RBI Allows Rupee Derivative Trading Through International Financial Service Center

Posted On - 11 November, 2019 • By - Akshay Ramesh

RBI has dived into the ocean of the international
financial market to protect the interest of the onshore rupee derivative market[1] which is getting financially fractured due to the overactive offshore
rupee derivative markets[2]. The offshore rupee derivative markets has an adverse effect on the
Indian currency value. This bothered the RBI, who is responsible to maintain
the financial health of the Indian Economy in par with international
requirements. As a reformative measure, the RBI established a task force to
look into this issue and suggest a way forward to curb the negative effects
caused by the offshore rupee derivative market upon the onshore rupee
derivative markets. Wherefore, the task force chaired by Deputy Governor, Dr.
Usha Thorat has successfully submitted its recommendations with high hope of
strategically strengthening the onshore rupee derivative market.

Present day’s
need of International Financial Service Centre (“IFSC”) in the global
economy

By understanding the services provided by the
IFSCs, we can infer the requirement of having our own IFSC in India. The
services provided by the IFSCs are as below: 

  • Fund-raising for individuals, corporations, and
    governments, 
  • Asset management and global portfolio diversification are undertaken by pension funds, insurance companies, and mutual funds,
  • Wealth management; 
  • Global tax management and cross-border tax liability
    optimization, which provides a business opportunity for financial
    intermediaries, accountants, and law firms,
  • Global and regional corporate treasury management
    operations that involve fund-raising, liquidity investment, and management and
    asset-liability matching,
  • Risk management operations such as insurance and
    reinsurance, and
  • Merger and acquisition activities among
    trans-national corporations.

Establishment
of India’s first IFSC

RBI and the Government of India have taken some
effective decisions to make people trade the currencies through the onshore
rupee derivative markets. One such decision was the establishment of India’s
first IFSC at GIFT City in Gandhinagar, Gujarat. The Government of India
decided to set up this unified authority for regulating all financial services
in the IFSCs in the country. Currently, the banking, capital markets and
insurance sectors in IFSCs are regulated by multiple regulators like the RBI,
Securities and Exchange Board of India (“SEBI”), and Insurance Regulatory and
Development Authority (“IRDAI”) respectively. 

Recent actions
which are taken by the RBI

After a thorough examination of the recommendations
made by the task force headed by Smt. Usha Thorat, the central bank of India
decided to take up the following actions to boost the onshore rupee derivative
market.

  • To allow domestic banks to freely offer foreign
    exchange prices to non-residents at all times, out of their Indian books,
    either by a domestic sales team or through their overseas branches; and
  • To allow rupee derivatives (with settlement in
    foreign currency) to be traded in International Financial Services Centres
    (IFSCs).

However, the directions for implementing the above
two recommendations will be issued by the RBI in consultation with the Central
Government. On the other hand, the RBI has decided to enhance the overall scope
of non-interest-bearing special non-resident rupee (“SNRR”) account by permitting individuals resident outside India to open such
accounts and facilitate the rupee-denominated External Commercial Borrowing (“ECB”),
trade credit and trade invoicing. These decisions taken by the RBI shall also
indirectly impact Non-Deliverable Forward (“NDF”), the opaque
and non-transparent, Over the Counter (“OTC”) Rupee
derivatives market active in London and in the United States of America. 

Major recommendations by the task force are:

  • Enabling rupee derivatives (settled in foreign
    currency) to be traded in the IFSC in India;
  • To allow users to undertake forex transactions up
    to USD 10,00,00,000 million in OTC currency derivative market without the need
    to establish underlying exposure (security that must be delivered when a
    derivative contract is exercised);
  • To facilitate non-residents to hedge their foreign exchange exposure onshore rupee derivate markets by:
  • 1.Establishing a central clearing and settlement mechanism for non-resident transactions in the onshore market;
  • 2.Implementing margin requirements for non-centrally cleared OTC derivatives and allowing Indian banks to post margins abroad;
  • 3.Aligning the tax treatment of foreign exchange derivatives with that in major international centres; and
  • 4.Centralizing the KYC requirements across financial markets with uniform documentation requirements.
  • On the other hand, the task force has recommended
    extending the onshore market hours to improve access of overseas users and
    permit Indian banks to freely offer prices to global clients around the
    clock. 

Highlights on
the reasons behind having an IFSC in India

The establishment of IFSC would no doubt create a
mega trajectory in the performance of the onshore rupee derivative market in
India. The reason behind this is IFSC seeking to bring to India, these types of
financial services and transactions that are currently carried on outside India
by overseas financial institutions and overseas branches/ subsidiaries of
Indian financial institutions. The policy objective behind establishing an IFSC
in India is to provide a platform for international financial services to
operate from India and to specialize in exports of high value-added
International Financial Services. 

Legal
provisions on IFSC in India

Section 18 and Section 55 of India’s Special Economic Zone Act, 2005 provides for the establishment of an IFSC within a Special Economic Zone in India and enables the Central Government to regulate IFSC activities respectively. However, as per Section 18 of Special Economic Zone Act, 2005, the Central Government of India can approve for the establishment of only one International Financial Services Centre in a particular Special Economic Zone.

Also, IFSC shall be designated for all practical purposes as a ‘deemed
foreign territory’ which would have the same ecosystem as other offshore
locations, but which is physically on Indian soil. 

Conclusion 

Government of India and RBI has decided to
establish IFSCs in GIFT City in Gandhinagar, Gujarat through the International Financial
Services Centers Authority Bill, 2019[3] to bring back the financial services and transactions that are
currently carried out in offshore financial centres by Indian corporate
entities and overseas branches or subsidiaries of financial institutions (FIs) in
India. In order to ensure this, the business and regulatory environment must be
comparable to other leading IFSCs in the world like London and Singapore. In
order to compete with other IFSCs such as Dubai International Financial Centre
and Shanghai International Financial Centre, which are located within SEZs,
Indian IFSC needs to meet the basic requirements such as rational-legal
regulatory framework, stable political environment, developed infrastructure,
strategic location, and sustainable local economy. Also, wide access to the
forex-retail trading platform to non-residents would be a major incentive to
use the onshore market.

For instance, in the year 2013, the Indian currency value received a strong blow due to the rising influence of the offshore rupee derivative market. Also, the quantum of trading in the onshore market is shrinking at the expense of the offshore rupee market in recent times. One evident example for the previous statement is the latest report of Bank for International Settlements (“BIS”) which stated that London has surpassed India’s financial capital Mumbai to become the top centre for trading rupee.

Henceforth, it is well understood that the
off-shore rupee derivative markets are all capable of weakening the local
markets in India. However, in order to strengthen the local economy from the
grass-root level, the RBI has now allowed the local banks to freely offer
foreign currency prices to non-residents. This shall attract more foreigners as
well as non-resident Indians to approach the onshore rupee derivative markets.

Contributed By – Gokul. L, Associate
Akshay Ramesh, Associate

King Stubb & Kasiva,
Advocates & Attorneys

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