students of Symbiosis Law School, Pune. Introduction On 28 December 2023, the Securities and Exchange Board of India (“SEBI”) published a new Consultation Paper on Amendments to SEBI Regulations with respect to Verification of Market Rumours (“Consultation Paper”). The paper seeks to use material price movement instead of material event as defined under Regulation 30 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 (“(LODR) Regulations”) attributable to a rumour to determine when a rumour verification is necessary. The paper also aims to give more clarity on the determination of price change to be considered on stocks, bonds and valuation in buybacks while allowing for relaxation on the 24 hour timeline on the rumour verification. This consultation paper was published after taking into consideration various observations and suggestions put forth by the Industry Standard Forum (“ISF”) composed of representatives from industry bodies such as FICCI, ASSOCHAM, and CII. The need for such a framework can be traced back to the recent case of Reliance Industries Limited v. SEBI dealing with the JIO-Facebook deal where market rumours fuelled price variation. Proposed Changes  Through this paper, SEBI seeks to suggest the criteria of material price movement based on the price range of securities for determining the need for rumour verification. In order to ascertain a material price change, the price range of such a share needs to be taken into consideration. While accounting for shares falling within the higher price change, any small change in the price will be considered material in terms of absolute price, while a higher price change will be considered material for cheaper shares. The changes in benchmark indices will be a determining factor while accounting for market dynamics influencing such a price change. It notes that for shares falling under the high price range, a low percentage move would be considered as a material price change, and for shares falling in the lower price range, a higher percentage move in price would be considered as a material price change in order to determine the difference of prices in absolute terms in both price ranges. This shall also be determined by taking into account movement in the benchmark indices such as NIFTY50 and Sensex to factor in market dynamics.  The consultation paper suggests two frameworks for the determination of material price movement. “Framework A” entails considering the price from the day before the company confirmed the rumour while ignoring subsequent market changes to determine the transaction price. On the other hand “Framework B” entails  excluding the price variation in price due to the rumour and its subsequent confirmation from the Volume Weighted Average Price calculation and adjusting the same according to the daily prices. Irrespective of the Framework chosen, SEBI clearly intends to allow for fairness in price determination while acknowledging potential drawbacks in both the frameworks in its consultation paper.   The consultation paper also suggests a minor amendment to the proviso to Regulation 30(11) of the (LODR) Regulations which requires listed entities to verify, deny or clarify any rumours within 24 hours of its report in any mainstream media. This timeline is now suggested to be changed to within 24 hours from the material price movement. This is said to be implemented from 1st February 2024 for the top 100 listed companies and from 1st August 2024 for the top 250 listed companies.  The unaffected price as proposed by the ISF will be applicable from 60 days admeasuring from the date of confirmation of the rumour till the date of public announcement by the company or any other relevant disclosure such as a board approval by the company. In cases of competitive bidding for a potential M&A deal without an unidentified buyer, the applicable time period for unaffected price shall be 180 days from the date of confirmation of the rumour to the relevant date under the applicable regulations.  The rationale behind these implementations on the basis of material price movement is to provide an effective mechanism to combat false market sentiment and nullify any impact of the securities of such listed entities. The metric of material price movement helps in narrowing the pool of rumours of potential rumours that can cause an upheaval in the market. The consultation paper in order to reinforce this sentiment by casting an obligation upon the Key Managerial Personnel (“KMP”) to provide accurate and timely response as required under Regulation 30(11) of the (LODR) Regulations. The consultation paper also imposes a restriction upon the listed companies to not hide under the garb of UPSI when the same news report may be used by an insider as a defence. This initiative aims to establish and uphold industry standards for a more efficient business environment. Hurdles in practical implication and impact on the market  Regulation 30(11) of the (LODR) Regulations acts as a  general provision for listed entities to verify any market rumour. The consultation paper strengthens this obligation by imposing the same on all top 250 listed companies by 1st August 20024 which ensures that such listed entities give heed to rumours being spread through mainstream media. This is an interesting move as most companies choose not to comment on any such rumours due to internal policies. SEBI substantiated its resolution for combating misinformation by relying on similar mechanisms under Section-202.03 of the New York Stock Exchange (NYSE) Company Manual on “Dealing with Rumours or Unusual Market Activity” where companies are supposed to confirm, clarify or deny such rumours with appropriate public statements. After comparing the two statutes, it should be noted that there are a few deviations in SEBI’s methodology pertaining to such rumours. SEBI in the paper relies on Regulation 30(11) for the definition of a rumour which mentions that a rumour triggering this provision should not be general but specific in nature and deal with an impending material event. The yardstick on what will be considered “specific” is not spelt in the paper or any

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Decoding MCA’s move allowing Direct Listing of Indian Securities on Foreign Exchange

Leave a Comment / Company Law / CBCL

[By Anand Vardhan & Piyush Raj Jain] The authors are students of Gujarat National Law University. Introduction The Ministry of Corporate Affairs has enforced section 5 of The Companies (Amendment) Act, 2020, through a notification dated 30th October, 2023 . This has led to an addition to section 23 of The Companies Act 2013 . It is a welcome move as it seeks to boom the Indian Economy by opening the routes for Indian Companies to raise funds by directly listing their equity on foreign stock exchanges and also opening a million-dollar Indian market for foreign Investors. There is a need for diversification of investors across the Indian economy given ongoing evolution and internationalization of capital market across the globe. As foreign competitiveness being the need of the hour for our corporate culture, this post analyzes the earlier regime, present amendment and its analysis along with our suggestions for the proposed framework by uncovering the lacunae in the proposal and the regulatory framework needed to address such lacunae. Earlier regime Under the existing framework, if an Indian company wished to access the global market to list its equity capital, it can only get listed through the American Depository Receipts (ADR) and Global Depository Receipts (GDR). These depository receipts acted as a security certificate representing a certain number of a share of a company of other country, not listed on stock exchange of that country, which can be purchased by investors. Further, an Indian company can directly list its debt securities on foreign stock exchange through Foreign Currency Convertible Bonds (FCCB), also known as masala bonds, and foreign currency exchangeable bonds, which are issued by companies in currencies other than the domestic currency of the company issuing it. Present Amendment The new provision allows direct listing of the public companies registered in India on foreign stock exchanges as permitted by the government. The added provision also empowers Central Government to exempt certain classes of public companies from following the procedural requirement prescribed in the Companies Act to get listed on the stock exchange, which may include declaration by beneficiary to the company share, filing return of significant beneficial owners of the company, punishment on non-payment of dividend etc. Analysis Implications One of the most important implications and benefits which this amendment would provide to Indian Companies, especially startups is the option of a new jurisdiction to raise funds. Further, this will also help the companies in increasing their valuation. The option for companies incorporated in India to list their shares on Foreign Exchanges will enhance and diversify their sources and pool of capital as well as provide them with a larger and diverse base of investors. This will help the Indian Companies to trade their securities in major currencies across the world, like Euro, Dollar, or Renminbi. As discussed earlier, for raising funds overseas in the earlier regime, ADR and GDR were used to list in the foreign exchanges, but it required a complex procedure even a complex restructuring such as externalization, but this amendment may do away with any such requirements by providing an alternate route to raise funds overseas. Further, this will even allow companies incorporated in India to access foreign funds at a lower cost. In the earlier regime, Indian companies had to invest cost and time for accounting in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) for ADR and GDR respectively, but the direct listing will allow Indian companies to prepare accounts in Indian Accounting Standards (IndAS) only which will help them to reduce the cost and time involved as IndAS is now globally accepted. The implications that this amendment will have on the Indian Economy are threefold, i.e., it will lead to the spreading of the strength of the “India” brand across the globe. Along with it, the amendment will also lead to boost competitiveness for Indian Companies which will further lead to boost efficiency and growth for Indian Economy. This amendment to the Companies Act will also contribute to the development of a clear and advanced legal regime for reverse-flipping the holding structure of companies incorporated in India by allowing the shifting of such holdings’ domicile to India. Lacunae There are certain lacunae concerning the amendment. These need to be clarified by the MCA at the earliest through detailed rules and regulations so that the companies incorporated in India can get the benefits of listing in a foreign exchange and explore the foreign market. Certain points which need to be clarified by MCA at the earliest are that which kind of securities can be listed in the foreign exchanges, in which foreign exchanges could the listing be done and by which class of companies it can be done. The amendment even talks about the power of the Central Government to exempt any class of public companies from procedural requirements under the Companies Act, but it doesn’t talk about what kind of exemptions and the procedure to give those exemptions along with the eligibility of the companies to avail those exemptions. The other lacunae that revolve around these amendments are will the investors give the valuation same to the company listed on foreign exchange same as that they would have provided in India and also what will be the commercial benefits of the listing of a company incorporated in India on a Foreign Exchange. There are other legal challenges, mainly related to the disparities between the compliances required by the companies in the Indian regime vis-à-vis the securities regime of the overseas countries where the company intend to be listed. The implementation of the amendment will also require the amendments to the current legal regime governing the listing of securities on stock exchanges and foreign exchanges, namely FEMA, Companies Act and SEBI Regulations. Suggestions for Proposed Framework In order to do away with the above-discussed lacunae, the MCA could take its route through the following proposed frameworks. The main question before the MCA being the criterion to choose the

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