Using Derivatives in India

- A Snapshot

February 7, 2000

February 7, 2000 Mumbai

Salient Features

Purpose
• To be used to hedge underlying loans or trade transactions

Participants
• Professional- Foreign & new Private sector banks and Financial
Institutions
• Corporate- large to medium companies with FX loan exposures

Products
• FX, Structured and Vanilla Cross-Currency and FCY interest rate
Options, Interest Rate Swaps, FRAs, Currency/ Coupon swaps,
Gold and Commodity derivative

February 7, 2000 Mumbai

Down memory lane

• Globalization  greater long term exposures

• Deregulation  greater market risks
• Demand for hedging through derivatives.
• Foreign Bank facilitators
• Transactions against specific regulatory approvals

February 7, 2000 Mumbai

Regulatory Response

• Progressive relaxation on curbs

• Introduction of new derivative products
• Initiatives to strengthen and develop the market

February 7, 2000 Mumbai

Regulatory response- Landmark developments

Jan’94- Cross Currency Options

Mid’95- 3rd Currency Hedging
Mid’96- Structured Cross Currency Options
Aug’96- FCY Interest rate Derivatives
Apr’97- Rupee Swaps
Sep’98- Commodity hedging
May’99- Gold hedges and Commodity derivatives
July’99- Interest Rate Derivatives in INR

February 7, 2000 Mumbai

At the same time..

Simultaneous efforts to develop a yield curve - removal of

CRR on interbank liabilities.
Increased freedom to banks to set and manage their Asset-
liability, FX positions.
Focus on risk monitoring and risk management- Capital
adequacy norms, Value at Risk
Steps to deepen the market- increase market participants
Transparent and market friendly profile
…while fostering a low interest rate, stable rupee environment

February 7, 2000 Mumbai

Market response

Leap in transaction volumes.

More participants - Public and Private Sector Banks, Financial
Institutions
Steps to self-regulate: FEDAI, FIMMDA
Some way to go:
• Understanding of products, risks and control still inadequate
• Documentation and Accounting standards not fully developed
• No retail interest until Equity derivatives scheduled for next month
• Market not yet integrated, nascent yield curve

February 7, 2000 Mumbai

The Market- Turnover *
Interest Rate Swaps (3 mo to 5 years)
– FCY - USD 1 Billion
– INR - USD 1-2 Billion (nascent)
Currency Options (up to 2 years)
– Only FCY/FCY- USD 500 Million
Currency Swaps (1 - 5 years)
– USD/INR - USD 500- 750 Million
– FCY/FCY - USD 250- 500 Million
Commodity Derivatives - USD 50 Million
BIS Stastics
– Outstanding OTC contracts of $81.5 trillion at end-June 1999
– IRS (66%), FX (18%), Equities (2%) and commodities (0.5%)
– Slowdown in growth- hit by Euro introduction

* Turnover includes cancellation of deals

February 7, 2000 Mumbai

 Derivative Turnover

6000 50
commodity derivatives (forecast)
5000 40

USD/INRSpot
INR IRS
DerivativeVolumes

(USDMillion)

INR CCY swaps

4000
cross currency options, 30
3000 G7 derivatives allowed
20
2000
1000 10
0 0

01-Jan
Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00
Derivative Volumes
USD/INR Spot

February 7, 2000 Mumbai

The Participants
O th e rs
P u b lic
S e c to r
B anks

F in a n c ia l
I n s t itu t io n s F o r e ig n
B anks

P r iv a te
February 7, 2000 B anks Mumbai
RBI Guidelines

Derivatives as hedges - Suitable documentary evidence

Non-rupee derivatives through Authorized Dealers only.
Appropriate Authorizations - Board Resolutions
Back office infrastructure and risk management capability
(e.g. for Commodity risk)
Option writing - Principle of Limited risk - No receipt of
premiums by any market participant including banks.
Rupee stability paramount - No linkage between interest rate
and rupee forward premia.

February 7, 2000 Mumbai

Documentation Issues

ISDA/Rupee ISDA/ICOM is the standard documentation to be

signed between various counterparts
Confirmation can handle most of the basic requirements
ISDA required for
• events of default
• set-off, etc.
ISDAs signed with corporate counterparts
• Hardly any between banks
• None at all with Public Sector Banks
• Both FEDAI/ FIMMDA looking at the issue closely

February 7, 2000 Mumbai

Legal issues

SCRA
FEMA
Wagering act
Tax implications
No legal derivative disputes so far.

February 7, 2000 Mumbai

New products on the horizon

Issuance and investment in foreign currency denominated

bonds with rupee settlement
USD/INR options- awaiting RBI approval
Structured deposits linked to the Rupee
Credit-default Swaps
Derivatives with payoffs linked to commodities
Equity derivatives- Exchange & OTC
Hybrids

February 7, 2000 Mumbai

Other Emerging Markets

Large capital inflows after exchange controls and local

markets were significantly de-regulated
Deregulation has enabled local companies and offshore
investors to hedge away exchange risks
Benchmark interest rates have developed from the foreign
exchange swap market
Unbundling of price, credit and liquidity risks made possible
by the development of :
• Liquid markets for underlying instruments
• Unsegmented markets to allow free access to underlying hedge
instruments
• Derivative instruments to hedge individual elements of risk

February 7, 2000 Mumbai

Disclaimer
Although the information contained herein is believed to be reliable, Citibank makes no
representation as to the accuracy or completeness of any information contained herein or
otherwise provided by Citibank.
The ultimate decision to proceed with any transaction rests solely with the customer. Citibank
N.A. is not acting as your advisor. Therefore, prior to entering into any proposed transaction, you
should determine the economic risks and merits, as well as the legal, tax and accounting
characterizations and consequences of the transaction, and that you are able to assume these
RISKS.
The contents of this presentation are proprietary in nature, and may not disseminated in whole or
in part without Citibank's written consent.

February 7, 2000 Mumbai