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What are guidelines on hedging risks in overseas markets?

Reserve Bank of India (RBI) has released guidelines on hedging of commodity price risk and freight risk in overseas markets.

What is hedging?

Hedging is the activity of undertaking a derivative transaction to reduce an identifiable and measurable risk. 

What is commodity price risk and freight risk?

  • Commodity price risk is the financial risk arising from fluctuations in the prices of commodities.
  • Freight risk is the financial risk arising from fluctuations in the freight charges.

Which entities are eligible for hedging commodity price risk and freight risk?

Residents other than individuals are eligible to hedge commodity price risk and freight risk through Authorised Dealer Category-I Banks.

How is exposure to commodity price risk and freight risk defined?

  • An eligible entity is said to have direct exposure to commodity price risk if –
    • It purchases / sells a commodity (in India or abroad) whose price is fixed by reference to an international benchmark; or
    • It purchases / sells a product (in India or abroad) which contains a commodity and the price of the product is linked to an international benchmark of the commodity.
  • An eligible entity is said to have indirect exposure to commodity price risk if it purchases / sells a product (in India or abroad) which contains the commodity and the price of the product is not linked to an international benchmark of the commodity.
  • An eligible entity is said to have exposure to freight risk if it is engaged in the business of refining oil or is engaged in the business of shipping.

Which commodities are eligible for hedging?

Commodities whose price risk may be hedged are –

  • In case of direct exposures to commodity price risk – All commodities (except Gems and Precious stones). 
  • In case of indirect exposures to commodity price risk – Aluminium, Copper, Lead, Zinc, Nickel, and Tin.

Which products are permitted for hedging?

Following products are permitted for hedging commodity price risk and freight risk –

  • Generic Products –
    • Futures and forwards
    • Vanilla options (call option and put option)
    • Swaps
  • Structured Products – 
    • Products which are combination of either cash instrument and one or more generic products
    • Products which are combination of two or more generic products

Structured products may be permitted to eligible entities who are –

  1. Listed on recognized domestic stock exchanges or 
  2. Fully owned subsidiaries of such entities or 
  3. Unlisted entities whose net worth is higher than INR 200 crore

How can commodity price risk and freight risk be hedged?

  • Eligible entities having exposure to commodity price risk for any eligible commodity may hedge such exposure in overseas markets using any of the permitted products.
  • Eligible entities having exposure to price risk of gold may hedge such exposure in the International Financial Services Centre (IFSC).
  • Eligible entities having exposure to freight risk may hedge such exposure in overseas markets by using any of the permitted products.

What are other guidelines for hedging transactions?

  • Banks are permitted to issue Standby Letters of Credit (SBLC) / Guarantees, for a maximum period of one year, on behalf of their clients in lieu of making a remittance of margin money for commodity hedging transactions entered into by their customers. 
  • Realisation and repatriation of foreign exchange due or accruing to an eligible entity resulting from permitted transactions shall be guided by the provisions of the Foreign Exchange Management (Realisation, repatriation and surrender of foreign exchange) Regulations, 2015.
  • Banks shall submit a quarterly report to the Financial Markets Regulation Department, Reserve Bank of India (RBI) through Centralised Information Management System (CIMS). In case of no transactions, a “Nil” report shall be submitted by the bank.

What is the recent update in the guidelines?

(Updated on April 15, 2024)

Resident entities were permitted to hedge their exposure to price risk of gold on exchanges in the IFSC recognised by the International Financial Services Centres Authority (IFSCA). Resident entities have now been permitted to hedge their exposures to price risk of gold using over-the-counter (OTC) derivatives in the IFSC in addition to the derivatives on the exchanges in the IFSC.

What are the reporting requirements?

(Updated on December 27, 2024)

  • Banks shall report all OTC transactions in gold derivatives undertaken by them in domestic markets, IFSC and outside India to the trade repository (TR) of Clearing Corporation of India Ltd. (CCIL) with effect from February 01, 2025.
  • Banks shall report all OTC transactions in gold derivatives undertaken by their eligible customers / constituents in domestic markets and IFSC to the TR with effect from February 01, 2025.
  • Banks shall report all the aforesaid transactions undertaken by them or their eligible customers / constituents to the TR before 12:00 noon of the following business day.
  • As a one-time measure, banks shall report all matured and outstanding OTC transactions in gold derivatives undertaken by them in the domestic markets, IFSC and outside India and transactions undertaken by their eligible customers / constituents in domestic markets and IFSC from April 15, 2024 to the TR by February 28, 2025.


References

Reserve Bank of India. (2022, December 12). 'Hedging of Gold Price Risk in Overseas Markets'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12423&Mode=0

Reserve Bank of India. (2022, December 12). 'Master Direction – Foreign Exchange Management (Hedging of Commodity Price Risk and Freight Risk in Overseas Markets) Directions, 2022 (Updated as on April 15, 2024)'. Retrieved from https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12427

Reserve Bank of India. (2024, April 15). 'Hedging of Gold Price Risk in Overseas Markets'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12662&Mode=0

Reserve Bank of India. (2024, December 27). 'Reporting Platform for transactions undertaken to hedge price risk of gold'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12757&Mode=0


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